Why A Solo 401k
You might be asking why I’m considering a solo 401k versus a SEP IRA or other self employed retirement savings options. Well, it all comes down to circumstance and how much you can save.
Let’s look at two scenarios that are similar to mine. First, in the past, I only saved in a because my income was lower and I was still maxing out my 401k at work, so I didn’t need any additional employee contributions.
With both a SEP and Solo 401k, on $30,000 of income, the employer contribution is $5,576.11. Since I was already doing the $18,000 at my primary employer, that amount didn’t make a difference.
However, fast forward to today, the business makes much more income, and my wife is now working for the business. As such, it can make a huge difference in savings and lowering our taxes. Let’s assume that the business is going to make $100,000 this year. That means that the business can contribute $18,587.05 to both my 401k and my wife’s 401k. Plus, my wife can contribute $18,000 of her salary to the 401k as well .
As such, the solo 401k provides much more savings options, and lower taxes today as a result.
Open An Account With Your Provider
Now that youve chosen your provider and obtained all required documents and disclosures, its time to open the Solo 401. This account should be formed any time prior to your tax-filing deadline and needs to be formed in accordance with any guidelines in your plan documents.
While youre allowed to set up a Solo 401 account after the year ends and make prior-year contributions in a way thats similar to how you fund an IRA, its typically a best practice to set up a new account in the year that itll be effective and make your first contributions in the same year.
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- Individual 401 plans allow you to start taking deductions after you turn 59.5 years old.
- You cannot employ any full-time employees and have a solo 401.
- In 2021, an employee can contribute up to $19,500 in one year, assuming youre under 50 years old.
- Annual or maintenance fees for solo 401 plans usually run between $20 and $200, and they are tax deductible.
The number of people who run their own business continues to trend up. The most recent data from the Bureau of Labor Statistics found that 9.6 million people worked for themselves in 2016. That is projected to increase to 10.3 million by 2026.
Working for yourself may give you the ability to make more money than you would working for someone else, but it also means you need to have your own retirement plan in place. One of the most popular retirement plans for independent workers is a self-employed 401. We spoke to two financial experts to find out how these retirement plans work.
Logan Allec, CPA and owner of the personal finance site Money Done Right, and Adam Bergman, a trained tax attorney and president of IRA Financial Trust and IRA Financial Group, offered their insights about these plans, including the maximum contributions, taxes, investments and fees.
Editors note: Looking for the right employee retirement plan for your business? Fill out the below questionnaire to have our vendor partners contact you about your needs.
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What Is The Deadline To Make Salary Deferrals Into The Individual 401k
Sole proprietorship, partnership or an LLC taxed as a sole proprietorship – The deadline for depositing salary deferrals into the Individual 401k is generally the personal tax filing deadline April 15 .
S corporation, C corporation or an LLC taxed as a corporation The salary deferral contribution must be made into your Individual 401k within 15 days of the period in which you are paying yourself. For example, 401k salary deferral contributions made at the end of a calendar year on December 31 need to be deposited into the Individual 401k by January 15 at the latest.
Understand The Eligibility Requirements For A Solo 401
Because IRS regulations say Solo 401 plans can only have one participant, these plans are only appropriate for self-employed individuals and small business owners who have no full-time employees. Solo 401 plans will require a plan administrator, also known as an investment provider, wholl help ensure regulatory paperwork is completed. If you plan to hire full-time employees in the future, a Solo 401 plan can convert easily to accommodate additional full-time employees within the companys 401 plan.
An alternative to the Solo 401 is the simplified employee pension individual retirement account . While both plans allow you to contribute a maximum of $58,000 each year, the SEP-IRA only allows you to contribute up to 25% of your income or $58,000, whichever is less. Also, if you have a SEP-IRA and hire additional full-time staff, you are required to make contributions for those employees whenever you make contributions for yourself. That said, a SEP-IRA can be rolled over to a new 401 plan, whether it be solo or traditional, should you unexpectedly need to hire staff.
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Advice For Employees And Also Employers
A Roth 401 is a relatively recent alternative to a traditional 401 retirement plan, with different tax advantages to a 401 or traditional IRA account. Not all employers offer them, but it is worth investigating as a retirement vehicle option.
