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 similar to the 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 will have to 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 is equal to 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to a designated Roth account, which does not reduce current taxes, but both principal and earnings are tax-free when withdrawn, just as with a Roth IRA.
The employee contribution is limited to the lesser of 100% of compensation or the statutory contribution limit for that year, which is $18,000 for 2015, and $24,000 for taxpayers who are at least 50, which includes the catch-up contribution of $6,000. Total contributions cannot exceed the statutory limits plus any allowed catch-up contribution. So for taxpayers under 50, the statutory limit for 2015 is $53,000; for taxpayers who are at least 50, the limit is $59,000, when the additional catch-up contribution is added. 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 + |
|2015 - 2017||$18,000||$6,000||$24,000||$53,000||$59,000|
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, assume that you are at least 50 and you earned $100,000 in 2015 in self-employment income. To calculate the employer contribution, you would have to 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 + $18,000 + $6,000 = $42,587
Note that if a taxpayer earns more than the contribution base, which, in 2015, was equal to $265,000, then the maximum contribution under either plan would be equal to the statutory limit of $53,000.
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.
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.