The Benefits of a Solo 401(k)

Dec 7, 2021 | Retirement, Tax Topics

As true wealth managers, we are always looking for potential strategies to help our clients with their current objectives as well as their long-term goals. One of the many areas that we help with is year-end tax planning. By working together with our clients and their CPAs, we strive to implement the best tax planning strategy for their specific needs. One beneficial tool is the Solo 401(k), (also known as a Self-employed 401(k) or an Individual 401(k)). Not only can the Solo 401(k) lower current year taxes, but it is also a great way for self-employed individuals to put large amounts of money away for retirement.

What is a Solo 401(k)?

A Solo 401(k) is a retirement plan that covers a self-employed individual with no employees or a self-employed individual and his or her spouse. The Solo 401(k) has become the premier retirement saving vehicle for the self-employed.  Unlike normal 401(k) plans, there is no discrimination testing for Solo 401(k)s because the plan only covers one or two people. One of the main benefits of a Solo 401(k) is the plan allows for the participant to contribute money as both the employee and the employer. This key feature allows for participants to make larger contributions in any given year than they could to other retirement saving options, such as a SEP-IRA.

Who Can Contribute and How Much?

As mentioned above, to qualify for a Solo 401(k) you must be a self-employed individual with no employees other than your spouse.  This self-employed status can be achieved as a sole proprietor, consultant, or independent contractor for an LLC, Partnership, or Corporation. You must also have active income to contribute to your Solo 401(k). Most Solo 401(k)s allow for pre-tax employee salary deferral contributions, employer profit sharing contributions, Roth employee contributions, voluntary after-tax contributions, and catch-up employee contributions. Below you will find the 2021 contribution limits:

Tax Year Annual Contribution Limit Age 50+ Catch-up Contributions
2021$58,000$6,500
2022$61,000$6,500
The annual contribution limit includes both the employee and employer contributions combined. The maximum employee contribution in 2021 is $19,500 and in 2022 is $20,500. Anyone age 50 or older can also make a catch-up contribution of $6,500. In addition to the employee contribution, the self-employed individual can make employer contributions. The maximum employer contribution amount is 25% of gross income if your business is a corporation and 20% of net income if your business is a Sole Proprietor or Partnership. The sum of the employee and employer contribution cannot exceed the annual contribution limit listed above.

Key Information

If you would like to make 2021 Solo 401(k) employee contributions, the plan itself must be adopted and established before December 31, 2021. While you can make contributions (employee and employer) in 2022 for tax year 2021 (up until the tax filing deadline including extensions), you will not be allowed to make employee contributions if the plan was not established before this date. Hence if you plan to adopt and open a Solo 401(k) it is a best practice to have all documents executed and signed by December 31, 2021 to ensure you have full funding capabilities. Things to know:

  • To open a Solo 401(k) you must obtain an employer identification number (EIN) for the plan itself.
    • NOTE: this EIN is separate from any EIN associated with your business or your SSN.
  • You may be able to make a Traditional or Roth IRA contribution in the same year in which you contribute to your Solo 401(k).
    • This depends on your ability to meet certain rules (i.e., income limitations, etc.).
  • If you hire a full-time employee other than your spouse you will no longer be eligible to maintain a Solo 401(k).
  • If the value of your Solo 401(k) plan exceeds $250,000 as of December 31st of any calendar year, you must file a form 5500-EZ for that year.
    • The form must be filed by July 31st.
  • Solo 401(k)s are subject to Required Minimum Distributions (RMDs) beginning at age 72.
  • Most brokerage firms/custodians provide prototype Solo 401(k)s when you the employee act as the plan’s Third Party Administrator (TPA).
    • You may also have a Trust drafted plan and use a separate TPA.
      • It is best to work with your financial advisor and/or CPA to determine what works best for you.
    • It is important to work with your CPA determine allowable yearly contributions.

Year-end is an important time for financial planning. Proactive decisions can help your current year outlook as well as pave a smooth path forward. SageVest highly recommends that you consult with your CPA and your financial advisor to determine the correct next steps.  To learn more about our true wealth management approach and how SageVest can help you achieve your financial objectives, we welcome you to contact us or visit our website.

Prepared by SageVest Wealth Management. Copyright .
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