Solo 401(k) Plans
Solo 401(k) (aka Individual 401(k), Solo-k, Uni-k, One-participant k) and Solo Roth 401(k) plans are like 401(k) retirement plans, but they apply only to 1-person businesses, regardless of the type of business entity chosen, such as a sole proprietorship or an S or C corporation. Although these plans only cover a business owner with no employees, spouses can be covered. If the business later acquires employees, then the Solo 401(k) plan must be terminated and replaced with another retirement plan, such as a regular 401(k).
Contributions to the Solo 401(k) plan can be made with either pre-tax or after-tax dollars. The Solo 401(k) plans are much like the Simplified Employer Pension (SEP) plan for the self-employed, including contribution limits, which are adjusted annually for inflation and allowing both employee and employer contributions. However, a major benefit to the Solo 401(k) is that much higher contributions can be made at lower income levels than for any other type of defined contribution retirement plan. Like the SEP plan, the employer's nonelective contribution is limited to 20% of self-employment compensation, unless the business owner is an employee of his own S or C corporation, in which case, the maximum percentage rate = the 25% limit for employees. The other major benefit to the Solo 401(k) plan is that the employee portion of the contribution can be made to a designated Roth account, which does not reduce current taxes, but both principal and earnings are tax-free when withdrawn, just as with a Roth IRA. Note, however, that the taxpayer must wait at least 5 years, including the year when the first designated Roth account was set up, to withdraw the earnings tax-free. Thereafter, earnings can be withdrawn tax-free from any other designated Roth account, if the withdrawals would otherwise be qualified. This rule is like the 5-year rule that applies to Roth IRAs.
The employee contribution is limited to the lesser of 100% of compensation or the statutory contribution limits listed in the table below. Total contributions cannot exceed the statutory limits + any allowed catch-up contribution. These limits apply to each person, so if a business owner is also employed by another business with a 401(k) plan, then the elective deferral limit applies to the total contributions to both plans.
| Tax Year | Maximum Employee Contribution | Catch-Up Contribution | Employee Contribution + Catch-Up Contribution | Maximum Account Contribution, Including Employer Contribution | Maximum Account Contribution + Catch-Up Contribution |
|---|---|---|---|---|---|
| 2024 | $23,000 | $7500 | $30,500 | $69,000 | $76,500 |
| 2023 | $22,500 | $7500 | $30,000 | $66,000 | $73,500 |
| 2022 | $20,500 | $6500 | $27,000 | $61,000 | $67,500 |
| 2021 | $19,500 | $6500 | $26,000 | $58,000 | $64,500 |
| 2020 | $19,500 | $6500 | $26,000 | $57,000 | $63,500 |
Compensation is defined, in calculating the limits, as self-employment net earnings minus ½ of the self-employment tax. The taxpayer's contribution to the plan is also subtracted, but in an indirect way, by using the following formula that depends on the contribution percentage for employees as defined in the plan. (Although the business has no employees now, it may acquire them later on, so the plan must specify the employee contribution percentage, used to calculate the contribution rate for the owner):
| Employer's Contribution Rate | = | Employees' Rate 1 + Employees' Rate |
So to claim the full 20% of net business income, the contribution rate for employees in the retirement plan must also be set to the maximum employee rate of 25%:
Employer's Contribution Rate = .25/1.25 = .20 = 20%
Example: Calculating the Maximum Solo 401(k) Contribution
For instance, if you are at least 50 and earned $100,000 in self-employment income, then to calculate the employer contribution, you must deduct ½ of your self-employment tax, which would be about $7065. So:
- Maximum Employer Contribution = (Self-Employment Compensation − ½ of Self-Employment Tax) × 20% = ($100,000 − $7065) × 20% = $92,935 × 20% = $18,587
- Maximum Contribution for Solo 401(k) = Employer's Contribution + Employee's Contribution + Catch-Up Contribution = $18,587 + $23,000 + $7,500 = $49,087
Note that if a taxpayer earns more than the defined-benefit wage base, then the maximum contribution under either plan would equal the statutory limit, the defined contribution dollar limit.
| Year | Defined Contribution (DC) Dollar Limits | Defined Benefit (DB) Wage Base |
|---|---|---|
| 2024 | $69,000 | $345,000 |
| 2023 | $66,000 | $330,000 |
| 2022 | $61,000 | $305,000 |
| 2021 | $58,000 | $290,000 |
| 2020 | $57,000 | $285,000 |
| 2019 | $56,000 | $280,000 |
| 2018 | $55,000 | $275,000 |
Source: COLA Increases for Dollar Limitations on Benefits and Contributions | IRS | ||
Loans can also be taken out from Solo 401(k) plans. The maximum loan amount is limited to the lesser of $50,000 or 50% of the account balance, which must be repaid within 5 years. The frequency of repayments must be at least quarterly and a reasonable interest rate must be charged.
Solo 401(k) plans must be set up prior to the tax yearend. Contributions for unincorporated businesses must be made by the tax filing deadline, including extensions. Profit contributions made by corporations must be made by the tax filing date for the business, including extensions. Corporations must also fund the accounts within 15 days after the fiscal year end for salary deferral contributions.
