Do you work for yourself, with no employees other than your spouse? Are you trying to improve your retirement savings situation? If you can answer “yes” to both questions, it’s time to learn about the solo 401(k), which marries a traditional employee retirement savings account to a small business profit-sharing plan.
With a solo 401(k), small business owners have a chance to ramp up retirement savings and reduce their tax bill at the same time. In the administration of a solo 401(k) plan, the business owner wears two hats: employee and employer. Contributions are allowed for both hats.
As an employee, you can defer up to $19,000 (2019) of your compensation into a solo 401(k). If you are 50 or older, catch-up contributions of $5,000 for tax year 2019 are allowed. (The employee contribution cannot surpass earned income or salary.)
As an employer, you can have your business make a tax-deductible, profit-sharing contribution of up to 25% of your compensation as defined by the plan. If your business isn’t incorporated, the annual employer contribution limit is 20% of your net earnings rather than 25%. If you are a self-employed individual, you must calculate the maximum amount of elective deferrals and non-elective contributions you can make using the methods in Internal Revenue Service Publication 560.
Total employer + employee contributions to a solo 401(k) are capped at $56,000 for tax year 2019.
The annual employer contributions you make are tax-deductible to your business, up to I.R.S. limits. The employee contributions can be made on a pre-tax basis or post-tax Roth basis.
Are you married? If your spouse earns income from your business, then he or she can also make an employee contribution to the plan in 2019, and you can make another profit-sharing contribution on your spouse’s behalf. To qualify for a solo 401(k) plan, only your spouse is allowed to be an employee of your company. Any other employees who reaches certain thresholds will disqualify you from having a solo 401(k)
You can “go Roth” with your solo 401(k). The 2019 employee contribution limits for a Roth solo 401(k) are the same as those for any 401(k): $19,000 for individuals under 50, and $25,000 for individuals 50 or older. Only employee contributions can be Roth contributions. Profit-sharing contributions must be made on a pre-tax basis.
Are plan loans allowed? Sometimes. Certain plan providers do permit them, though standard federal taxes and tax penalties apply if the loan is not paid back within five years. Some also allow hardship withdrawals from these plans (that is, withdrawals taken prior to age 59½) under certain circumstances.
The administration duties for a solo 401(k) plan are relatively light. There are no compliance testing requirements, and you will only need to file an annual Form 5500 with the I.R.S. when the assets in your solo 401(k) exceed $250,000.
On the whole, solo 401(k)s give small business owners increased retirement savings potential. The plans are relatively easy and inexpensive to create, and you are free to have one whether your business is a sole proprietorship, S corporation, C corporation, limited liability company (LLC), or limited partnership. Certain independent contractors have the freedom to create solo 401(k)s as well.
Being a small business owner comes with a number of complicated tax and savings decisions. We’re here to help.
Andrea L. Blackwelder, CFP®, ChFC, CDFA® and Joseph D. Clemens, CFP®, EA are the founders and partners of Wisdom Wealth Strategies. Their shared passion is simple: to bring financial empowerment, understanding, and peace-of mind to people who wish to improve their financial future, build wealth for their families, and achieve financial independence. Click here to find out more about how you can work with the Denver Financial Advisors at Wisdom Wealth Strategies.
“Wisdom Wealth Strategies, LLC is a registered investment advisor offering advisory services in the states of Colorado and California, and in other jurisdictions where exempted.” This material was prepared by MarketingPro, Inc., and does not necessarily represent the views of the presenting party, nor their affiliates. This information has been derived from sources believed to be accurate.