Employer Plan Contribution Limits
Only working for one employer
If you are self-employed and work for no one else, the maximum contribution that can be made to your Solo 401k for the 2020 tax years is:
$57,000 in employer and employee contributions . If you are 50 or older by the end of the 2020, you may contribute an additional $6,500 as catch-up salary deferral contribution.
Working for More than One Employer
If you work for more than one employer, the contribution limit is increased.
For example, if you are self-employed and work for another employer, you adopt a solo 401k for your self-employed business and your other employer offers a profit sharing plan, you can contribute $57,000 to your solo 401k for 2020 and another $57,000 as a profits sharing contribution to your other employer plan. This would result in a total contribution of of $114,000 to both plans combined for tax year 2020.
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What Are The Deadlines For Opening And Making Contributions To A Solo 401
The deadline to both open and contribute to a Solo 401 is now the applicable tax-filing deadline of the taxpayer, including extensions, thanks to the SECURE Act passed in late 2019. This means that, depending on the business entity, a Solo 401 could be opened as late as September or October of the following year for prior year contributions, as is the case for .
Importantly, if you open a Solo 401 in the following calendar year, but still plan to make prior year contributions, please consult your accountant. The SECURE Act extended the establishment deadline to open a Solo 401, but the IRS has not changed its guidance that the plan participant must make his/her salary deferral election by the last day of the calendar year. In other words, to make salary deferrals that first year, the plan needs to be in existence by December 31st! The good news is that the same rule does not apply to profit-sharing contributions, which can still be made the following calendar year.
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How Does A Solo 401 Work
As a reminder, a Solo 401 plan is nothing more than an individual retirement plan for self-employed people or small businesses without any employees. Also, remember that a Solo 401 is nothing more than a vessel youll use to save for retirement. You still have to choose the investments youll use within your account to build wealth.
The biggest benefit of this account is the fact that individuals who use it can contribute considerably more than they can with a traditional 401 plan, which in turn helps these individuals save more for retirement and reduce their taxable income.
As an employer, one of the main features of a Solo 401 is that youll need to determine what your actual income is to determine your maximum employer contribution, which can be up to 25% of your compensation. According to the IRS, your compensation is earned income, defined as net earnings from self-employment after deducting one-half of your self-employment tax and contributions for yourself. But once again, this depends on the business structure for your company.
Solo 401 participants can open their account with any brokerage firm they want, although online providers have become extremely popular due to the fact you can get started at home and on your own time, and often with access to an array of helpful investing tools and resources. Online brokerage firms also tend to come with low costs overall, which is another reason investors seek them out.
What Is A Solo 401k
A solo 401k is a retirement plan designed for people who work for themselves. If you run a small business with no employees, you can qualify for a solo 401k.
Your spouse can qualify if he or she is involved in the business. A fellow business partner who is an owner is also eligible.
The key is that no common-law employees are eligible to participate. A solo 401k is not the right option for your business if you have employees that you want covered by a retirement plan.
This retirement plan can be a powerful tool in your savings efforts. It allows you to invest in just about anything. Investment options include stocks, mutual funds, bonds and exchange-traded funds.
Keep in mind there are some prohibited investments. Consult with your 401k custodian firm for more information.
Contributions to a solo 401k can be made on a pre-tax basis to a traditional account. They can also be made on an after-tax basis to a Roth account if your custodian offers this option.
Just like employer 401k plans, you typically cant withdraw money in a solo 401k until age 59 ½. Taking money out before then means you may pay taxes on those funds in addition to a 10% penalty.
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Who Is Eligible For A Solo 401
Solo 401 plans are intended for the self-employed. If you have employees and are looking for a retirement plan, then you have other options such as the or SIMPLE IRA, both of which allow you to provide tax-advantaged benefits to your employees. A lesser-known program called a SIMPLE 401 also allows businesses to set up retirement plans.
While solo 401 plans are intended for one-person businesses, there is an exception. The spouse of the business owner can also participate in the plan. With a spouse in the plan, your small business can really stash away cash for retirement. A qualifying couple could save as much as $114,000 annually in the plan, and even more if they were eligible for catch-up contributions.
