Top 10 Mistakes to Avoid With A Solo 401k

Saving for retirement as a self-employed professional comes with its own set of responsibilities and decisions. 

A Solo 401k can offer high contribution potential and certain tax benefits, but managing one isn’t always straightforward. From IRS deadlines to plan rules, even minor oversights may lead to penalties or missed opportunities.

Understanding how to properly set up and maintain a Solo 401k may help reduce administrative errors and improve long-term plan success. Below are some common mistakes that Solo 401k owners might encounter, and what to keep in mind instead.

Mistake #1 – Misunderstanding Contribution Limits

A Solo 401k allows self-employed individuals to make both employee and employer contributions. However, misinterpreting these limits can result in overcontributions, which may trigger IRS penalties.

Here’s a breakdown of the 2025 Solo 401k contribution limits:

Common issues when contribution limits are misunderstood include:

✅ Overestimating Allowable Contributions: Contributing more than the permissible limits may result in tax penalties and corrective filings.

✅ Misclassifying Contributions: Confusing employee deferrals with employer contributions can cause you to exceed your individual limits.

✅ Overlooking Other Plans: If you participate in another employer’s 401k plan, your total elective deferrals across all plans must not exceed the annual limit ($23,500 for 2025).

📝 Note: Always calculate contributions based on your net earnings from self-employment, after accounting for self-employment tax and plan contributions. The income available for contribution depends on whether you’re taxed as a sole proprietor, S Corp, or other entity type.

📌 Also Read: Consequences of Excess 401k Deferrals and Contribution Limits Across Multiple Plans

Mistake #2 – Missing Key Deadlines

It’s easy to overlook deadlines when managing everything on your own. But with a Solo 401k, timing matters. Missing key dates could limit your contribution options or create tax compliance issues.issues.

Here are the key deadlines to keep in mind:

✅ Employee Deferrals 

✅ Employer Contributions – May be made up to the business’s tax filing deadline, including extensions. This applies to both incorporated and unincorporated businesses.

✅ Plan Establishment – To make contributions for the current year, the Solo 401k must be formally set up by December 31.

📌 Also Read: Solo 401k Contribution Limits & Deadlines for 2024 & 2025

Mistake #3 – Neglecting Required Filings

Missing key IRS filings is one of the most common—and costly—mistakes Solo 401k owners can make. Here are the required forms to be aware of:

✅ Form 5500-EZ – Required if your Solo 401k has more than $250,000 in assets at the end of the plan year. This form helps the IRS monitor the plan’s financial activity. Failure to file may result in a penalty of $250 per day, up to $150,000.

✅ Form 1099-R – Must be filed for each distribution of $10 or more, including rollovers, withdrawals, or required minimum distributions (RMDs). It reports the amount distributed, taxable portion, and any tax withheld.

📝 Important Note: Skipping or delaying these filings can lead to significant IRS penalties and could even jeopardize the tax-deferred status of your plan.

📌 Also Read: Important Forms for Solo 401k Owners

Mistake #4 – Engaging in Prohibited Transactions

Solo 401k rules prohibit certain transactions that personally benefit you or other disqualified individuals. Violating these rules could lead to tax penalties and potential disqualification of the entire plan. 

❌ Using plan funds for personal expenses or loans – Borrowing from a Solo 401k for personal use is not allowed under IRS rules.

❌ Buying personal-use property with plan assets – You cannot use plan funds to buy a vacation home, personal residence, or any other property for personal benefit.

❌ Selling personal assets to the plan – Transferring personal investments or property into your plan in exchange for cash or other assets is prohibited.

Potential consequences include:

When unsure, it’s always a good idea to check the IRS rules or consult a qualified tax advisor.

📌 Also Read: Tax on Prohibited Transactions | IRS

Mistake #5 – Failing to Update Plan Documents

A Solo 401k is not a “set it and forget it” plan. The IRS requires plan documents to stay current with changing laws, which means updates are sometimes required, especially when tax rules change. Failure to update can cause the plan to fall out of compliance.

Here’s what to track:

✅ Regulatory Changes – Congress and the IRS occasionally introduce new legislation affecting retirement plans. If your plan doesn’t include the required provisions, it could become noncompliant.

✅ Restatement Cycles – If your plan uses a pre-approved document, the IRS requires restatements on a fixed six-year schedule. The most recent IRS restatement deadline was July 31, 2022 (Cycle 3). Restatements combine all prior amendments into a single updated document.

✅ Best Practice – Review your plan annually with your provider or plan document sponsor to ensure that your plan is up to date. Some providers may manage restatements for you, but only if you’re still an active client.

📝 Note: Keep an eye out for the IRS’s annual Required Amendments List to check for updates that might apply to your plan.