Immigrant And Ethnic Minorities
Self-employment is relatively common among new immigrants and ethnic minorities in the United States. In the United States, immigrants tend to have higher rates of self-employment than native-born Americans regardless of race or ethnicity. But, self-employment in the United States is unevenly distributed across racial/ethnic lines. Immigrants and their children who self-identify as White have the highest probability of self-employment in lucrative industries such as professional services and finance. In contrast, racial and ethnic minorities are less likely than native-born Whites to be self-employed, with the exception of Asian immigrants who have a high rates of self-employment in low prestige industries such as retail trade and personal services. Much like the regular labor market, self-employment in the United States is stratified across racial lines. In general, self-employment is more common among immigrants than their second-generation children born in the United States. However, the second-generation children of Asian immigrants may continue to seek self-employment in a variety of industries and occupations.
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Ease Low Cost And Flexibility
Individual 401 accounts are easy to open and manage. If you open one at a discount broker, you may incur practically no costs other than for trading. They are also extremely flexible when it comes to investing. In addition, you are not required to file Form 5500 with the Internal Revenue Service, provided your plan contains less than $250,000 worth of assets. This is true for both individual 401 plans and SEP IRA plans.
Mom And Brothers Participation Question:
Yes provided they are all owner-employees in the S-corp with not other full-time W-2 common-law employees. The S-corp would sponsor the solo 401k plan and all 5 would participate in the same solo 401k plan. Each participant would separately hold their retirement funds in participant accounts. Lastly, when it comes time to determine if a Form 5500-EZ will need to be filed for the plan, all of the participants balances will need to be added up and if the combined value exceeds $250,000, a Form 5500-ez will need to be filed each year by 07/31.
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What If I Don’t Have Access To A 401
If you don’t work for a company that offers a 401, you can save for retirement using one or more of these other accounts:
- 403: A 403 is similar to a 401, but it’s available only to public school employees, select ministers, and employees of tax-exempt organizations.
- SIMPLE IRA: A SIMPLE IRA is designed for self-employed individuals and small business owners. It offers fairly high contribution limits and has mandatory contribution requirements for employers.
- : A SEP IRA is available to self-employed individuals with or without employees. Contribution limits depend in part on annual income.
- Solo 401: A solo 401 is simply a 401 that a self-employed person can open for themselves. Contribution limits are higher than for traditional 401s because you can make contributions as both employee and employer.
- IRA: Anyone can open and contribute to an IRA if they’re earning income throughout the year, but these accounts have more restricted contribution limits.
Drawbacks To A Solo 401
A solo 401 may not be right for small businesses that plan to expand and hire employees in the near-term, since doing so would likely result in plan ineligibility. In addition, calculating profit-sharing contributions for sole proprietorships and partnerships tends to be complex because it requires modified net profits. The formula for this calculation is available in IRS Publication 560.
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Comparing The Most Popular Solo 401k Options
I’ve been doing my research over the last few months on the best solo 401k providers for small businesses and side hustlers like myself. I’ve shared in the past the best options for saving for retirement with a side income, and I’ve leveraged a SEP IRA in the past.
However, as the side business income has grown, a solo 401k is a better option for sheltering more money for retirement tax free today. One of the big reasons I’ve opted for a SEP IRA in the past is that it’s very easy to setup and my income wasn’t really high enough to justify a solo 401k.
Today, however, I’m willing to accept a little more paperwork to save a lot more in taxes. Even after contributing for a few years, I’ve actually found that there isn’t that much extra paperwork – it’s very similar and when you open the account at your brokerage, you can’t really even tell the difference.
So, let’s get started and look at the Solo 401k.
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What Are The Factors That Differentiate The Solo 401 From An Employer 401
Three main factors distinguish a self-employed 401 plan from an employer 401 including:
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You are the employer and employee on the plan as the business owner.
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Solo 401 plans allow you to make far higher contributions to your retirement plan than if you are an employee in an employer 401.
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Any self-employed person can open a solo 401 plan regardless of the product or service you provide.
You can also run a self-employed 401 account as a self-directed plan. It allows you to invest your contributions on specific assets with an investment broker trustee.
A solo 401 plan is ideal if you want to set up a retirement plan as a self-employed person. It has the highest contribution restrictions, which allows you to grow your retirement savings faster and you can also enjoy solo 401 tax benefits. It is also easy to set up and administer.
Self-employed 401 plans give you complete control of your investment choices if you open them in a self-directed brokerage account. If your business hires employees at a later date, you only need to convert the solo 401 account into a standard employer 401 plan.
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Contribution Limit As An Employer
Wearing the employer hat, you can contribute up to 25% of your compensation.
The total contribution limit for a solo 401 as both employer and employee is $58,000 for 2021, and $61,000 in 2022, or 25% of your adjusted gross income, whichever is lower.
People ages 50 and above can add an extra $6,500 a year as a “catch-up contribution.” In other words, in 2022 you can contribute a total of $61,000 along with a $6,500 catch-up contribution if applicable for a maximum of $67,500 for the year.
