Small Business Retirement Plans Part 2: The Solo 401k
More and more, I see people quit the corporate America lifestyle and venture into owning their own business. This can take the shape of a freelancer, consultant, or someone who actually starts a new brick and mortar operation. Many of these folks will ask questions about whether they should incorporate their business or not which I have discussed in other articles. Once they become profitable, they often ask which kind of retirement plan would suit them best. For someone who is a business of just one, the Solo 401(k) provides a great option to help you maximize your retirement contributions. Here’s a little history on the Solo 401(k) and a little advice on how it can be a smart money move for your business.
The Solo 401k came about in 2002 after Congress passed Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA). EGTRRA added some small paragraphs to the tax code that put forward the solo 401(K) as the preferred retirement vehicle for the self-employed.
Before EGTRRA, a self-employed person had the ability to design a 401(k) plan just for themselves. However, there wasn’t a particularly compelling reason to do this because the deduction limit for a 401(k) plan was identical to a SEP-IRA. Many small business owners set up plans like a SIMPLE IRA or a SEP-IRA because they are slightly easier to administer traditionally than 401(k) type plans.
More like this: Small Business Retirement Plans Part 1 — The SIMPLE IRA
The tiny paragraph in the EGTRRA basically says the employee contributions to a 401(k) plan do not count toward the deduction limit. Since most business owners I have met over the years are usually interested in maximizing all available tax deductions for retirement, a solo 401(k) plan became preferred to a SEP-IRA. If the plan is set up correctly, a small business owner can not only put away as the ‘employee’ up to $18,000 for 2015 pre-tax, but may also be able to contribute up to an additional $35,000 pre-tax through a profit share to make the total pre-tax contribution $53,000 ($59,000 with catch-up contributions) in 2015– a $1,000 increase from 2014.
Self-Employed individuals and owner-only (and the owner’s spouse) businesses and partnerships can save more for retirement through a 401(k) plan. The Self-Employed 401(k) allows you to take advantage of this increased retirement and tax savings opportunity with a full range of investment options.
Solo 401(k) Quick Reference Chart
| Tax benefits | Tax-deferred growth, tax-deductible contributions, and pre-tax deferral contributions |
| Fees | No set-up or annual account fee |
| IRS maximum contribution | Salary deferrals up to $18,000 for 2015. |
| Catch-up contribution | Salary deferrals up to $6,000 for 2015 (if age 50+) |
| Profit sharing contribution | Up to 25% of compensation, up to the annual maximum of $53,000 for 2015 plan year |
| Establishment deadline | The deadline to open a new plan is December 31 (or fiscal year-end) |
| Administrative responsibilities | Annual Form 5500 filing after plan assets exceed $250,000 |
| Withdrawals |
Minimum required distributions starting at age 70½. 10% early withdrawal penalty if under age 59½ with few exceptions (hardship, permanent disability, and large out-of-pocket medical expenses are most common) |
It’s important that you do your homework on making sure the calculations are done correctly and the plan is set up correctly so you don’t contribute more than your allowed especially if you are self-employed. You probably shouldn’t fly solo on this 401(k), and get the help of a professional financial advisor and/or accountant. Remember, if you own a business where you take salary and distribution, you need to plan your salary level and what distribution level carefully to maximize your solo 401(k) contribution. The company you choose to set the plan up with will help you determine the type of investment you have in the plan, but it should be very similar to a corporate 401(k) plan with many different types of mutual funds and/or a self directed brokerage account.
Maybe this plan is right for you in 2015. Check back next when I’ll look at the Simplified Employee Pension plan- though you may know it as the SEP.
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