What Is A Solo 401
The 401 plan has gained popularity among small business owners ever since 2001, when some changes to federal tax law made it a better and more flexible choice for their needs compared with some other retirement savings options. These 401 plans are known as solo 401 or self-employed 401 plans.
Its a retirement savings option for small businesses whose only eligible participants in the plan are the business owners . It can be a smart way for someone who is a sole proprietor or an independent contractor to set aside a decent-sized nest egg for retirement.
Understanding The Solo 401 Employer Profit Sharing Contribution Rules
Any business can establish a 401 plan. A business with no full-time employees other than the owner or their spouse can establish a Solo 401 plan which allows the business owner to contribute the lesser of:
- 100 percent of the employees compensation, or
- $58,000 for 2021 or $64,500 if over the age of 50 .
Whereas, a business that has non-owner full-time employees would establish a 401 plan and offer plan benefits to the employees.
The Solo 401 plan contribution rules are the foundation of the Solo 401 plan. There are three types of contributions that can be made to a Solo 401 plan: employee deferrals, employer profit sharing contributions, and after-tax contributions. Note your plan adoption agreement must allow for after-tax and employer profit sharing contributions. For 2021, no more than $290,000 of an employees compensation can be taken into account when figuring contributions.
How Are Solo 401k Contributions Calculated
If the following applies:
- You are under 50
- You do not make contributions to another plan, i.e., a 401K plan via a full-time employer
- The S-Corporation provides you with a W-2
- Box 1 has $32,000
- $19,000 Pre-tax employee contributions NOT in Box 1, you can do the following:
If you have an S Corporation, all contributions MUST be based on your W-2 and not be based on the business profits or the pass-through income.
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Should You Consider An Owners
This type of retirement savings plan is appropriate for individuals who are the sole operators of their businesses. It may also be appropriate for those who share ownership and responsibility with family members or with partners, as long as those individuals each own at least 5% of the business. The owners-only 401 is available to business entities including sole proprietorships and partnerships, as well as C, S and limited liability corporations.
Owners who employ or who may employ in the near future workers who cannot be excluded under 401 eligibility requirements may find other plans to be more suitable. Employees who may be excluded include those under age 21 or who work fewer than 1,000 hours in a 12-month period, nonresident aliens, and union employees covered by a collective bargaining agreement.
Theres Little Reason Not To Offer Roth
Honestly, theres little reason not to offer this contribution feature. It requires a little extra work when setting up your payroll for contributions, but this isnt terribly time-consuming or complex. If youve yet to set up your plan or are thinking of changing it, this is an excellent box to check.
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What Else Do Small Business Owners Need To Know About 401 Plans
Small business owners who offer retirement savings plans may be able to take advantage of tax incentives. Matching employee contributions, for instance, is generally tax deductible as a business expense. For the first three years of the plan, employers may also be eligible for tax credits up to 50% of the start-up and administration costs or $5,000 , as well as a $500 automatic enrollment credit per year.
Contribution Limits Of An S
As the business owner, you play two distinct roles in the contribution of your Solo 401: employee and employer. Both roles contribute to the plan via the following:
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Qualifying For A Solo Roth 401
One-participant 401, Solo 401, and Solo Roth 401 plans are tax-advantaged retirement accounts for the self-employed or for business owners with no full-time employees. These plans may also be called Self-Directed 401, Individual 401, Individual Roth 401, Self-Employed 401, Personal 401 or One-Participant 401, Solo 401, Solo-k, Uni-k, or One-Participant k depending on the vendor offering the plan. Qualifying for a Solo 401 requires earned income, which is also true for a 401, SEP plan, IRA etc. As with the traditional IRA and Roth IRA, the difference between a Solo 401 and Solo Roth 401 is that the Solo 401 involves tax-deductible savings and taxable withdrawals. The Solo Roth 401 involves already-taxed savings and tax-free withdrawals. Most other features of these two Solo plans are the same, including tax-free growth. I will use the terms interchangeably except when discussing their tax implications.
Recall that the Solo 401 plan is for businesses with no full-time employees. There is one exceptiona spouse who earns income from the business. Your spouse, as a full-time employee, can make the same employee contribution you can make as the business owner up to the legal limits, including catch-up provisions, if he or she has qualifying income. In addition, you as the owner can provide the same percentage of employer contribution to your spouse that you give yourself, up to 25% of compensation.
As A Small Business Owner What Are Your Retirement Plan Options
Being self-employed gives you a certain measure of freedom, but it definitely doesnt give you an out on skipping on something as important as saving for retirement.