Mistake #6 – Overlooking Required Minimum Distributions (RMDs)

Once you reach a certain age, the IRS requires you to begin withdrawing a portion of your Solo 401k each year, known as a Required Minimum Distribution (RMD). The rules have changed in recent years, so it’s important to stay updated on the latest guidelines to remain compliant.

Here’s a quick overview of the key dates:

✅ Start Date – April 1 of the year after reaching the applicable RMD age (73 or 75).

✅ Annual Deadline – Each year’s RMD must be withdrawn by December 31.

Starting in 2025, the RMD age depends on your birth year:

These changes were introduced under the SECURE 2.0 Act.

You’re allowed to delay your first RMD until April 1 of the year after reaching the applicable age. However, doing so means you’ll take two RMDs in the same calendar year, which could increase your taxable income for that year.

Here’s what to keep in mind if an RMD is missed:

📌 Missed Deadline Penalty – A 25 percent excise tax applies to the amount not withdrawn.

📌 Correction Window – If corrected within two years, the penalty may be reduced to 10 percent.

📌 IRS Reporting – Use IRS Form 5329 to report any shortfall.

📌 Penalty Relief – A written explanation may be required to request a waiver or reduction based on reasonable cause.

Mistake #7 – Improper Rollovers

Rollovers are a useful way to move retirement funds while maintaining tax-deferred growth, but only if handled properly. Even minor errors may result in taxation or penalties.

✅ Missed 60-Day Deadline – If you perform an indirect rollover, you must deposit the full amount into a new retirement account within 60 days. Missing the deadline generally results in a taxable distribution. If you’re under age 59½, a 10 percent early withdrawal penalty may also apply.

✅ Withholding Surprise – If the distribution is made to you personally, the provider will typically withhold 20% for federal taxes. To complete the rollover in full, you’ll need to replace the withheld amount yourself.

✏️ Hypothetical Example: 

You receive a $50,000 distribution from your Solo 401k. Your provider withholds $10,000 for taxes. To roll over the full $50,000, you must deposit the entire amount, including the $10,000 withheld, into your new plan within 60 days. If you only deposit $40,000, the IRS may treat the rest as a taxable distribution.

📝 Note: It’s generally safer to choose a direct rollover, where the money moves between accounts without ever passing through your hands.

📌 Also Read: Rollovers of Retirement Plan | IRS

Mistake #8 – Not Considering Roth Contributions

Overlooking the Roth option in your Solo 401k could mean missing out on potential long-term tax advantages in retirement.

Some key points to consider:

✅ Tax-Free Withdrawals – Roth Solo 401k contributions are made with after-tax dollars. Qualified withdrawals may be tax-free if both of the following conditions are met:

When both apply, withdrawals — including earnings — are generally tax-free. 

✅ No Income Limits – Unlike Roth IRAs, Roth Solo 401k plans do not have income restrictions, making them accessible regardless of your earnings level.

✅ Strategic Tax Planning – Contributing to a Roth Solo 401k may be beneficial if you anticipate being in a higher tax bracket during retirement. This allows you to pay taxes now at a potentially lower rate.

📌 Also Read: The 5-Year Rule Of A Roth IRA, Roth 401k, And Roth Solo 401k

Mistake #9 – Ignoring Plan Eligibility Rules

A Solo 401k is meant for owner-only businesses, but that status can change if your business grows.

✅ Hiring Employees – Bringing on a full-time employee (defined as someone working 1,000 hours or more in a year), generally requires offering them access to a retirement plan. At that point, your Solo 401k no longer qualifies and the plan may need to be upgraded to a traditional 401k with full compliance rules.

✅ Adding Your Spouse – If your spouse works for your business, they are allowed to participate in the Solo 401k. This could effectively double your household’s total contribution limit, a benefit many Solo 401k owners overlook.

📌 Also Read: How to Add Your Spouse to Your Solo 401k Plan

Mistake #10 – Investing in Non-Compliant Assets

Not every investment is permitted within a tax-advantaged retirement account. Even if an asset seems like a good opportunity, it may not be allowed under IRS rules or your plan documents.

✅ Generally permitted assets (depending on your provider and plan documents):

❌ Assets prohibited by the IRS: IRS rules prohibit specific asset types, even if they’re held for investment:

📝 Note: Always check your Solo 401k’s plan document to verify what is permitted, and refer to IRS guidelines to avoid unintentionally violating compliance rules.

Wrapping It Up

A Solo 401k offers meaningful control over your retirement savings—but with that control comes added responsibility. Even minor errors, such as missing key deadlines or misunderstanding contribution rules, can have long-term tax and compliance consequences.

✅ Take time to review your Solo 401k plan annually to confirm that contributions, plan documents, and filings are up to date.

✅ If anything is unclear,consider consulting with a tax or financial professional who specializes in self-employed retirement plans.

The rules are not always simple, but taking a proactive approach can help you stay compliant and get the most out of your Solo 401k over time.

📌 If you’re managing a Solo 401k, you might also be interested in these topics:

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