If you’re self-employed or you’re a small business owner with no employees other than a spouse, a Solo 401(k) or individual 401(k) can help you save considerably more for retirement than you could with just an IRA.
This type of account comes with astronomical contribution limits ($58,000 in 2021) when you consider both the employee and the employer contribution, and you don’t need a traditional employer or “boss” to open this account on your behalf.
The Solo 401(k) works just like it sounds like it would. Once you decide on an online brokerage firm, you take the initiative to open this account yourself. There are a lot of online brokerage firms to consider for your Solo 401(k), and you’ll want to compare all the top options before you open this account. This guide can help you understand exactly how Solo 401(k)s work and how much you can save. We’ll also provide insights into the best online brokerage firms to consider for your retirement planning needs.
Quick Solo 401(k) Rules Guide
Table of Contents
How Much Can You Contribute to a Solo 401(k)?
In 2021, individuals with a Solo 401(k) can contribute a maximum amount on the employee end and the employer side of the equation.
As an employee, individuals can defer all their compensation up to the annual contribution limit of $19,500 for 2021. The only exception is, individuals ages 50 and older can contribute up to $26,000 as an employee of their company.
Note: These figures are up from 2019, when employee contributions were capped at $19,000 or $25,000 for individuals ages 50 and older.
The rest of the contribution Solo 401(k) participants can make is on the employer side. Here, you can contribute up to 25 percent of your compensation “as defined by the plan” up to an annual limit of $58,000 total (up from $57,000 in 2020), or up to $64,500 if you’re 50 or older.
How does this actually work in practice? Consider this succinct example:
Ashley, age 51, earned $50,000 in W-2 wages from her small business in 2020. She deferred $19,500 in regular elective deferrals plus $6,500 in catch-up contributions to the 401(k) plan. Ashley’s business contributed 25% of her compensation to the plan for the year, or $12,500. Total contributions to the plan for the 2021 tax season were $38,500.
The above computation reflects the contributions the taxpayer can make if the business is established as a Subchapter S-corporation. If operating as a sole proprietor, Ashley would be required to first deduct the $26,000 “employee” contributions, as well as half her self-employment tax from her net business income before calculating the 25% “employer” contribution.
This is why I strongly recommend using the services of a CPA when you have a Solo 401(k) plan, or are contemplating establishing one.
Note that this type of plan allows you to contribute considerably more to a tax-advantaged retirement account than you could with a traditional 401(k) plan, which is limited to just $19,500 for 2021. The individual 401(k) lets you max that part out and contribute another 25 percent of your compensation on the employer side. The end result is the ability to save a ton for retirement and to reduce your taxable income in the process.
For reference, here’s how employee and employer contributions limits have changed for Solo 401(k) plans over the years for retirement savers under the age of 50.
| Contribution Year | Employee Contribution Limit | Total Annual Contribution Limit (Employee + Employer) |
|---|---|---|
| 2021 | $19,500 | $58,000 |
| 2020 | $19,500 | $57,000 |
| 2019 | $19,000 | $56,000 |
| 2018 | $18,500 | $55,000 |
| 2017 | $18,000 | $54,000 |
| 2016 | $18,000 | $53,000 |
| 2015 | $18,000 | $53,000 |
| 2014 | $17,500 | $52,000 |
| 2013 | $17,500 | $51,000 |
| 2012 | $17,000 | $50,000 |
| 2011 | $16,500 | $49,000 |
| 2010 | $16,500 | $49,000 |
How Does a Solo 401(k) Work?
As a reminder, a Solo 401(k) plan is nothing more than an individual retirement plan for self-employed people or small businesses without any employees. Also, remember that a Solo 401(k) is nothing more than a vessel you’ll use to save for retirement. You still have to choose the investments you’ll use within your account to build wealth.
The biggest benefit of this account is the fact that individuals who use it can contribute considerably more than they can with a traditional 401(k) plan, which in turn helps these individuals save more for retirement and reduce their taxable income.
As an employer, one of the main features of a Solo 401(k) is that you’ll need to determine what your actual income is to determine your maximum employer contribution, which can be up to 25% of your compensation. According to the IRS, your compensation is earned income, defined as “net earnings from self-employment after deducting one-half of your self-employment tax and contributions for yourself”. But once again, this depends on the business structure for your company.
Solo 401(k) participants can open their account with any brokerage firm they want, although online providers have become extremely popular due to the fact you can get started at home and on your own time, and often with access to an array of helpful investing tools and resources. Online brokerage firms also tend to come with low costs overall, which is another reason investors seek them out.