Theres an argument that it makes putting money away that much more critical, because unlike an employee who might have access to a 401K, youre on your own.
So what are your options? Youre definitely not left without them, thats for sure. Lets go over what the right IRA custodian and administrator can do for you and your business.
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Start Side Hustling Already
I hope everyone now knows how to calculate what they can contribute to their self-employed 401k plan. Go over the example a couple more times if you are still confused. And check with an accountant if you want to be extra sure. Make sure you dont contribute too much to your self-employed 401k plan. If you do, it can be a pain to unwind the contribution.
Given the benefits of being able to contribute to a self-employed 401k plan, I highly recommend you start your own online business. Not only can you contribute your operating profits to a tax-deferred self-employed 401k plan, you can also deduct business expenses.
If you dont want to start an online business that cant be shut down during the coronavirus pandemic, be a rockstar freelancer. Being one allows you to contribute to a solo 401 as well.
If you are only a W-2 employee, your 401k contribution is capped at the maximum a a year + any 401k employer match . Unfortunately, very few employers are generous enough to contribute ~20% of their operating profits to you.
For those who work at startups or money-losing organizations, you are SOL in terms of receiving any profit sharing. Youll get paid below market rate, have options likely not worth what you hope, and get minimal retirement benefits.
Why A Retirement Plan Is A Smart Move
A 401 plan can be a very powerful benefit for your company and your employees. But offering a 401 plan is a big commitment. How do you know if its right for your company?
Here are some reasons starting a 401 plan is a smart move.
- Attract and retain employees: It can be difficult to find and keep the right people for your business. A 401 might help. According to a Glassdoor study, 401 plans are one of the top five benefits employees care about.
- Deferred tax growth: A traditional 401 plan offers deferred tax growth to help fuel retirement. If you participate in your plan that means both you and your employees are reaping that benefit.
- Tax deductions: Not only can a 401 plan be good for your financial health, it can be good for your business health. Any contributions that you make to your employees plan are tax-deductible. And your business may even be eligible for a $500 tax credit for the first three years after setting up your plan.
- Offer solutions:48% of people 55 and over have nothing set aside in a retirement plan. This isnt good for anyone. Offering a retirement plan can help your employees protect their financial future and show that you care about their wellbeing.
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Solo 401 Plan Components
There are two components to the solo 401 plan: employee elective-deferral contributions and profit-sharing contributions.
- Employee Contribution Limits: You may make a salary-deferral contribution of up to 100% of your compensation but no more than the annual limit for the year. For both 2021, the limit is $19,500 , plus $6,500 for people age 50 or over.
- Employer Contribution Limits: The business may contribute up to 25% of your compensation but no more than $58,000 for 2021 . An employee age 50 or above can still contribute an additional $6,500 for 2021 and 2022.
Other Financial Benefits Of A Solo 401
The solo 401 can be an excellent choice for those with a side gig as well, especially if theyre already able to live comfortably on their main salary. With the solo 401 you can go above the usual limits of a 401.
While you may contribute to multiple 401 accounts, your total employee contribution to all types of 401s may not exceed the annual maximum contribution, that is, $19,500 in 2020 and 2021.
But the solo 401 can be valuable even if you already have a 401 plan and even if youve maxed out that other plan for a given year. Thats because you can still make an employer contribution, allowing you to exceed the smaller employee-only contribution amount. So the solo 401 allows you to save more with the employer contribution, reducing your business taxes.
Another benefit of the solo 401 is that it doesnt prevent you from taking advantage of other retirement plans such as the IRA. You can still contribute up to the annual maximum there. If youre an individual looking to set up a traditional IRA or Roth IRA, then youll want to look at the benefits of those plans.
Like the typical 401 plan, the solo 401 also allows you to take out a loan against your account. loan.)
While I generally encourage clients to avoid that strategy, it can come in handy at times, Conroy says.
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Can I Contribute To Other Retirement Accounts
There are no restrictions on having multiple retirement accounts, including an owner-only 401 plan, but contribution limits apply across accounts. For example, if you have an owner-only 401 and also participate in an employer-sponsored 401 plan at another job, the limit for the year applies to cumulative contributions across all plans you have, not each individual plan. As an employee, you can contribute a maximum of $20,500 across all of your 401 plans in 2022.
You Can Elect To Contribute The Annual Maximum Limit Of $18000
- If your annual salary is at least $18,000, you can contribute up to $18,000 annually into your S-Corp 401. And, if you are 50 years of age or older, you can make an additional $6,000 annual contribution.
- These limits are for the year 2017. The 2018 limits are $18,500, or $24,500 if you are age 50 or over. Current limits can also be found on the IRS website.
