There are many options for individuals when it comes to shopping around for retirement plans. You might set one up with your employer, you can pursue one independently, or there are options for business owners with no employees. This particular one, the solo 401(k) – also commonly referred to as a one-participant 401(k), one-participant k, solo-k, or uni-k – can help you deposit retirement funds as both the employee and employer. Let’s look at some of the common components of a solo 401(k).
What Is a Solo 401(k)?
Image by 401(K) 2013 licensed under CC BY-SA 2.0
A solo 401(k) is a retirement savings plan for a a self-employed individual or a business owner that doesn’t have any other full-time employees. These are similar to the traditional 401(k) where an employee can contribute a certain percentage of their income into the account. As business owners, they can also contribute money as the employer from funds they earn before paying themselves a salary.
Eligibility and Contribution Requirements
The only eligibility requirement for this type of retirement plan is to be a single owner with no employees. Under a solo 401(k) plan, there are no age or income requirements, unlike some other retirement plans.
As of 2022, the total contribution limit for a solo 401(k) is $61,000. In 2021, this was slightly lower at $58,000. This doesn’t include an allowance of $6,500 for catch-up contributions for people older than 50. There are several other rules for which you comply as both the employer and the employee of a company. For example, as the sole employee, you can contribute up to $20,500 in 2022 or 100% of your salary, whichever is less.
As the employer, you can contribute an additional amount of profit sharing. This is up to 25% of your compensation for the business or the $61,000 maximum amount. To calculate your total compensation, you can subtract the amount you pay for your self-employment tax and individual contributions from your business’s net profit. If your spouse earns money from the business, they can also contribute to the solo 401(k). They can make elective deferrals up to $20,500 and you, as the employer, can make additional profit-sharing contributions.
Benefits of a Solo 401(k)
One of the biggest benefits is how you can contribute to your account as both the employer and the employee. This means that you can set aside a certain percentage of what your business earns and what you pay yourself to build a solo 401(k). You’ll also find a number of investment options you can pursue when you start depositing money. Many of these also offer participant loan options, where you can remove up to 50% of the amount in your account before you pay it back incrementally.
Another benefit of this plan is that you have several tax options. With a traditional solo 401(k), you make contributions to reduce your income annually. This means when you distribute the funds after retirement, you pay taxes on them as part of your income. You can also pursue the Roth solo 401(k), where you don’t take a tax break when depositing, but your distributions aren’t taxable after retirement.
What Do I Need For a Solo 401(k)?
You only need an employee identification number (EIN) for your business and prove that you’re the owner and sole employee for your business. Some financial organizations may require you to fill out paperwork before determining your eligibility. To claim any of these adjustments, you’ll need to open an account and deposit in it before the end of the calendar year. If your account has $250,000, you’ll fill out a Form 5500-EZ at the end of the year.
Testing
Whereas most companies perform audits to ensure compliance with IRS regulations, annual testing isn’t required of solo 401(k)s. They also might test to ensure that all eligible employees receive the option of a 401(k) program. Once you hire additional employees, you’ll have to test and remediate any issues with employees that don’t receive the option to have their own 401(k).
Other Types of Retirement Plans
There are several other types of retirement plans you could explore. The most common are a traditional 401(k), a traditional IRA, Roth IRA, and SEP IRA.
Traditional 401(k)
A traditional 401(k) is a sponsored program offered by employers. In many cases, the funds go directly into the account from an employee’s paycheck. Companies may also choose to match a certain percentage of contributions.
Traditional IRA
An IRA, or an individual retirement account, is a retirement savings package that you can pursue independently of a job. People pursue these with banks or credit unions and deposit money as they see necessary. This helps you decrease your taxable income pay taxes on any distributions after retirement. Once you turn 72, you have the requirement to take out a minimum disbursement regularly or face fines.
Roth IRA
Roth IRAs are a form of individual retirement account that you cannot deduct from your earnings. The benefit of a Roth IRA, similar to the Roth solo 401(k), is that you don’t pay taxes on the money when distributing after retirement. This can be a good option if you expect to earn more money in retirement.
SEP IRA
SEP IRAs are simplified employee pension plans. Common with independent contractors and freelancers, this option follows the same tax model as the traditional IRA. Rather than the business owner contributing as an employer and employee, only the employer contributes here. This might be a better option if you hope to hire employees but still want to offer a retirement plan option. You can also select a SIMPLE, or savings incentive match plan for employees, IRA if you have a similar situation and want to offer employees the opportunity to deposit.
Contact Hawaii Partners For All Your Solo 401(k) Questions!
Especially if you’re a business owner with no other employees, this could be the right solution for your retirement plan. Now that you’ve learned the basics of solo 401(k)s, consider meeting with a finance professional to discuss your options. These professionals can help guide you to the best solution to plan for your retirement, help with the application process, and set up your accounts. Whether planning or ready to execute, the team can help you out.