Solo 401(k) Rules You Need to Know
As you move closer to opening a Solo 401(k), there are some more details and rules you should know and understand. Here are some of the main Solo 401(k) rules that can help you figure out if this is the right plan for you.
Who Qualifies?
To qualify for a Solo 401(k) plan, you need to be self-employed or own your own small business. You cannot have any full-time employees except for a spouse. You can have a part-time employee and still have this plan, provided your part-time worker puts in less than 1,000 hours per year or less than 20 hours per week.
When Do You Have to Take Distributions?
Where you were required to take Required Minimum Distributions (RMDs) at age 70 ½ until 2019, the recent passage of the Setting Every Community Up for Retirement Enhancement (SECURE) Act bumped that figure up to age 72.
In short, this means you’re required to begin taking distributions once you reach that age. This is unlike the Roth IRA, which doesn’t require distributions at any age.
Note that you can take distributions without a penalty any time after you reach the age 59 ½.
When Does a Solo 401(k) Have to Be Established?
To make a contribution to a Solo 401(k) for 2020, you are required to establish your account before the end of the year, or by December 31, 2020. It’s possible to make contributions to a Solo 401(k) after the new year (and before your tax filing deadline, which is normally April 15) provided your business isn’t incorporated.
The $250,000 Rule
You should also be aware of one more rule. Once your Solo 401(k) plan grows to over $250,000 in assets, you’re required to file an annual Form 5500 EZ. You’re also required to file this form if you close your account.
When Does It Make Sense to Open a Solo 401(k)?
A Solo 401(k) isn’t the right investment strategy for everyone. Here are some scenarios when opening a Solo 401(k) makes sense:
- You’re a business owner and the only employee of your company: This might seem like a given, since this is the exact person Solo 401(k)s are for, but it’s worth mentioning that it’s also the only person Solo 401(k)s are for — if you’re not self-employed or if you have additional employees it won’t work to open a 401(k).
- You’re self employed and want a retirement plan your spouse can contribute to: Since you can add contributions from your spouse to a Solo 401(k), opening one could be a strong strategy if your spouse currently doesn’t have a retirement plan or if they haven’t maxed out other retirement contributions.
- You want the ability to take loans from the plan: While taking a loan from your own retirement plan isn’t ideal, the realities of being a small business owner could mean you want or need that flexibility.
Where to Get Help Opening an Account
You can open a Solo 401(k) with any brokerage firm that supports this type of account — most do. However, some online brokerage accounts do offer more perks and benefits than others, which could make them ideal.
What is a Brokerage Firm?
A brokerage firm is a company that helps buyers and sellers complete financial transactions. They earn money based on fees, or in some cases commissions, involved with the transaction. In many cases, special licensing is required to buy and sell financial products, which is where brokers are necessary and helpful. You might also find individual brokers who work independently, but typically brokers are connected to a larger team (their firm) that can collaborate to help with transactions.
How Can Brokers Help?
When it comes to setting up a Solo 401(k) a broker can help you set up a plan and process stock trades. Even if you want to direct your own Solo 401(k) you will still need a broker with the appropriate credentials to set up your plan and complete your trades.
What to Expect When Working With a Broker?
Not all brokerage firms are created equal. You can find some that take a hands on approach to managing your finances and others that will step back and allow you to do-it-yourself if that is your preference. You should expect that all brokers will charge a fee or commission. Some brokers might provide additional tools or resources, such as a mobile app or financial educational trading, that could make them a preferable option.
We compared some of the top providers to help you narrow down your list of potential options. There are lots of excellent brokerage firms out there with various pros and cons,
Summary
Opening a Solo 401(k) comes with a ton of important benefits, the most important of which is your ability to save more money for retirement than you would otherwise. Since contributions to a Solo 401(k) are tax-advantaged, you can also invest more to reduce your taxable income now, although you will pay income taxes on Solo (k) distributions once you begin taking them in retirement.
If you’re self-employed, you should absolutely consider opening a Solo 401(k), but you can also consider the SEP IRA, which works differently but comes with an annual limit of $58,000 for 2021.
And either way, make sure you compare all the top online brokerage firms to see which ones offer the internal investments you want with plenty of investing tools and resources. Also, make sure to compare fees so you know how much you’ll pay for account administration and any trades you make throughout the year.
What’s Going down i’m new to this, I stumbled upon this I have discovered It positively useful and it has helped
me out loads. I hope to give a contribution & assist different
customers like its helped me. Good job.