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Traditional Or Roth Ira
Best for: Those just starting out, or saving less than $6,000 a year. If youre leaving a job to start a business, you can also roll your old 401K into an IRA.
IRA contribution limit: Up to $6,000 in 2020, plus a $1,000 catch-up contribution for those 50 or older.
Tax advantage: Tax deduction on contributions to a traditional IRA no immediate deduction for Roth IRA, but withdrawals in retirement are tax-free.
Can An Llc Partnership Have A 401k
Partner or member of an LLC tax-based as a partnership often make contributions into a 401 during the year using their guaranteed payments. So no income is earned for purposes of retirement planning, which means that employer contributions for 401s cant be received or contributions to retirement plans cant be made.
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What Happens To My 401k If I Start My Own Business
If you decide to withdraw money from a 401 for a business startup, you can use a specific type of funding called 401 business financing. This allows you to use the money from your 401 account without having to pay income tax on the withdrawal, called a distribution, or without getting a traditional bank loan.
How Do I Max Out My Solo 401k
So now that we have defined the maximum amounts that you can contribute, you need to make sure that your W2 is in line. By looking at the table above, you will see that the contribution will max out in 2020 at $150,000.
As such, you will notice that there is no difference in contribution levels with the $150,000 example and the $200,000 example. But you are required to pay yourself a reasonable wage.
You and your accountant may determine that your reasonable wage should be $250,000. That is fine, but a wage that high will not allow you get more money into the solo 401k. Your max is already met.
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How Human Interest Helps
On top of that, our investment philosophy is centered around keeping costs down for plan participants. A Human Interest 401 is designed to keep costs down with:
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Low and transparent fees. Just as interest compounds, so can fees. Human interest is fully transparent with our fee structures. We do not accept kickbacks of any kind and only make money when you and your employees save more.
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Low-cost investments. Our recommended investment lineup includes low-cost Vanguard index funds, which tend to have lower expense ratios and outperform actively managed funds. Customers also have access to nearly every mutual fund and index fund on the market so employees who want more flexibility can choose and manage their own funds.
Figure. The average annual cost of providing a 401 vs. health insurance for one employee.
*Note: Estimates here are shown for illustration purposes and do not include plan start-up fees. Contact us for more details on pricing for your business. The average price of health insurance is sourced from the Kaiser Family Foundations 2019 Employer Health Benefits Survey.
% Of Small Businesses Add A Discretionary Match
One of most effective ways a small business can persuade employees to contribute pre-tax or Roth salary deferrals to a 401 plan is by matching some portion of them. This is unsurprising when you consider an employer match is like a guaranteed return on salary deferrals – or free money.
Most employer matches that arent intended to meet safe harbor 401 requirements are discretionary in nature so small businesses have the option to make them or not. A discretionary match made to a traditional 401 plan must pass the ACP test to be considered nondiscriminatory, while a discretionary match made to a safe harbor plan can be exempt from the ACP test when certain conditions are met.
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What Else Should I Know About Roth Iras
Lets tie up some loose ends here and quickly answer some other questions that you may have.
- What is earned income? Its simply the money youve received from wages, salaries, tips, bonuses, commissions, and self-employment income. It does not include alimony, child support, income from rental property, interest and dividends from investments, retirement income, social security, or unemployment benefits.
- As a business owner, does my contribution limit change? No. Just like everyone else you can only contribute as much as $6,000 to an IRA or $7,000 if youre aged 50 and older. Keep in mind though that you must have enough earned income to cover that limit. So, if you earned $4,000, then thats the amount that youre allowed to contribute.
- What happens if I contribute too much? That may notify the IRS, which will probably trigger a penalty. You could ease the pain by reducing the following years contribution by the excess amount. Youll still have to pay a 6% penalty on the excess that was contributed, but its better than having your investment income wiped out.
- Am I still able to contribute if my income is too high? Yes via a backdoor Roth IRA. It sounds shady. But, this is where you would deposit money in a traditional IRA and then convert it to a Roth IRA.
- Can you lose money in a Roth IRA? Sure you can. But, spread out among different types of mutual funds, the risk is minimal.
You Get Tax Diversification In Retirement
If you have a traditional IRA or 401 youll have to pay taxes on withdraws in retirement. You may also be taxed on a portion of your Social Security income. And, thats no Bueno if youre trying to stick to a budget in your golden years.
Thats not the case with a Roth IRA. You have the flexibility to juggle your distributions between your accounts. As a result, you can avoid getting placed in a higher tax bracket.
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