Tax Deductible Ira Contributions If I Have A Solo 401k Question:
My question: As my wife and I are *not* contributing to our solo401k plan, does that mean that we are not active participants and IRA contributions are tax deductible?
Good question. Yes, you are still considered covered by a retirement plan at work even if you are not making solo 401k contributions.
While you can still contribute to a traditional IRA, your traditional IRA contribution deductions will be reduced if your AGI is a certain amount.
For 2021, if you are covered by a retirement plan, your deduction for contributions to a traditional IRA is reduced if your AGI is:
- More than $104,000 but less than $124,000 for a married couple filing a joint return or a qualifying widow,
- More than $65,000 but less than $75,000 for a single individual or head of household, or
- Less than $10,000 for a married individual filing a separate return.
Take Advantage Of The Higher Contribution Limits Of A Solo 401
A solo 401, also known as an individual 401 or a 401 with only one participant, is a retirement account available to business owners with no employees.
The big draw of a solo 401 is the high contribution limit. For 2021, you can contribute up to $58,000 or $64,500 if you’re 50 or older. For 2022, it is $61,000 or $67,500 if you’re 50 or older.
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.
Recommended Reading: Can I Start A 401k Without A Job
What Are The Contribution Levels And Limits Of A Solo 401
To take full advantage of contributions to a Solo 401 plan you must understand your limits as an employee and employer, as well as contributions allowed on behalf of a spouse if applicable.
When contributing as the employee, you are allowed up to $19,500 or 100% of compensation in salary deferrals for tax year 2021 and $20,500 or 100% of compensation for tax year 2022. If you are over 50, an additional $6,500 catch-up contribution is allowed bringing the total contribution up to $26,000 for 2021 and $27,000 for 2022. This is the type of contribution that can be made as pre-tax/tax-deferred or Roth deferral or a combination of both. Additionally, as the employer, you can make a profit-sharing contribution up to 25% of your compensation from the business up to $58,000 for tax year 2021 and the maximum 2022 solo 401k contribution is $61,000. When adding the employee and employer contributions together for the year the maximum 2020 Solo 401 contribution limit is $57,000 and the maximum 2021 solo 401 contribution is $58,000. If you are age 50 and older and make catch-up contributions, the limit is increased by these catch-ups to $64,500 for 2021 and $67,500 for 2022.
What Are Some Regulations On Self
The self-employed 401 plans have several regulations designed to help you contribute towards retirement. Here are the main solo 401 rules:
-
If you withdraw from the account before age 59½, you may pay a 10% early withdrawal penalty and applicable income taxes.
-
Once you reach age 72, in accordance with the SECURE Act,* you must take Required Minimum Distributions .
-
You may structure the plan to fund loans and hardship distributions.
-
They may transfer savings from another compatible 401 plan or an IRA account into a self-employed 401.
-
If your business adds employees later, you must either convert the solo 401 to a standard 401 or close the account.
Also Check: When Changing Jobs What To Do With 401k
Calculations For A S Or C Corporation Or A Llc Taxed As A Corporation
S corporations, C corporations and LLCs electing to be taxed as a corporation pay the business owner a W-2 salary. The calculation of how much can be contributed to a Self Employed 401k is based only on the W-2 salary of the self employed business owner .
Salary Deferral Contribution:
In 2020, 100% of W-2 earnings up to the maximum of $19,500 or $26,000 if age 50 or older can be contributed to a Self Employed 401k .
Profit Sharing Contribution:
A profit sharing contribution up to 25% of W-2 earnings can be contributed into a Self Employed 401k.
- EXAMPLE 1A 50 year old self employed consultant is the owner of a Subchapter S business with $50,000 of W-2 earnings in 2020. In this example, the consultant could contribute $26,000 of salary deferrals + $12,500 profit sharing contribution = $38,500 Total Self Employed 401k contribution.
- EXAMPLE 2 A 50 year old self employed consultant is the owner of a Subchapter S business with $100,000 of W-2 earnings in 2020. In this example, the consultant could contribute $26,000 of salary deferrals + $25,000 profit sharing contribution = $51,000 Total Self Employed 401k contribution.
How Much You And Your Employer Can Contribute For You In 2022
Adam Hayes, Ph.D., CFA, is a financial writer with 15+ years Wall Street experience as a derivatives trader. Besides his extensive derivative trading expertise, Adam is an expert in economics and behavioral finance. Adam received his master’s in economics from The New School for Social Research and his Ph.D. from the University of Wisconsin-Madison in sociology. He is a CFA charterholder as well as holding FINRA Series 7, 55 & 63 licenses. He currently researches and teaches economic sociology and the social studies of finance at the Hebrew University in Jerusalem.
If your employer offers a 401 plan, it can be one of the easiest and most effective ways to save for your retirement. But while a major advantage of 401 plans is that they let you put a portion of your pay automatically into your account, there are some limits on how much you can contribute.
