Solo 401K Retirement Plans for U.S. Expats

For Americans employed abroad as contractors, sole proprietors, or small business owners, the perception may exist that there are limited U.S. tax-advantaged options for saving towards retirement. Many expats not affiliated with U.S. companies are often unaware that they qualify to contribute to U.S. tax-advantaged retirement plans. Depending on individual circumstances, there may be several alternatives available.

The solo 401(k), also known as the single 401(k) or individual 401(k), stands out as a robust retirement savings tool for certain U.S. expatriates who are self-employed or own a small business.

What is a Solo 401(k) Plan for U.S. Expats?

A Solo 401(k) is a retirement savings account for self-employed individuals or employers with no employees other than themselves and their spouses. Qualification requires reporting some self-employment income on your tax return, and the key eligibility criterion is the absence of full-time employees, except for yourself and your spouse. Even if your small business has part-time workers (working fewer than 1,000 hours per year), you can still establish a Solo 401(k) account.

Benefits of Solo 401(k) Plans

Qualified U.S. expat contractors, sole proprietors, or small business proprietors can derive various advantages from participating in a solo 401(k) plan. While the evident perks include the accumulation of savings in U.S. tax-advantaged accounts, the solo 401(k) stands out for its higher annual contribution limits compared to individual retirement accounts (IRAs) and other small business plans like the simplified employee pension IRA (SEP IRA). Moreover, the flexibility of the solo 401(k) extends to the choice between making tax-deferred or tax-exempt (Roth) contributions.

Contributing to a Solo 401(k) Plan

A paramount advantage of the solo 401(k) is its typically superior contribution limits compared to other types of retirement accounts. Similar to a conventional 401(k), contributions can be made by both the employer and the employee. In the case of a solo 401(k), you assume both roles, enabling you to contribute to both aspects of the plan.

For 2024, you’re allowed to elect to defer $23,000 of your self-employment income as an employee contribution, with a $7,500 catch-up contribution or a total of $30,500 if you’re over the age of 50.

Furthermore, you have the option to contribute 25% of your self-employment income or compensation as an employer contribution, with an overarching maximum of $69,000 (or $76,500 over age 50) in 2024.

It’s crucial to emphasize that the employer contribution must be made on a pre-tax basis, irrespective of your preference for making elective deferrals on a pre-tax (traditional) or after-tax (Roth) basis.

Determining compensation for entrepreneurs without a fixed salary, like sole proprietors, involves adjusting self-employment income for the employer’s half of the self-employment tax and accounting for the employer’s contribution. Entrepreneurs can contribute up to $69,000 to a SEP-IRA in 2024, capped at 25% of their compensation, similar to the employer portion of a solo 401(k). 

A solo 401(k) stands out as the preferred choice for entrepreneurs looking to allocate the highest percentage of income to a retirement account due to its more favorable contribution limits compared to other options.

U.S. Tax Implications

Pretax Option – Deductible contributions, encompassing both employee and profit-sharing contributions, are eligible for deduction from U.S. taxable earned income at the point of contribution. These contributions subsequently experience tax-deferred growth until withdrawal, a process that begins post the age of 59½. Upon withdrawal, these funds are subjected to taxation as ordinary income at your prevailing U.S. marginal tax rate.

Roth Option – If permitted by your 401(k) plan documents, the employee contribution segment can be directed toward a Roth vehicle. This entails contributing to a distinct Roth 401(k) account, facilitating tax-free growth within the scope of U.S. taxation.

After-tax Option – Subject to plan provisions, you have the opportunity to make voluntary non-Roth, after-tax contributions, with a limit of up to $69,000 in 2024 or $76,500 if aged 50 or above. Importantly, these non-Roth, after-tax assets can be seamlessly rolled over to a Roth IRA without incurring conversion or tax implications.

The optimal choice between making pretax, Roth, after-tax, or a combination of contributions to a 401(k) plan hinges on your individual circumstances. A thorough assessment of your current and projected U.S. tax liability, both now and in retirement, is essential to determine the most advantageous option for you.

Special Consideration for U.S. Expats: Unexcluded Earned Income Requirement

It’s essential to remember that Solo 401(k) contributions must be made with unexcluded earned income, such as wages or self-employment income. If you lack earned income or are excluding all earned income from U.S. taxation through the Foreign Earned Income Exclusion (FEIE), contributing to a Solo 401(k) is not permissible.

This underscores the importance of contemplating a retirement plan only when your income surpasses the Foreign Earned Income Exclusion. Another consideration is the impracticality of tying funds into a retirement account when you can receive it as tax-free salary.

If you are presently excluding all earned income using the FEIE but could achieve comparable benefits by utilizing the Foreign Tax Credit instead, it might be rational to abandon the FEIE to contribute to a Solo 401(k). Specifically, if you incur substantial local taxes on your salary in your residing country, transitioning to the foreign tax credit might not disadvantage you in terms of U.S. taxation and could enable participation in a Solo 401(k) plan.

Note: Should you make this switch and then reconsider within five years, seeking IRS approval to revert to using FEIE requires a ruling from the IRS.