Pre-tax 401(k)/403(b)/457(b)

The 401(k) is the largest tax shelter most people will ever have access to, and it exists by accident — IRC §401(k), “Qualified pension, profit-sharing, and stock bonus plans” was a 1978 provision meant to clarify the treatment of cash-or-deferred bonus plans instead of replacing the American pension system, which is nevertheless what it did.

The mechanics are simple. You divert a percentage of each paycheck, up to the limit in Table 8.3, into an investment account before the money is taxed; your employer may match part of it; and you choose from whatever menu the plan offers, which is usually a short list of mutual funds and rarely the one you would build yourself. The constraint worth internalizing early is that the limit is annual and does not carry forward. A year you do not fill is a year you cannot get back.

The main difference between a 401(k), a 403(b) and a 457(b) is who offers these plans. Private employers offer 401(k)s, whereas 403(b)s and 457(b)s are generally offered by public sector employers:

401(k)

Private employers, such as for-profit businesses, generally offer 401(k)s.

403(b)

Public sector employers, such as schools, churches, and nonprofits, generally offer 403(b)s.

457(b)

Public sector employers, such as government and municipal employees, generally offer 457(b)s. Tax-exempt organizations may also offer 457(b)s to a select group of highly compensated or management employees.

The contribution limits for 403(b) plans are now identical to those of 401(k) plans. You can contribute to both a 403(b) and a 457(b) in the same year, and—because the 457(b) carries its own separate limit—the two do not share the 402(g) elective-deferral cap. If you need more room to put aside money for retirement, a 457(b) plan may be best for you. A 403(b) often offers a larger array of investment options. However, you can also split your contributions between both plans. In 2026, you can save $49,000 between the two plans, excluding any catch-up contributions if you’re eligible.

A 401(k) comprises three buckets: pre-tax, Roth, and after-tax (see Table 8.4). To appreciate the scale of this tax shelter, compare it to a taxable account, where your returns are chopped in half by ordinary income rates or capital gains taxes on realizations.

• A 401(k) is only taxed once, either before contributing the money (Roth) or when withdrawing the money (Pre-tax).
• A 401(k) grows without taxation in any way. In particular, interest (from bonds) and dividends (from stock) accumulate and grow tax-free. Moreover, you can buy, sell, or rebalance freely with zero tax consequences.
• Your highest priority savings are the elective deferral 401(k) contribution ($24,500 for 2026), in order to get the employer’s match
• If you’re 50 years of age or older you can make a $8,000 catch-up contribution (not matched)
• Your elective deferral contributions can go to pre-tax 401k or Roth 401k
• Roth contributions are made from after-tax income, but once contributed to your Roth account, you do not pay taxes on that money ever again
• Because the dollar cap is the same either way but you own every dollar in a Roth outright, the Roth limit shelters more real purchasing power — $24,500 of Roth is worth more at withdrawal than $24,500 of pre-tax. If your goal is to maximize the amount of after-tax wealth inside tax-advantaged space, use the Roth. If your goal is to minimize lifetime tax at a peak marginal rate, the pre-tax deduction usually wins; the trade-off is worked through in section “Tax-Advantaged Accounts: Choosing Between Pre-Tax and Post-Tax Options”.
• You can borrow up to 50% of your account balance, capped at $50,000 ( IRC §72(p)(2)(A)), which can be useful for emergencies.

At minimum, contribute enough to capture the entire employer match. Declining it is the only guaranteed 100% return you will ever be offered, and people decline it every year.

One thing you cannot do, however you route the money: drive a bonus to zero tax by electing 100% of it into the pre-tax 401(k). A 401(k) deferral reduces income-tax wages, but it does not reduce wages for Social Security, Medicare, or state disability. Those taxes are owed on the gross bonus regardless, and payroll has to withhold them out of the same check — so if the entire bonus went into the plan there would be nothing left to withhold from, and payroll cannot issue you a negative paycheck. Some slice of the bonus therefore has to stay out of the deferral to cover the payroll taxes, and that slice is itself ordinary income for federal and state purposes. Expect a small taxable residue on any “100%” bonus deferral; it is arithmetic, not a payroll error.