Each year, usually in October or November, the Internal Revenue Service reviews and sometimes adjusts the maximum contribution limits for 401 plans, individual retirement accounts , and other retirement savings vehicles. In November 2021, the IRS made updates for 2022.
Recommended Reading: How To Withdraw My 401k From Fidelity
Deadline To Contribute To A Self
The employee deferral contribution must be elected by December 31 of the year you want to make the contribution. However, some 401k third party administrators may allow you to set up your 401k plan now and backdate your election. The actual contribution can be made up to the tax filing deadline including extensions.
Therefore, the contribution for your 2022 self-employed 401k can be made as late as October 15, 2023 if thats the date you file your tax return. To be safe, after your CPA has calculated your self-employed net income, give your financial advisor one month to work with the TPA to set up the 401k plan.
Timely Withdrawal Of Excess Contributions By April 15
- Excess deferrals withdrawn by April 15 of the year following the year of deferral are taxable in the calendar year deferred.
- Earnings are taxable in the year they’re distributed.
- There is no 10% early distribution tax, no 20% withholding and no spousal consent requirement on amounts timely distributed.
Also Check: Do You Pay Taxes On 401k Withdrawals
Solo 401 Eligibility And Contribution Limits
The solo 401 annual contribution maximum in 2021 is $58,000 and $61,000 in 2022. Unlike SEP IRAs, people age 50 and older can make additional catch-up contributions of $6,500 a year to a solo 401, bringing the potential total to $64,500 in 2021 .
Heres the tricky part: Since the solo 401 owner acts as both employer and employee, both types of contributions can be madeand that means most workers can contribute more and receive a higher tax break. Thats because as employee they can contribute up to $19,500 in 2021 , but as employer they can add onto that up to 25% of their adjusted income for a maximum total contribution of $58,000 in 2021 .
In the $100,000 example above, our hypothetical under-50 worker with $100,000 in annual net profit could make a total contribution of up to $38,087. Of that total contribution, in 2021, $19,500 would be the salary deferral as an employee while $18,587 would be a profit sharing contribution as an employer. If the same worker were 50 or older, they could add $6,500 on to that total. Thats more than double what the same worker could contribute to a SEP IRA.
Eligibility requirements are fairly straightforward: Anyone who generates net profits from a sole proprietorship, LLC or other business organization can open a solo 401 as long as they have no employees aside from their spouse.
What Does It All Mean
For the past two years, the employee deferral has remained the same at $19,500. For 2022, you can contribute an additional $1,000 to a 401 plan. However, the catch-up contribution, for those at least age 50, remains the same as 2021. The employer contribution increased a whopping $3,000 from 2021, which means you may contribute a lot more money as the employer.
Those with self-employment income can contribute as both the employee and employer. This means anyone with a Solo 401 plan may contribute up to $67,500, an increase of $3,000. A percentage of your business/self-employment income is used to determine the amount you can contribute as the employer. The compensation used for this calculation also increases to $305,000, which is $15,000 more than 2021.
Further, if your employer allows for them, you can contribute after-tax funds up to the new annual limit of $67,500. However, the recently-updated tax proposal has closed the backdoor on after-tax conversions. Beginning in 2022, you will no longer be able to convert after-tax funds to a Roth. As a result, making after-tax contributions to a 401 may not be a wise decision.
Its important to keep in mind, that the overall contribution limit is for all 401 plans and types of contributions in the aggregate. Therefore, if you contribute to a 401 plan through your employer, this lessens the amount you can save in a Solo 401 plan. Obviously, if you only have one 401 plan, you may contribute the maximum to that plan.
You May Like: How Do I Find My Old 401k
How To Open A Solo 401k
The next step is to set up your Solo 401k with Nabers Group. After you complete our short online application we will get your documents back to you within 2-4 hours. Next you can set up your holding accounts at the bank and/or brokerage of your choice. Then make new contributions and/or roll over funds from other qualified plans and IRAs. Select your investments and simply invest your funds how you want.
Solo 401 Establishment Deadline:
For 2021, in order to make employee contributions for 2021, the self-employed business owner had to establish the solo 401k plan by December 31, 2021. However, if the plan was established on January 1, 2022 or after by your business tax return due date including the business tax return extension, then you cam make employer profit sharing contributions for 2021 but cannot make employee contributions. For example, an employer operating the plan on a calendar-year basis had to complete the solo 401k plan documentation no later than .
For makin 2021 solo 401k plan contributions, the solo 401k has to be adopted by December 31, 2021 for self-employed businesses operating the plan on a calendar-year basis in order to preserve the right to make both employee and employer contributions in 2022 for 2021 by the business tax return including business tax return extensions. Otherwise, if the solo 401k plan is adopted on January 1, 2022 or after but by your business tax return due date including extensions, you will only be allowed to make employer contributions not employee contributions to the solo 401k plan. To learn more about the December 31, 2021 plan adoption/establishment deadline VISIT HERE.
