If your business is essentially a one-person operation, there's an option to help you save more money for retirement: The Solo 401(k) plan.
Ordinarily, traditional defined contribution retirement plans allow annual contributions that are limited to either 25% of salary if you're employed by your own S or C corporation or 20% of self-employment income if you operate as a sole proprietor or single member LLC. Also, traditional profit sharing plans, Keogh or SEP plans are subject to a $57,000 cap on contributions to your account for 2020 (up from $56,000 in 2019).
Not bad, but with a Solo 401(k) plan, you can probably make substantially larger contributions that lower your tax bill and generate more tax-deferred earnings for retirement.
A Solo 401(k) is made up of two separate parts. Together, the two parts make the plan advantageous:
The sum of the two parts is capped at 100% of your annual employee compensation or self-employment income, or $57,000 in 2020, whichever is smaller (up from $56,000 in 2019). However, the dollar cap is increased to $63,500 for people age 50 or older.
A Solo 401(k) doesn't force you to contribute more than you can comfortably afford: The plan lets you rack up major tax savings in good years, by making maximum contributions, but gives you the option of contributing less -- or even nothing -- in lean years when you need to conserve cash.
Plus, you generally get the benefits of traditional 401(k) plans, such as the ability to borrow from your account.
Under Age 50 - $19,500
Over Age 50 - $26,000
Under Age 50 - $57,000
Over Age 50 - $63,500
Establishing and operating any 401(k) plan means some up-front paperwork and ongoing administrative effort. With a Solo 401(k), however, the administrative work is simplified since you are the only participant.
There are a couple of caveats:
Ask your employee benefits advisor to sort out the complexities of various retirement plans and determine whether a Solo 401(k) is right for you.
Annual elective deferral and employer contributions to a solo 401(k) can add up to big numbers. To illustrate, consider the following examples.
Lisa, age 40, is the only employee of her corporation. (It makes no difference whether it's a C or S corporation). In 2020, the corporation pays Lisa a salary of $80,000. For 2020, the maximum contribution to a solo 401(k) plan set up for Lisa's benefit is $39,000. That amount is composed of:
The employer contribution has no effect on Lisa's taxable salary, but it reduces her corporation's taxable income by $19,500. The $39,000 is significantly higher than the $20,000 maximum contribution (25% x Lisa's $80,000 salary) that would be allowed with a traditional defined contribution plan, such as a SEP or profit-sharing plan. The $19,500 difference is due to the solo 401(k) elective deferral contribution privilege.
Len, age 45, operates his business as a sole proprietorship. In 2020, Len has $80,000 of self-employment income. For 2020, the maximum allowable deductible contribution to a solo 401(k) plan set up for Len's benefit is $35,000. That amount is composed of:
The $35,000 amount is significantly higher than the $16,000 maximum contribution (20% x Len's $80,000 of self-employment income) that would be allowed with a traditional self-employed plan, such as a SEP. Again, the $19,500 difference is due to the solo 401(k) elective deferral contribution privilege.
Get in touch today and find out how we can help you meet your objectives.