For the self-employed among us who want to capitalize on tax advantages, and are open to retirement-saving vehicles that go beyond the standard Roth and simple IRA, there's an alternative to consider: the solo 401(k).
Available only to small business owners/operators and their spouses, the solo 401(k) is an options for sole proprietors, S corporations, C corporations, and limited liability companies (LLCs).
You can boost your retirement-saving strategy by contributing pre-tax for a tax deduction, or making Roth contributions (post-tax) for tax-free growth. (Distributions from 401(k) plans before age 59½ may be subject to tax and a 10% federal income tax penalty.)
Wearing two hats? The business owner wears two hats in a solo 401(k) plan, too: employee and employer. Contributions can be made to the plan in both capacities.
As the employee, you can make “salary deferral” contributions of 100% of your income up to $19,500 in 2021. In addition, individuals 50 and older can add an extra $6,500 per year in "catch-up" contributions. This brings the potential contributions for the employee to $26,000!
As the employer, you may also make “profit-sharing” contributions, in addition to the maximum “salary deferral” described above. Profit-sharing contributions can be as high as 25% of compensation, bringing the total to $58,000 if you are under age 50 and $64,500 for those aged 50-plus. Contributing the maximum is based on a variety of factors. If you are not paying yourself a salary (W-2), calculating contributions can be tricky, and you may want to contact us or your tax professional for guidance.
Example: Ben, age 51, earned $50,000 in W-2 wages from his S corporation in 2021. He deferred $19,500 in regular elective deferrals, plus $6,500 in catch-up contributions to his solo 401(k) plan. His business contributed 25% of his W-2 compensation to the plan ($12,500). Total contributions to the plan for 2021 were $38,500. This is the maximum that can be contributed to the plan for Ben for 2021.
You can also “go Roth” with your solo 401(k). The annual employee Roth contribution limits for a solo 401(k) are the same as those for a traditional solo 401(k): $19,500 for individuals under 50, and $26,000 for those 50 or older. Only employee contributions can be Roth contributions.
Administrative duties for a solo 401(k) plan may be relatively light, and implementing the plan is even easier! There are no compliance testing requirements. You need to file an annual Form 5500 with the I.R.S. when the assets in your solo 401(k) exceed $250,000.
Advantages to this type of plan are plentiful, as you can see. However, the real value is the freedom and flexibility it creates when you decide it’s time to travel more, spend more time with family, or simply fish, golf, or otherwise take things easy.
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