Read Also: How To Start My 401k
Mega Backdoor Roth Solo 401k Ban Question:
Since the Build Back Better bill did not pass in 2021, yes the solo 401k participant can still make voluntary after-tax solo 401k contributions for both 2021 and 2022 and subsequently convert the contributions to the Roth IRA or the Roth solo 401k. Since congress was not able to pass the BBB in 2021 which would have banned both the backdoor and the mega backdoor starting in 2022, if the bill is passed in 2022 it would be effective at the earliest starting in 2023 as this is how retirement regulation generally works .
Big Advantages Of A Solo 401k
1. Pro: Running your own business is rewarding.
2. Pro and Con: You need to run your own business and make adequate money to fund your life and the Solo 401k investment.
3. Pro: Massive contribution limits enable you to make up any lost time pretty quickly. This is great if you didnt save as early or as much as you would have liked.
4. Pro: Many tax benefits supersized.
5. Pro: You can make up lost time pretty quickly for what was missed in the early years, assuming you dont actually need too much of the earnings from the self-employment to get by.
6. Pro: Roth options are possible. This is massively compelling to people who wanted to save in a Roth account because they think that tax rates will be higher in the future, but could not due to high earnings.
NOTE: You can only contribute to a Roth plan with your employee contributions, not employer.
7. Pro: Relatively simple to set up.
8. Pro: Flexible investment options.
9. Pro: With a Solo 401k you can borrow up to $50,000 or 50% of your account value whichever is less at a low interest rate. The loan can be used for any purpose.
10. Pro: You control the account. You do not need a custodian to administer the account.
11. Pro: The plans are easy to operate and dont generally have any hidden fees.
Also Check: How To Rollover Fidelity 401k To Vanguard
Looking For A Financial Advisor
Get In Touch With A Pre-screened Financial Advisor In 3 Minutes
That may be just as well because many financial advisors feel its a good idea to hedge your bets for any tax scenario by investing in a mix of pre-tax and after-tax retirement accounts. room for strategy in the future, says Shon Anderson, a certified financial planner in Dayton, Ohio. Ultimately, the choice of whether to invest your money in a traditional solo 401 versus a Roth solo 401 is a matter of age, income, location and preference.
Administering A Solo 401 Plan
Once your Solo 401 plan exceeds $250,000 in assets at the end of the year, the IRS requires you file an annual Form 5500 EZ. Or if you ever terminate the plan, you must also file a Form 5500 EZ.
Unlike Traditional 401 plans, there are no compliance testing requirements to ensure Solo 401 plans do not favor highly compensated employees and are non-discriminatory, as long as you have no employees participating in the plan.
These plans can be called Self-Directed 401, Individual 401, Individual Roth 401, Self-Employed 401, Personal 401 or One-Participant 401 depending upon the vendor offering the plan services.
Important Plan Provision Changes: New plan loan provisions are no longer offered in the TD Ameritrade Individual 401 plan. All outstanding plan loans must be paid off by May 31, 2022 to continue to use the TD Ameritrade plan document. Roth 401 deferral contributions in the Individual 401 plan will no longer be accepted as of December 1, 2022.
Recommended Reading: Should I Roll My 401k Into An Ira
Limits For Highly Paid Employees
If you earn a very high salary, you may be considered a highly compensated employee , subject to more stringent contribution limits. To prevent wealthier employees from benefiting unfairly from the tax benefits of 401 plans, the IRS uses the actual deferral percentage test to ensure that employees of all compensation levels participate proportionately in their companies’ plans.
If non-highly compensated employees do not participate in the company plan, the amount that HCEs can contribute may be restricted.
How Much Can I Contribute To My Self
Updated: by Financial Samurai
A self-employed 401k plan is a great way to save for retirement if you are an entrepreneur or solopreneur. A self-employed 401k plan is also know as a Solo 401k plan. This article will discuss how much you can contribute to your self-employed 401k plan.
For 2021, the IRS says you can contribute up to $61,000 in your self-employed 401k plan. The amount should go up by $500 $1,000 every one or two years.
The $61,000 self-employed 401k plan limit consists of $20,500 from the employe and $40,500 from the employer. Therefore, to contribute the maximum to your self-employed 401k plan, you must pay yourself enough and have high enough operating profits.
The employer can generally contribute roughly 20% of its operating profits to the employer portion of the 401 plan. Therefore, in order to contribute the maximum employer contribution of $40,500, the company would need an operating profit of at least $202,500.
If youre at least age 50, then you can make an additional $6,500 catch-up contribution.
Here is the 401k maximum contribution limit chart for employee and employer for 2022 and 2021.
Don’t Miss: How To Calculate 401k Employer Match