See section “Lazy Portfolio for 401k” for possible assets allocation in 401k.

Self-directed 401(k) plan

Some 401(k) plans allow self-directed brokerage accounts. The Self-Directed Brokerage Account associated with your 401(k) is allowing you to purchase various investment products not available in your core mutual fund lineup. Plan administrators may charge a fee for this service, and may also set restrictions on the types of investments you can make and fraction of your 401(k) you can invest in the brokerage account. Note, IRA accounts are “self-directed” by default.

To get started, you’ll need to first apply for a Self-Directed Brokerage Account. After submitting your application, you will be able to begin transferring funds into your Self-Directed Brokerage Account within 1–2 business days.

If available, this option allows you to invest in individual stocks, bonds, ETFs, cryptocurrency and wider range of mutual funds. You can also use advanced investment strategies such as options and futures. The investment custodian (Schwab, Fidelity, Vanguard, etc.) where you establish your account will often have its own rules. In some situations, these rules and more restrictive than IRS rules.

Solo 401(k) plans

A Solo 401(k) plan (also known as an Individual 401(k) or Self-Employed 401(k)) is an exceptional retirement savings plan designed for self-employed individuals and small business owners with no employees other than a spouse. It shares the same contributions limits and rules as a regular 401(k) but offers a dual-capacity advantage that business owners can leverage.

You can open a Solo 401(k) with any major financial institution or brokerage. To adopt the plan, you must establish an Adoption Agreement and secure an employer identification number (EIN) from the IRS.

The true power of the Solo 401(k) is that you can make contributions as both the employee and the employer:

Employee elective deferrals

Up to 100% of your net self-employment income, capped at the standard elective deferral limit ($24,500 in 2026, or $32,500 if age 50+).

Employer non-elective contributions

25% of compensation — but for an unincorporated owner that phrase does not mean what it appears to mean, and getting it wrong is the most common self-employed contribution error there is.

The trap is circular. For a sole proprietor, “compensation” is net earnings from self-employment after subtracting both one-half of self-employment tax and the employer contribution itself — so the 25% is applied to a base that the contribution shrinks. Solving the circularity collapses it to a flat 20% of the pre-contribution figure. Write $P$ for net Schedule C profit:

Apply 25% to $E$ directly and you will over-contribute by a quarter, which is an excess-contribution problem with a 10% excise tax attached, not a rounding difference. An S-corporation owner is on the other side of this: their compensation is the W-2 salary, so the employer contribution is a clean 25% of that salary with no circularity. The combined employee and employer contributions cannot exceed the Section 415(c) limit ($72,000 in 2026). Refer to IRS Pub. 560, “Retirement Plans for Small Business”, whose Deduction Worksheet for Self-Employed runs this computation line by line.

If you already max a 401(k) at a day job. This is the most common Solo 401(k) question and the answer is better than people expect. The two limits count differently. The elective-deferral cap of IRC §402(g) is a personal limit — $24,500 in 2026 across every plan you participate in — so if your employer’s 401(k) or 403(b) already absorbs it, you have no employee deferral left for the side business. But the IRC §415(c) annual-additions limit is applied per unrelated employer, and your consulting practice is a different employer than the hospital. The employer non-elective contribution therefore remains fully available: 20% of net earnings from the side business, on its own $72,000 ceiling, entirely separate from whatever your main employer contributed to your account there.

For a physician, attorney, or engineer with a day job and $100,000 of 1099 income, that is roughly $18,500 of additional tax-deferred space every year that most people in that position never use — and it stacks with, instead of replacing, the backdoor Roth, because a Solo 401(k) balance is not an IRA and does not enter the pro-rata calculation of section “Backdoor Roth IRA”. The one genuine constraint is the controlled-group and affiliated-service-group rules: if your side business and your main employer are related, or you own another business with employees, the plans are aggregated and this stops working. Unrelated 1099 work for unrelated payers is the clean case.