A solo 401(k) can be an excellent way for self-employed individuals to save more money for their retirement than they could by using traditional retirement accounts, such as IRAs. If you're self-employed, a solo 401(k) is definitely worth looking into, so here's what you need to know about the benefits of this type of account, whether or not you qualify, and how much you could potentially contribute.

What is a Solo 401(k)?
A Solo 401(k) is a type of retirement savings account designed for self-employed individuals, or for employers with no other employees besides themselves and their spouses. These accounts are often referred to as individual 401(k), self-employed 401(k), or one-person 401(k) accounts, and you may see these terms used interchangeably among brokers and financial advisors.

Clock next to stacks of coins and a jar labeled RETIREMENT filled with coins

Image source: Getty Images.

In order to be eligible to open a solo 401(k), you need to claim some self-employment income on your tax return. It's important to keep in mind that self-employment doesn't need to be your only source of income. For example, if you work a full-time job for an employer and do some consulting work on the side, you can use a solo 401(k) to set aside some of that extra income.

The only real requirement, other than self-employment income, is that you cannot have any full-time employees other than yourself and your spouse. If you operate a small business with a couple of part-time workers, you can still open a solo 401(k) account. However, if any of your employees work full time -- generally defined as more than 1,000 hours per year for solo 401(k) purposes -- your options are limited to other retirement plans targeted at self-employed individuals such as a SIMPLE IRA or SEP-IRA. Or you could also potentially establish a regular 401(k) plan.

Perks of a Solo 401(k) -- tax benefits and high contribution limits
There are several advantages to a solo 401(k) that you should know about. For starters, the money you invest in a solo 401(k) can generally be invested in a wide variety of stocks, funds, and bonds -- you're not limited to a small basket of mutual funds like most corporate 401(k) plans.

You can choose to make elective contributions on a pre-tax (most common) or post-tax (Roth) basis. Pre-tax contributions work just like contributions to a regular 401(k) in that they reduce your taxable income for the current year, and grow and compound tax deferred until you retire. Roth contributions, on the other hand, do not offer any immediate tax benefit, but any qualified withdrawals will be 100% tax free.

Speaking of contributions, one of the biggest benefits of a solo 401(k) is that the contribution limits are usually the highest of all retirement account types. Just like with a regular 401(k), contributions can be made from the employer and the employee. However, in a solo 401(k), you serve both roles, so you can make both contributions.

For 2015, you're allowed to elect to defer $18,000 of your self-employment income as an employee contribution, and this limit is increased to $24,000 if you're over 50 in order to allow you to "catch up" on your savings. In addition to this, you can contribute 25% of your self-employment income as an employer contribution -- up to an overall maximum of $53,000 ($59,000 if you're over age 50). It's also important to note that your employer contribution must be made on a pre-tax basis, regardless of whether you choose to make your elective deferrals on a pre-tax or after-tax basis.

The calculation of your maximum contribution is a bit complicated, because the 25% employer contribution amount is determined after you deduct half of your self-employment tax and your own (employee) contribution. Fortunately, most brokerages that offer solo 401(k) accounts will help you calculate your maximum contribution. Here's an excellent calculator from Fidelity to give you an idea of how much you could save in a 401(k).

You have until April 15 of the following year to make your contributions. For example, if you want to max out your contributions for 2015, even though it's already late in the year, you have until April 15, 2016 to do it.

The results can be pretty incredible
I realize that many self-employed individuals don't have the ability (or need) to contribute the maximum amount allowed to a solo 401(k). However, even modest contributions can really add up over time.

For example, let's say that you're self-employed and that you'll have $80,000 in net self-employment income for 2015. You decide to set aside a total of 10% of your net self-employment income in a solo 401(k). Not only could this reduce your taxable income by $8,000 this year, but if you repeat the process every year, you could end up with a retirement nest egg of more than $928,000 after 30 years -- and that assumes just 2% annual income increases and a historically conservative 7% annual rate of return.

Imagine if you decided to invest even more. With a solo 401(k), you can dramatically reduce your taxable income while building up a million-dollar nest egg.

The bottom line
While there are other ways for self-employed individuals to save for retirement, such as with a SEP-IRA, SIMPLE IRA, or a Roth IRA, a solo 401(k) generally offers the ability to save more than other plans because you can take advantage of generous employer and employee contribution limits. In short, a solo 401(k) can be an excellent way to set aside lots of money for the retirement of your dreams, while reducing your current tax bill at the same time.