Solo 401(k) Plans

Solo 401(k) plans for self-employed individuals in Battle Creek, Michigan and across the United States.

If you are self-employed and don’t have employees, a solo 401(k) may be the very best way for you to save for retirement and reduce your current income taxes.  Depending on your profits, you could put a whopping $52,000 away on a pretax basis per year.  You also have the ability to borrow half of your balance up to $50,000, whichever is lower.

Is a solo 401(k) better than a SEP IRA?

I like SEP IRAs and have recommended them to certain clients.  They allow you to defer your funding until your tax filing deadline and are very easy to manage.  You can fund it throughout the year or you can make a one-time contribution from your business right before you file your tax return(s).  Like the solo 401(k), you can contribute up to  $52,000 into a SEP IRA per year, but your income must be substantially higher to get to that level of funding.  Let’s look at a hypothetical situation to get a better understanding.
Jill is a realtor with no employees and her business is structured as a sole proprietorship.  Her business profit, or net Schedule C, last year was $130,000.  She is over 50 and does not have enough saved for retirement.  Her husband also makes a good living and their youngest child recently graduated college and they now have substantial discretionary income to catch up on their retirement savings.  If Jill were to open a SEP IRA to save through her business, the IRS would make her use the following calculation:
(Net schedule C – 1/2 of self-employment tax) x 20% =
In Jill’s case, that would be ($130,000 -$8,790.20) x .2 = $24,241.96.   If Jill were to open a solo 401(k), she could contribute $17,500 for herself plus the $24,241.96 for profit sharing (same amount as SEP above) and add the $6,500 catch up provision because she is over 50.  That is a total of $48,241.96 in the Solo 401(k) and only $24,241.96 in the SEP IRA, for a difference of over $24,000!  Please note the catch up is above and beyond the $52,000 limit.  SEP IRAs do not allow over 50 catch ups.
For someone around that income level, the solo 401(k) can really help defer more money.  Solo 401(k)s also allow owners to open a Roth 401(k).  At this time, there is no Roth SEP.  Once you have a balance of over $250,000 in your Solo 401(k), you are required to file a form 5500 EZ each year.  It can be found here and is a very simple 2 page form.

What entities can set up a solo 401(k)?

Sole proprietorships, LLCs, partnerships, and corporations can all set up solo 401(k)s.  If your business is a corporation, you must pay yourself W2 wages to be able to contribute to a solo 401(k).  The profit sharing contribution can only be based on your W2 wages.  If Jill decided to incorporate and paid herself a W2 salary of $70,000 and took the remaining $60,000 of income as a dividend, she could still save $24,000 ($17,500 + $6,500 catch up) as an employee, but her profit sharing would be limited to $17,500 ($70,000 x .25).  That is less than what she could contribute in our sole proprietorship example, but still $24,000 more than what she could contribute to a SEP if she was a corporation and paid W2 wages of $70,000.

When must I establish a solo 401(k) plan?

The plan documents must be signed by 12/31.  Sometimes, I don’t meet people until the year is over and it is too late to establish a solo 401(k) plan.  In this case, it is possible to establish a SEP IRA just before the tax filing deadline.  Employer plans are flexible and it is important to remember that you can terminate your plan and opt for a different plan in the future.  Both the SEP and solo 401(k) allow you to make large contributions when you have the profits in one year and do not require contributions if you have lean years.

How do I determine my self-employment tax?

The easiest way is to fill out Schedule SE with your 1040 or you can use a calculator like the one offered here.

What else should I be aware of?

Solo 401(k)s are designed for businesses where there is only one person working in the business.  You can set one up, but you will likely need to terminate the plan when you hire your first employee.  At that point, you could consider either a regular 401(k) plan, SEP IRA, or SIMPLE IRA for your business.  Some of the rules related to solo 401(k) plans can be complex.  It is recommended that you consult IRS Publication 560 and your tax advisor before proceeding.

Generations Financial Planning and Wealth Management is here to help

If you would like to set up a complementary consultation to explore different retirement plans for your business, we are here to help.  We are a small business that understands business’ needs and can offer professional advice to help you reduce taxes and reach your retirement goals.