401k for Entrepreneurs: Plan Options and Setup

Many entrepreneurs believe 401(k) plans are only for large corporations, but a range of retirement plans are available to the self-employed, offering opportunities for tax reduction and wealth accumulation. These plans are designed for businesses of all sizes, from a solo freelancer to a growing enterprise with employees. This guide details the types of plans available, the setup process, and ongoing administrative duties.

The Solo 401k for the Self-Employed

A Solo 401(k), or Individual 401(k), is a retirement plan for self-employed individuals or business owners with no employees other than a spouse. This structure is ideal for freelancers, consultants, and owners of single-person businesses. If a spouse earns income from the business, they can also participate. The plan allows the owner to act as both the employer and the employee for contribution purposes.

The Solo 401(k) features a dual-contribution structure. As the “employee,” the owner can contribute up to 100% of their compensation, to a maximum of $23,500 for 2025. Individuals aged 50 and over can make a catch-up contribution of $7,500, while a provision of the SECURE 2.0 Act allows those aged 60 to 63 to contribute $11,250.

As the “employer,” the owner can make a profit-sharing contribution of up to 25% of compensation. The IRS limits the amount of compensation used for this calculation to $350,000 for 2025. The combined employee and employer contributions cannot exceed $70,000 for 2025 for those under age 50.

For example, a 45-year-old consultant with $100,000 in self-employment income could contribute the employee maximum of $23,500. As the employer, they could contribute an additional 25% of compensation, which is about $18,587 after accounting for self-employment taxes. This results in a total contribution of $42,087 for the year.

Many Solo 401(k) plans also offer a Roth contribution option, allowing the owner to make employee contributions with after-tax dollars. This provides no immediate tax deduction, but qualified withdrawals in retirement are tax-free. This feature offers tax diversification for future planning.

Retirement Plans for Businesses with Employees

When a business hires employees, the Solo 401(k) is no longer an option. Entrepreneurs must transition to a plan that accommodates a team, with the primary choices being the SIMPLE 401(k) and the Safe Harbor 401(k). Each has distinct features for small to medium-sized businesses.

The SIMPLE 401(k) is designed for businesses with 100 or fewer employees and is less complex to administer. It requires a mandatory employer contribution that is immediately 100% vested. The business must either make a matching contribution up to 3% of an employee’s compensation or a 2% non-elective contribution for all eligible employees.

For 2025, the employee contribution limit is $16,500. The catch-up contribution for employees age 50 and over is $3,500, with a higher limit of $5,250 for participants aged 60 to 63.

A Safe Harbor 401(k) is another option that automatically satisfies the IRS’s annual nondiscrimination testing. This testing ensures that plans do not unfairly favor highly compensated employees. By adopting a Safe Harbor plan, business owners can contribute the maximum to their own retirement without worrying about these testing limits.

In exchange, the employer is required to make specific contributions that are always 100% vested. Common formulas include a non-elective contribution of at least 3% of compensation to all eligible employees, or a matching contribution, such as a 100% match on the first 3% of employee contributions plus a 50% match on the next 2%. Employee contribution limits are higher than in a SIMPLE plan, aligning with the standard 401(k) limit of $23,500 for 2025, plus the applicable catch-up amounts.

Information Needed to Establish a Plan

Before opening a retirement plan, an entrepreneur must gather information and make several decisions. This groundwork ensures a smooth application process.

A foundational requirement for establishing any employer-sponsored retirement plan is obtaining an Employer Identification Number (EIN) from the IRS. This nine-digit number acts as a unique tax identifier for the business. While a sole proprietor might use their Social Security Number for business, an EIN is required to formally separate the business’s retirement plan from personal finances. Business formation documents, such as articles of incorporation, are also necessary.

The next step involves selecting a 401(k) provider or custodian, such as a brokerage firm or mutual fund company. It is important to compare providers, as their services and fee structures can vary. Factors to evaluate include administrative fees, investment fees, and the range and quality of investment options offered within the plan.

With a provider in mind, the entrepreneur must make decisions about the plan’s features. A choice is whether to include a Roth contribution option, which allows for after-tax employee deferrals in exchange for tax-free qualified withdrawals. Another feature to consider is the availability of participant loans, which adds an administrative layer. These decisions culminate in a formal written plan document. This legal document outlines all the rules of the plan, and the chosen provider will generate it based on the entrepreneur’s selections. It must be formally adopted by the business owner.

Step-by-Step Setup and Funding Guide

After making key plan design choices, the entrepreneur can formally establish and fund the 401(k). This phase involves completing applications and transferring funds. Following the correct sequence and deadlines ensures the plan is effective for the desired tax year.

The first action is to complete the application and adoption agreement provided by the chosen financial institution. This is where the EIN and business details will be used to formally open the account. The adoption agreement will list all the plan features selected, such as a Roth option or loan provisions, and requires the owner’s signature to legally establish the plan.

After the plan is established, the next step is to fund it by transferring money from the business’s bank account into the 401(k) account. For a Solo 401(k), the owner will make both their “employee” and “employer” contributions. For plans with employees, a system must be established to withhold employee deferrals from payroll and deposit them, along with any employer contributions, in a timely manner.

Understanding the deadlines is a part of the setup process. For a Solo 401(k), the deadline to establish the plan for a given tax year depends on the business structure. For S-Corporations and C-Corporations, the plan must be established by December 31 for employee contributions to be made for that year. The deadline for making employer contributions, however, extends to the business’s tax filing deadline, including extensions.

For plans like the SIMPLE 401(k) and Safe Harbor 401(k), the deadlines are often earlier. A new calendar-year Safe Harbor 401(k) must typically be established by October 1 to be effective for that year, as it needs to be in place for at least three months. Similarly, the general deadline for establishing a new SIMPLE 401(k) is October 1.

Annual Administrative Requirements

A 401(k) plan has ongoing administrative responsibilities to remain in compliance with IRS and Department of Labor regulations. For entrepreneurs with a Solo 401(k), these tasks are manageable but include annual government reporting.

The main reporting duty for a one-participant plan is the filing of IRS Form 5500-EZ. This form is required only after the total assets in the plan reach or exceed $250,000 at the end of the plan year. If the plan’s assets are below this threshold, no annual filing is required, which is a significant administrative relief for smaller plans.

Form 5500-EZ is an informational return that reports details about the plan’s assets, contributions, and distributions for the year. The form is due by the last day of the seventh month after the plan year ends. For a calendar-year plan ending on December 31, the filing deadline is July 31 of the following year, with an extension available.

A final Form 5500-EZ must be filed when the plan is terminated, regardless of the total asset value. Failure to file when required can result in substantial penalties, with the IRS imposing a penalty of $250 per day, up to a maximum of $150,000. Tracking the plan’s asset value at year-end is an annual task.