What You Need To Know About a Solo 401(k)

A solo 401(k) lets a self-employed individual set up a 401(k) plan combined with a profit-sharing plan. You can create one of these if you work for yourself or if you own a small business with just 1-2 full-time employees including yourself (the second FTE must be your spouse).

Reduce your tax bill while you ramp up your retirement savings. Imagine nearly tripling your retirement savings potential. With a solo 401(k), that is a possibility. Here is how it works:

*As an employee, you can defer up to $19,000 of your compensation into a solo 401(k) in for 2019.

*As an employer, you can have your business make a tax-deductible 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 for yourself using the methods in IRS Publication 560.

*Total employer & employee contributions to a solo 401(k) are capped at $56,000 for 2019; if you are 50 or older, you can also make an employee catch-up contribution of up to $6,000 for 2019.

If you are 50 or older and self-employed, you could potentially put as much as $62,000 into a solo 401(k) for 2019. Now add your spouse to the mix. Is he or she age 50 or older and a full-time employee of your business? Then the two of you could potentially contribute up to $124,000 to the plan.

If you hurry, you can create & fund a solo 401(k) for 2019. If you can get a solo 401(k) up and running by December 31, you can make contributions for the 2019 tax year. The profit-sharing contribution that the business makes to the solo 401(k) is tax-deductible for the business, and the cost of setting up the plan is tax-deductible both for the business and the individual.

You can skip contributions to the plan in a lean year. Employer and employee contributions to a solo 401(k) are wholly discretionary. You determine how much goes in (or doesn’t) per year.

You can even create a Roth solo 401(k). The Roth version of a solo 401(k) is just like any other Roth account: you put in after-tax dollars as a tradeoff for tax-free gains and eventual tax-free withdrawal. If you don’t want to go Roth, you can have a traditional solo 401(k) with pre-tax dollars going in, tax-deferred growth and eventual taxed withdrawals.

Rollovers into the plan are allowed. If you have money in a SEP-IRA, an IRA or an old 401(k), 403(b) or 457 plan somewhere, those assets may be rolled over into a solo 401(k). (The exception: Roth IRA assets may not be.) Certain plan providers even allow hardship withdrawals (loans) from these plans prior to age 59½.

There are some demerits to the solo 401(k). As you are setting up and administering a 401(k) plan for your business, you have to see that it stays current with ERISA and IRC regulations. Obviously, it is much easier to oversee a solo 401(k) plan than a 401(k) program for a company with 15 or 20 FTEs, but you still have some plan administration on your plate. You may not want that, and if so, a solo 401(k) may have less merit than a SEP or traditional profit-sharing plan. The plan administration duties are relatively light, however. If the assets in your solo (k) exceed $250,000, you will need to file a Form 5500 annually with the IRS.

What if you want to hire more employees? If you do, you will have to convert your solo 401(k) into a standard 401(k) plan per the Internal Revenue Code.

On the whole, solo 401(k)s give SBOs increased retirement savings potential. If that is what you need, then take a good look at this option. These plans are very easy to create, their annual contribution limits far surpass those of IRAs and stand-alone 401(k)s, and some custodians for solo 401(k)s even give you “checkbook control” – they let you serve as trustee for your plan and permit you to invest the funds across a variety of different asset classes.