You can have a solo 401 even if you’re moonlighting. If you have a 401 plan at both jobs, the total employee contribution limits must be within the maximum for the year, but the employer contribution is not limited. If you’re one of these lucky folks with two retirement savings plans, talk to a tax adviser to make sure you follow the IRS rules.
Solo 401k Contribution Deadline 2021
You need to establish your plan and formally elect your contributions before December 31. Do this by filling out the contribution form in the Solo 401k dashboard. You do not have to actually make the contribution until you file your taxes. This depends on what your business structure is. For S Corp, C Corp and Partnership this is March 15, or September 15 if you file an extension. For Sole Proprietorship and Single Member LLC this is April 15 or October 15 if you file an extension. There are many important dates to remember for the Solo 401k. Rather than memorize them, here is a handy article which goes over some of the most important Solo 401k dates to remember.
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Taking Rmd From Roth And Pretax Solo 401k Funds Question:
With respect to taking the RMD from the solo 401k plan, the standard practice is to take a separate RMD amount from each account . In that case, two separate calculations would need to be performedone on each source . If the plan allows you to do so, however, the amount of the distribution may be aggregated across account balances meaning that the total required minimum distribution amount can be satisfied in any combination between the two accounts. Please note that our Solo 401k plan would allow for this approach to satisfy the RMD requirement. A scenario where this approach may be preferable would be one where the requirements to make a qualified Roth distribution have not been satisfied .
How Much Does It Cost To Open A Solo 401
There is no cost to open a 401 account but watch out for those fees later on. While you’re researching your options, check for account maintenance fees, transaction fees and commissions, mutual fund expense ratios, and sales loads.
A fractionally higher fee can mean a big hit to a retirement portfolio. If you make the right choices you can minimize the fees you pay.
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How A Simple Ira Works
The SIMPLE IRA follows the same investment, rollover, and distribution rules as a traditional or SEP IRA, except for its lower contribution thresholds. You can put all your net earnings from self-employment in the plan, up to a maximum of $13,500 in 2021 , plus an additional $3,000 if you are 50 or older.
Employees can contribute along with employers in the same annual amounts. As the employer, however, you are required to contribute dollar for dollar up to 3% of each participating employee’s income to the plan each year or a fixed 2% contribution to every eligible employee’s income whether they contribute or not.
Like a 401 plan, the SIMPLE IRA is funded by taxdeductible employer contributions and pretax employee contributions. In a way, the employer’s obligation is less. That’s because employees make contributions even though there is that mandated matching. And the amount you can contribute for yourself is subject to the same contribution limit as the employees.
Early withdrawal penalties are hefty at 25% within the first two years of the plan.
To Roll Over Other Plan Assets
If you already have a retirement savings plan for your business, you may be able to roll over or transfer existing plan assets to a Self-Employed 401. Consult with your tax advisor or benefits consultant prior to making a change to your retirement plan.
Assets from the following plans may be eligible to be rolled over into a Self-Employed 401:
- Profit Sharing, Money Purchase, and 401 plans
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Are Individual 401k Contributions 100% Tax Deductible
Yes, salary deferral and profit sharing contributions are generally 100% tax deductible. Roth 401k contributions made with the salary deferral portion of an Individual 401k are not tax deductible.
Subchapter S and C corporations or LLCs electing to be taxed as a corporation can generally deduct the salary deferral contribution from personal W-2 earnings and the profit sharing contribution as a business expense.
A sole proprietorship, partnership or an LLC taxed as a sole proprietorship can generally deduct salary deferral and profit sharing contributions from personal income.
Open Your Solo 401k With Nabers Group
Our Solo 401k platform is a dream come true for the modern Self-Directed Investor. Our platform is the only one in the world of its kind that combines the strengths of both 401k and IRA accounts and solves the weaknesses. Your Investments can be self-directed and there is no need to hire, pay, and wait for a custodian to hold your assets. You get Checkbook Access built-in, without the need to register any LLCs. Your Solo 401k is exempt from taxation on debt leveraged real estate investments. You will never have a third party deny you from investing in a legally compliant investment . There are no transaction fees or asset fees, ever.
Your Solo 401k can include additional Unlimited® sub-accounts for your spouse as wellTax deferred and Roth. You can borrow up to $50,000 from your Solo 401k funds tax-free for any reason. Your spouse, if named as a participant, can also have unlimited rollovers received that can be self-directed into alternative investments. Every Solo 401k includes a Roth 401 subaccount for you and one for your spouse, even if you make too much money to be allowed to contribute to a Roth IRA.
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