Hi Jeff – Question:
When the owner closes their business that is tied to their solo 401K and opens a new business in a different state – is it possible to change/move/update the existing solo 401K to the new entity? If not (which I think may be the case), and a new account with a new Trust EIN for the new company is required, what becomes of any loans against the previous solo 401K? Can the previous loan be assumed by the new solo 401k? Or is the unpaid amount considered a distribution?
Thanks – Gina
This is great information. Perhaps I missed this answer, but I have a lingering question: Does the money I put into my Solo 401(k) have to come from my business revenue or does it not matter? In other words, can I automatically contribute via the contracting company I work for since they don’t have a 401(k)? I am not an independent contractor in this scenario.
I/we contributed to our IRA for 10 years the actt. was dormant for 14 years.
Finding the document as of 2004 showing a nice balance I found that BANK ONE HAD BEEN ABSORB INTO CASE BANK .
After many phone many phone calls found informaion that my account had been completely depleted.
Seems that IRAs are not protected by bank lns.
Some one was able to withdraw all my funds.
This seems so unfair, and is a criminal act..
Seems that I have to prove that I never took any
Withdrawals
Having never received any statements from CHASE yet they have my present address on file.
Something is really wrong here.
Hi Dean – You may want to talk to an attorney.
Thank you for a very informative article Jeff.
I have a question rather than a comment if I may?
I understand the employee portion of contributions to a solo 401k are subject to FICA taxes, but am wondering if my employer portion of contributions would be excluded from FICA, as in the case of a traditional 401k? Sorry if it was explained in your article and I misunderstood. It’s hard to put aside this much as a self employed person if you have to pay the FICA on both sides.
Hi Brenda – I’m not an accountant so I don’t know the specific answer to your question. But since a solo 401(k) is simply a 401(k) plan for one person, my guess is the rules are the same as for an employer plan. In that case, the employer match can be deducted from income before calculating the FICA tax. But that’s just an educated guess, you might want to check with an accountant.
There is no such thing as a “solo 401k” plan. A 401k plan is just a 401k plan. The rules for how to run it change depending on whether or not there are common law employees, but you should not have to “switch” from a solo 401k plan to a “traditional” 401k plan. They are all the same (assuming you haven’t bought into some weird legal document that is calling itself a “solo” plan and therefore contains legal restrictions that shouldn’t be there). See my article: What is a Solo 401k Plan at http://www.consultrms.com/Resources/55/Solo-401(k)/126/What-is-a-Solo-401(k)-Plan. As well as IRS website: https://www.irs.gov/retirement-plans/one-participant-401k-plans
Hi Annemarie – That’s somewhat true, except that the IRS does have a dedicated website for the solo 401(k), and the convention is to consider it as it’s own thing. It’s basically a 401(k) for one person (plus that person’s spouse), but it’s not entirely unique.
In order to qualify for a Solo 401k, do you need to have an Inc. or any other entity?
Or is it also possible, to just have an LLC?
Or even no type of company at all – just working as a Freelancer with your name and personal liability?
Another thing I wonder about the Solo 401k:
If you are self-employed you don’t have the opportunity to get an employer to match your contributions. That’s what I would see as the real “free” money and the true benefit of a 401k plan.
In the end, starting a Solo 401k … well, it’s all your money that’s going to be invested.
So what’s the real benefit of starting a Solo 401k then?
Thank you so much for any little help, appreciate it.
Hi Ben – You don’t need any type of business format, you can just file a Sch C or be a freelancer. You’re right, the “employer match” comes from you, but then it allows you to take a bigger tax deduction. The benefit is that you can contribute more to a solo 401k than you can for most other plans on less income.
What kind of rate of return (interest) do I make with the Solo 401(k)?
Hi Christopher – A Solo 401k is a self-directed investment account. The return is entirely dependent on what you invest the account in.
Hi, I created my solo 401k account and am interested in investing in real estate. My question is whether I can invest in a property with another investor that is not part of my solo 401k?
Thank you for your time.
Hi Sandra – I don’t know about direct investing in real estate through a solo 401k, but it is permitted with IRAs – IN THEORY! In practice, there are about a dozen violations that can get your plan killed. One of the big issues is that as holder of the plan you can’t participate directly in real estate investing. Talk to a CPA about this, it’s a true gray zone.
I just stumbled unto thi ssite searching for Solo 401k information.
I have a 401k from a previous employer while I was employed there and the account is sitting idle, yet still earning about 16% for 2017 (not bad). I am self employed now (same industry) and was thinking about rolling the 401k into a Solo 401k so I can make alternative investments.