Blog: Solo 401k Vs Sep Ira For Self
Are you self-employed and want to invest your savings while lowering your taxes? Maybe youre a realtor, interior designer, or a TikTok influencer, and you want to finally create your own retirement plan. Is Solo 401 or SEP IRA better for you? In this article, Im going to share a side by side comparison of the Solo 401 vs SEP IRA. These are the two most popular ways you can save if youre self-employed.
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Best For Mutual Funds: Vanguard
Vanguard
Vanguard is well known for its own mutual funds and ETFs. If you prefer investing in Vanguard funds, a Vanguard Individual 401 plan gives you easy access with no trade costs, making the company our review’s best choice for mutual funds.
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No fee to establish an account
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Trade the Vanguard family of funds with no commissions or load fees
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Roth contributions allowed
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$20 annual fee for each Vanguard fund held in this type of account
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401 loans are not supported
If youre looking to stick with a well-respected list of mutual funds from Vanguard, choose the Vanguard Individual 401. The account doesnt have an annual fee on its own for accounts with at least $10,000 in Vanguard funds. It charges a $20 annual fee below that balance plus a $20 annual fee for each Vanguard fund held in the account. Depending on how you invest, this fee can add up fast and could be a reason to consider buying those Vanguard funds elsewhere. You can also trade stocks and ETFs with no commission, in addition to options and fixed-income investments.
Vanguards founder, the late John Bogle, is credited as a pioneer in index investing, bringing the first index fund to market in 1976. Vanguard remains a leader in investment funds as the second-largest asset manager in the world with $6.2 trillion under management.
Read our full Vanguard review.
What Is A Solo 401
A solo 401 plan is a 401 for a self-employed individual. It retains all of the great, tax-saving features of a group 401 you would find at a large corporation but with far less compliance to deal with. This is because most of the compliance involved with group 401 plans has to do with fairness among employees, but this obviously isnt an issue for a self-employed person who will not seek to be unfair against him- or herself.
Solo 401 plans come by many other names, including:
- Individual 401
- Single K
- Uni K
- Self-Directed 401, which is actually a specific kind of solo 401 plan that I discuss below
Of course, something as great as a solo 401 does come with rules and guidelines that must be followed, so read on.
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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 years 2020 and 2021. If you are over 50, an additional $6,500 catch-up contribution is allowed for tax years 2020 and 2021. 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 $57,000 for tax year 2020 and $58,000 for tax year 2021. 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 be $63,500 for 2020 and $64,500 for 2021.
Compensation from your business can be a bit tricky. This is calculated as your business net profit minus half of your self-employment tax and the employer plan contributions you made for yourself plan). The limit on compensation that can be factored into your tax year contribution is $285,000 for 2020 and $290,000 for 2021.
Choose The Right Provider
With your provider, its important to ask questions. Two common questions people ask are how to make contributions with the Solo 401, and how to use the Solo 401 loan.
However, tailor your questions to your specific needs. At IRA Financial Group, you can call at 401 specialist for a free consultation. With the 401 specialist, you can answer any questions you may have regarding the Solo 401 retirement plan.
You have a few options when choosing a provider to set up a Solo 401k plan. Here are the three options you have to easily set up a Solo 401.
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Start Your Own Retirement Plan
When youre an employee, you can only use a 401 plan if your employer establishes a plan and youre eligible to contribute. All too often, thats not the case. But you still have options.
Ask for a 401: Your employer might be willing to set up a 401 they just havent done it yet. Start the conversation by asking why there isnt one, why you want one, and that there are potential tax benefits for employers. Explain that valuable employees like yourself would be even more valuable with excellent benefits. Offer to do some of the legwork required to get the plan up and running. In some cases, especially with small organizations, your employer simply doesnt have time to set up a plan. Cost is another factor companies and small nonprofits might be hesitant to pay plan costs . If cost is the primary concern, discuss less-expensive options like SIMPLE plans. Only time will tell if itll actually happen, but it never hurts to ask.
