What is Solo 401k?
A solo 401k is an individual 401(k) intended for business owners with no employees. In reality, IRS regulations state that you cannot make contributions to a solo 401k if you have full-time employees, though you can use the plan to cover up for you and your spouse.
You can contribute to a solo 401(k) as both “employer” and “employee.” The maximum contribution you can make as an employee in 2021 is $19,500 ($20,500 in 2022), or $26,000 ($27,000 in 2022) if you’re 50 years of age or older. While you may contribute up to 25% of your net adjusted self-employed income as an employer.
Traditional & Roth 401(k)s
When you take part in a standard 401(k) plan, the amount you contribute to your account reduces the amount of taxable income that your employer must disclose to the IRS. Income taxes on that money will therefore not be due until you withdraw it from your account, which is typically after you retire. Employers are increasingly providing employees with a relatively new 401(k) option called a Roth 401(k) (k). The amount you contribute to a Roth 401(k) does not lower your current income taxes or your taxable income. However, as long as you’re at least 59 ½ and your account has been open for at least five years, the money you remove after retiring is tax-free.
When you contribute a portion of your salary to an account in your employer’s retirement savings plan, both the regular 401(k) and Roth 401(k) offer tax benefits. Both allow for the account donations to be compounded tax-deferred. Both can be rolled over to an IRA when you retire or leave your work for any reason. And both have no income restrictions and usually start requiring minimum withdrawals after you turn 72.
Eligibility Criteria For Solo 401(k) Plan
- Eligibility Rules
There are no restrictions on age or wealth, but you must be a sole proprietor to make an investment in Solo 401(k).
- Tax on Contributions
Traditional 401(k): Pre-tax contributions lower taxable income for the year.
Roth 401(k): After-tax money is used for contributions.
- Contribution Limit
A total of up to $61,000 in the year 2022, or $66,000 in the year 2023, with a $6,500 catch-up contribution if you’re over 50 in 2022 and a $7,500 additional contribution in 2023.
- Tax on Qualified Distributions in Retirement
Qualified distributions from a traditional 401(k) are taxed as income. However, Qualified distributions from a Roth 401(k) are tax-free.
- How to Open
You can open a solo 401(k) with numerous online brokers as long as you have an employer identification number.
Solo 401(k) Contribution Limits
The maximum solo 401(k) contribution for 2022 and 2023 is $61,000 and $66,000, respectively. People who are 50 and older, have a catch-up payment of an additional $6,500 in 2022 and $7,500 in 2023.
To comprehend the regulations for solo 401(k) contributions, consider yourself to be both an employer (of yourself) and an employee (yes, also of yourself). Your contributions are subject to additional limits in each function under the overall $61,000 contribution limit in 2022 and $66,000 contribution limit in 2023:
- As An Employee
Your contribution as an employee may not exceed $20,500 in 2022, $22,500 in 2023, or 100% of your salary, whichever is less. Contributions for people over 50 will increase to $7,500 in 2023 and $6,500 in 2022.
- As An Employer
You have the option to contribute an additional 25% of your remuneration, which is calculated as your net profit minus your self-employment tax of 50% and the plan contributions you made for yourself, as the employer. Your contribution can only be factored in up to $305,000 in 2022 and $330,000 in 2023 in terms of pay.
Keep in mind that if you have a side business, employee 401(k) restrictions apply by person, not by plan. That means if you’re also participating in a 401(k) at your day job, the limit applies to contributions across all plans, not each individual plan.
Solo 401k tax advantages
The benefit of a solo 401k is that you can choose your tax benefit. You can choose the traditional 401(k), which allows contributions that lower your income in the year you make them. In this case, retirement distributions will be subject to regular income tax. The Roth solo 401(k) is an alternative that offers no initial tax advantage but permits tax-free payouts throughout retirement.
In general, a Roth is a better choice if you anticipate a higher retirement income. If you anticipate a decrease in income in retirement, use a traditional 401(k) to take advantage of the tax savings now (k). Due to these tax benefits, the IRS has quite rigorous guidelines on when you can withdraw funds from either type of account: With very few exceptions, any distributions made prior to age 59 ½ will be subject to taxes and penalties.
How to open a solo 401(k)
Most online brokers allow you to open a solo 401(k), but you’ll need an employer identification number. The broker will provide you with an account application and a plan adoption agreement to fill out. Once you’ve done that, you can set up contributions. You’ll have access to many of the investments offered by your broker, including mutual funds, index funds, exchange-traded funds, individual stocks, and bonds.Establishing the plan by December 31 and making your employee contribution by the end of the calendar year are requirements if you wish to make a contribution for the current year. Generally speaking, you have until your tax-filing deadline for solo 401k contributions for the tax year to make employer profit-sharing contributions.
Keep in mind that once the plan gets rocking, the IRS may require additional paperwork such as an annual report on Form 5500-SF if your 401(k) plan has $250,000 or more in assets at the end of a given year. Robo-advisor Blooom will manage your solo 401(K) at your current provider if you need help managing the money in it. You might choose an online planning provider if you want even more thorough financial assistance.