A one-participant 401(k) plan, also known as a Solo-K or Solo 401(k), is a traditional 401(k) plan designed for a business owner with no employees. It may also cover the business owner and his or her spouse. These plans must meet the same requirements and follow the same rules as any other 401(k) plan. These plans provide various benefits, including tax-advantages, to self-employed business owners and spouses. Let’s dive into the details of these Solo-K plans so you can evaluate if this plan would be the right fit for you.
How It Works
The business owner plays two roles: the employer and the employee and as such, you can contribute to the plan in two ways, which maximizes your retirement contributions and business deductions. As an employee, you can contribute up to $20,500 in 2022 ($19,500 in 2021), or 100% of compensation, whichever is less. If you are 50 or older, you get to contribute an additional $6,500. As an employer, you can make an additional profit-sharing contribution of up to 25% of your compensation, or net self-employment income (which is net profit minus half your self-employment tax and employee contributions you made for yourself). The limit on compensation is $305,000 in 2022 ($290,000 in 2021). If you work for another company and participate in its 401(k), you must be aware that these employee limits are cumulative across both jobs. However, the employer contribution limits are based on the plan, so employers can contribute the maximum annually.
With a Solo 401(k), you have flexibility to pick your tax advantage. All contributions you make as the employer will be tax deductible to your business. Any earnings are growing tax-deferred until withdrawn. For your employee contributions, you can opt for traditional 401(k) advantages where contributions reduce your taxable income for the year and grow tax-deferred with distributions in retirement taxed as ordinary income. Alternatively, you may opt for the Roth Solo 401(k) contributions which do not reduce your taxable income, but retirement distributions are typically tax-free.
Important Rules and Deadlines
Withdrawals made before age 59 ½ from traditional Solo 401(k) accounts, will result in a 10% penalty tax (with few exceptions). For Roth Solo 401(k) accounts, early withdrawals do not incur the 10% tax penalty, but you do pay the penalty and income tax on your earnings. If you expect your income to be higher in retirement, a Roth is probably the right fit for you. If you expect your income to decline in retirement, it is better to take the tax advantage now in the form of the traditional account.
One of the desirable differences between a Solo 401(k) and a Traditional 401(k) is that the Solo plans do not have as many compliance testing requirements, including discrimination testing, because there are no employees in the company and only owners are participating in the plan.
Opening the Solo 401(k) is not difficult, but you do have to meet the establishment deadline of December 31st of the year you want to contribute employee contributions, or you can establish it by the due date of your tax filing with all extensions if you only make the employer contributions for the first year of the plan, which extends the time to establish the plan well into the next calendar year.
Is A Solo 401(k) Plan Right For You?
If you want more information on Solo 401(k) plans or want to speak with someone to find the right plan to fit your needs, let us know! We are happy to help.