A business owner with no common-law employees does not need to perform the nondiscrimination tests that 401(k) plans generally require. However, if the business acquires employees, then any eligible employees must be included in the plan and, thenceforth, elected deferrals will be subject to nondiscrimination testing. Form 5500, Annual Return/Report of Employee Benefit Plan also must be filed annually if the Solo 401(k) plan has at least $250,000 by year-end.
Single taxpayers can choose anyone as a beneficiary of their retirement account, but married taxpayers require the consent of their spouse to choose a nonspouse beneficiary.
Secure Act 2.0
The Secure Act 2.0, passed at the end of 2022, makes it easier for employers to help workers open emergency savings accounts, assist employees who are repaying student loan debt and allow part-time workers access to retirement plans in 2 years instead of 3. There are also new benefits to both Roth IRAs and Roth 401(k)s, including moving leftover money from a 529 college savings account to a Roth I.R.A. Certain rules must be followed to avoid taxes and penalties, and there are some income restrictions. However, some provisions start in different tax years.
Secure Act 2.0 Changes for Employees with 401(k) Plans:
- Increases the required minimum distribution (RMD) age from 72:
- to 73 in 2023
- to 75 in 2033
- The penalty for not taking an RMD on time has been reduced from 50% of the amount that should have been withdrawn to 25%, and to 10% for IRAs if corrected.
- Employers could allow their employees to make 1 withdrawal, up to $1000 annually from their 401(k) or IRA, for certain emergency expenses without owing the 10% additional penalty for nonqualified distributions.
- An emergency is defined as an unforeseeable or immediate financial need related to the employee or his family.
- Employees can choose to repay the amount within 3 years, but if they choose not to, then they cannot make another emergency withdrawal for 3 years.
- Starting in 2025, the catch-up contribution limits for taxpayers aged 60 to 63 increases from $7500 per year to at least $11,250.
- The new rule says that the limits would increase to the greater of $10,000 or 50% more than the regular catch-up amount that year.
- But since the catch-up amount already = $7500,
- 50% more = $7500 + $3750 = $11,250
- Taxpayers earning more than $145,000 must put the catch-up money in a Roth 401(k).
- Starting in 2025, this wages threshold will be adjusted annually for inflation, rounded down to the lowest multiple of $5,000.
- So high income taxpayers will have to pay taxes on their catch-up contribution.
- Lower-income taxpayers may choose a pre-tax or after-tax contribution.
- The new rule says that the limits would increase to the greater of $10,000 or 50% more than the regular catch-up amount that year.
- Starting in 2024:
- Allow employees to make qualified student debt payments eligible for employer matches to a retirement account.
- Allows a one-time penalty-free withdrawal from a 401(k) or an IRA for an emergency, defined as an unforeseeable or immediate financial need related to the employee or his family.
- eliminates required minimum distributions from 401(k) Roth accounts.
- So, Roth accounts will be treated the same as Roth IRAs in regard to RMD’s.
Secure Act 2.0 Changes for Employers with 401(k) Plans:
- Employers must allow longer-term part-time employees to participate, including those with 1 year of service of at least 1,000 hours, or 2 consecutive years with 500 hours of service each year.
- Employers will be permitted to automatically enroll workers into emergency savings accounts, linked to employees’ retirement accounts.
- Contributions can be up to 3% of their salary, up to a maximum of $2500.
- These emergency savings accounts are like Roth accounts; contributions are taxed but withdrawals are tax-free.
- New employer plans created after 2024:
- Requires employers to automatically enroll workers into 401(k) and 403(b) plans once they become eligible while also allowing them to opt out if they so choose.
- The initial contribution rate must be at least 3% but not more than 10%.
- Contributions must increase 1% each year until reaching at least 10%, but not more than 15%.
- Plans created before 2025 do not have to follow these new rules.
- Exemptions:
- small businesses with no more than 10 workers
- new businesses operating for less than 3 years
- church and government plans.
Setting Every Community Up for Retirement Enhancement (SECURE) Act of 2019 (SECURE Act)
Setting Every Community Up for Retirement Enhancement (SECURE) Act of 2019 (SECURE Act) has changed the law regarding qualified tax-deferred retirement accounts:
- beneficiaries of tax-deferred retirement plans must receive the full distribution within 10 years after the death of the employee or account holder;
- the age for starting required minimum distributions has been increased from 70½ to 72;
- distributions from retirement plans can be penalty-free if used to pay for expenses of a birth or an adoption;
- pension and benefit plan administrators must disclose the plan's lifetime income stream to the beneficiaries;
- part-time employees may participate in 401(k) plans if they worked at least 500 hours annually for a minimum of 3 consecutive years and are at least 21 years of age at the end of the 3-year period that must start after 2020.
Choosing a Solo 401(k) Provider
Remember that what you can do with the solo 401(k) depends on both tax law and the retirement plan. Although many financial institutions offer solo 401(k) plans, most of them do not allow loans and some of them do not provide for a designated Roth account. Another major consideration is the investment options offered by the plan provider. Many plans offer few options. For instance, as of this writing, Vanguard only offers some of its mutual funds as an investment option. Investing in stocks, bonds, Treasuries, or even exchange traded funds is not permitted.