My question is: must I may myself as a W2 employee in order to contribute into the Solo 401k account, or do I simply just cut checks into the Solo 401k account until I max it? I have an S Corp, so all Net Income flows to my 1040.
I wanted to have a checkbook controlled Solo 401K. Is this a different way of opening the account, or are ALL Solo 401k accounts checkbook driven?
My plan is to LEND, as a private lender, funds from my Solo 401k. I may charge “points” on top of my requested interest rate. Is ALL income derived through the investment transaction considered earnings for the Solo 401K account, or only the interest rate on the note? For example, would be points charged for the loan also be considered earnings for the account, or that disallowed?
Thank you so much for in advance for your comments.
Hi Joe – You should be able to set up a solo 401k for you S corp. But I don’t think you can make private loans to individuals out of the account. Please consult with a tax attorney on this point, it’s not something I’ve ever heard of.
Is there a way me to put money into a SEP IRA or Solo 401k with my newly-opened single member LLC Blogging business? Right now it doesn’t have any profit and will probably not have any for the first 2 years, based on what I’ve read on other blogs.
A primary reason for opening my business was to boost my retirement savings. I’m a W-2 contractor who makes too much to contribute to T-IRA or R-IRA, and my employer does not have a good retirement plan.
It’s starting look like creating an LLC will not boost my retirement saving for a few years until it become profitable.
Thoughts?
Hi Major – You can’t do it on your blogging business until you have income from it. But you might be able to do a solo 401k on your contractor income. But I believe your employer will have to switch you over to a 1099 for you do to do that.
I have 100% ownership of an IT Consulting s-corp with only myself and my wife as W2 employees. I have a Solo 401k setup currently but I have only made contributions for myself.
Wife has her own beauty business, s-corp, 100% ownership, part-time employees who may become full time eventually. No 401k setup.
1. Are we both eligible to make Solo 401k contributions under my company?
2. Is she still qualified to make Solo 401k contributions under my company if she has full-time employees in her company?
3. If she takes on a partner in her company, would she still be eligible for my company to make Solo 401k contributions for her?
Hi Brian – My understanding is that she must be an employee of your company, and earn wages to be eligible. The fact that she has another business isn’t a factor, unless she has a plan there and is at risk of exceeding the cumulative maximum to all plans of $55,000. Check with your CPA to be sure.
If the wife has to be a wage earner, can she be 1099d by the husband or does she have to be W2?
I think the 1099 would work. She has to actively participate in the business. But check with your tax advisor before making any contributions. The 1099 route may open up other requirements.
Remember: In addition to Solo 401K you can also contribute to a traditional IRA for you and your spouse whether she works or not. For 2018 that comes to a deferral of $74,000.
I wish that were true Charles! The maximum contribution to all plans is $55,000 for 2018, or $61,000 if you’re 50 or older. You can have both plans, but the amounts contributed will have to fit neatly within the overall maximum for all plans. Like $5,500 into the IRA, and $49,500 into the Solo 401k, if you qualify to contribute that much to the plan.
I have taken your advice and set up a Solo 401K (through E*TRADE) for myself, an independent contractor. As the plan year-end approaches, I want to “elect” to make the 401K contribution. How is the election made? Is there a form? How should this paperwork be saved?
Thanks!
Rob
Hi Robert – You can check with E*TRADE, they’ll have a specific process for that, including the forms. Also, what do your plan documents proscribe for the contribution process.
So glad I found this site and string of messages. I have a single owner S Corporation. My accountant is pushing me to setup a 401K for the business. I have no employees and no intentions of hiring any in the future. I also do not plan on contributing more than $5,000-10,000 year. I am pulling about $85,000 in salary and the corporation has about $150,000 worth of profit.
I raised the question of a SEP IRA and again was pushed towards the 401K, which brings with it a $4,000 setup fee as well as an annual fee of about $1200. All run through the investment contact he provided.
For many years I have been contributing to a SEP IRA but now that I started this single owner S Corp, I am aware that I am no longer able to personally self-contribute to my SEP-IRA since I am now an employee of the S-Corp. That said, I thought that the S-Corp is allowed to make contributions to my own SEP-IRA, up to 25% of my W-2 income. Instead of me personally receiving the tax deduction for the contribution, the corporation would receive the tax deduction (which would still benefit me).
Am I missing something? I do see the benefit for offering a 401k to potential future employees, as well as being able to potentially increase my own contributions in the future (if I wanted to go above the 25% limit of my W-2 income) but as of now, I have no plans to do either of these things.