IRAs: If you dont have a 401, you may still be able to save in an individual retirement account , and you might even receive tax benefits similar to a 401. Unfortunately, the IRS sets maximum annual limits much lower for IRAs. Still, something is better than nothing. Evaluate traditional IRAs for potential pre-tax saving, and Roth IRAs for possible tax-free withdrawals . Another drawback of IRAs ) is that you may need to qualify to make contributions or receive a deduction. Speak with a tax expert before you do anything.
How Easy Is It To Set It Up And Maintain A Solo 401 Or Sep Ira
Theyre both actually easy to set up. When you open a solo 401, the provider will usually create a solo 401 plan document for you. There are several solo 401 providers you can choose from. If youre a fan of Vanguard, you can create a Vanguard solo 401. You can also create a Fidelity 401 or ETrade solo 401. One downside with a Vanguard solo 401 is it does not allow you to roll over an existing IRA into your Vanguard solo 401. For about 2 years, I kept calling Vanguard to ask if they will allow this feature soon. We got tired of waiting and ended up opening another solo 401 with Etrade. One downside with a Fidelity solo 401 is it does not have a Roth 401 option.
If youre setting up a SEP IRA, its pretty straightforward to do so via Vanguard or Fidelity or ETrade. A lot of people forget this next step though. You will need to complete a Form 5305-SEP. Its just half a page long. No need to file with the IRS. This form officially creates your SEP IRA plan.
How easy is it to maintain: Solo 401 vs SEP IRA? Both are easy. However, with a solo 401, once the plans assets reach $250,000, youll need to file a Form 5500 each year to remain in compliance with IRS rules.
Round 5 Winner: SEP wins, since theres a bit more paperwork with a 401.
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What Are The Drawbacks Of A Solo 401
While there are many advantages to a solo 401, there are also drawbacks. The biggest drawback of this plan is that if your business hires an employee, you must include that employee in the 401 plan, and adhere to all IRS testing requirements. This can become cumbersome and more costly for the business but isnt necessarily bad. It is just something to be aware of. You cannot hire an employee and simply exclude them from the 401 and keep it to yourself as the owner.
Another drawback, which is not much of one at all, is that once the plan assets are over $250,000, the plan owner must fill out an IRS form 5500-EZ each year. Again, not much of a hassle, just a little extra paperwork.
Roth 401k And Voluntary After
- Voluntary after-tax solo 401k contributions fall under the employee contribution umbrella.
- This type of contribution is not considered employer contributions, so the contribution is not tax deductible because it is considered made with post-tax dollars.
- When voluntary after-tax solo 401k contributions are converted to a Roth IRA or the Roth Solo 401k, the conversion has to be documented in writing by completing a conversion Form , and a Form 1099-R has to be issued to report the conversion whether taxable or not. This reporting is covered by our annual service and fee.
- Voluntary after-tax solo 401k contributions can be distributed and thus converted at any time. This is why the conversion of voluntary after-tax solo 401k contributions has been dubbed the mega-backdoor Roth solo 401k.
- There is a lesser known rule called the overall 415 limits. The overall 415 limit for 401 plans including solo 401k plans. For 2020, the overall limit is $57,000. The overall limit increased to $58,000 for 2021. The overall limit looks at the total annual additions to all of a participants accounts in plans maintained by one employer and includes not just their salary deferrals, but also matching contributions, allocations of forfeitures and other amounts. Voluntary after-tax solo 401k contributions are subject to the overall annual limit $57,000 for 2020, and $58,000 for 2021.
I have provided the following links for more information and examples: https: 401k-contributions/
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Employee Component: Elective Deferral
Now that weve defined earned income for contribution limit purposes, we can get into the math.
The first component of solo 401 contributions is the elective deferral available to you as your own employee.
For 2020, you can contribute up 100% of your earned income as an employee up to:
- $19,500 for those under 50 years of age as of December 31, 2020, or
- $26,000 for those 50 years of age or older as of December 31, 2020.
It is important to note that if your self-employment income is a side hustle, and if you contribute to your 401 plan through your day job, then you must reduce the employee elective deferral amounts above by any amounts you have contributed to your corporate 401 plan through your employer.
What if you contribute more than is allowed? If you make a mistake and contribute more than the allowable amounts, you can withdraw the excess by April 15, 2021, without penalty, though you will still be subject to tax on any earnings on those overcontributions.