What other benefit would there be to setting up the 401k at this point in time? I don’t want to leave a great opportunity on the table by only utilizing the SEP if there are other advantages that I am not understanding.
Thanks so much for your help!
Hi Paul – For most businesses, a solo 401(k) will allow for larger contributions than SEP IRA, but not in all cases. I also don’t see why you have to abandon the SEP IRA due to the S Corp status. However, there are some quirks with the SEP IRA when it comes to S Corps, and that may be what your accountant is referring to (he’s probably right). But you might want to see if you can find a plan that will be less expensive.
Paul, your accountant should be able to steer you to a Solo 401k plan with NO setup fees and NO annual fees, such as e*trade. There is no need to pay an investment company those inflated fees for a Solo 401k account.
Hey Jeff – I’m curious how / where you set up your solo 401k that allowed you to invest in non-traditional things like Lending Club (I assume this would also include crowdfunded real estate like Fundrise)? What are the administrative costs / headaches that come with that? Thanks!
@Jake I set it up with a local company that specializes in 401k plans. It’s definitely more expensive than a SEP IRA with the 5500 preparation and the fact I now have employees.
There are no headaches since they take care of it. Cost wise it’s about $1k per year.
Situation: Husband and wife both have W2 paying jobs, husband also is an independent contractor, hired on an as needed basis for the same services, at two different unrelated locations, paid directly via 1099. He does not work with any partners or have employees. Husband wants to setup solo 401k, and already contributes the maximum 18k to his w2 Jobs traditional 401k. He would like to put the maximum possible into the solo 401k, as close to the $54,000 limit.
1) Assuming he now can only make employeR contributions since he already reached 18k at his W2, up to 54k/100% earnings limit directly as an individual or does he have to form an LLC to make a profit sharing plan work?
(Or in another way, how does IRS know whats employee and employer contribution? If I work for myself as contractor, can I just fund my solo-401k up to the limit 54,000 throughout the year or do I need a different entity to be the “employer” to make that contribution? tryna figure out exactly what to do before I open an account)
2) if the gross amount earned from both job sites in the 1099 totals $100000, would the amount he can place as employer contribution be 20% of that or 25% of that?
Hi Peter – The solo 401k is pretty flexible so you don’t have to form an LLC to be the “employer” in the arrangement. You can be the employer even with a Schedule C. The employer portion will be based on the business profits.
The contribution will work out to be 20% effectively, since the IRS requires you to reduce your income by the amount of the contribution before calculating the contribution. That works out to be 20%. If you’re doing this for the first time, set it up with an accountant so you get the numbers right. The IRS has all kinds of tricky calculations you must follow.
“For both the SEP IRA and Solo 401k you would be able to make a $21,175 employer contribution (25% X $84,700, which is Net Earnings after self-employment tax is deducted).”
Incorrect for sole-proprietor owner!
The max profit sharing rate is 25% BUT it is ADJUSTED to the owner so using the max rate of 25%, it’s really 20% (formula is provided at IRS website in its publications) and has NOT changed for Years!
The Solo 401k is Better than the SEP IRA because of the 401k feature and that the profit sharing feature is Already Part of the Solo 401k.
The only other difference is that there is a possible fee involved because of the 401k plan section of a Solo 401k whereas there’s no such fee for the SEP IRA.
You’re correct, and I am aware of that calculation. We’ve included that factoid in some other retirement posts, but since this was one of the first, we left it out. We’re trying to do an overview without going so deep as to confuse.
The IRS has a convoluted calculation where you must first reduce your income by the amount of your contribution before calculating your contribution, which is something that usually only accountants understand. The net result is that the actual contribution is 20%, not 25%. (20% works out mathematically to be 25%, less the 20% contribution.)
Trust me, it wasn’t an oversight, but rather an attempt to avoid paralysis by mathematics. As I said, we’ve included that in other posts, but I’m not sure many readers can follow it. It’s sometimes best to present the basics then leave the number crunching to the accountants.
Husband and wife with an LLC recognized as a Sub S for taxes. If I make $18K and my husband makes $5k in the Sub S, both over 50, no other employees, how do I fill out a W2? Since the entire amount can go into our solo 401Ks is box 1 0 and box 3 and 5 the corresponding wages, $18 and $18K (and $5k and $5K) and then 12d indicates profit sharing? When do I need to pay then the SS and Medicare on the 940 and state? Each quarter or at end of year?
Thank you.
Hi Lou – That’s a payroll tax question, so I think you need to get input from an accountant. This is REALLY important since the penalties for filing errors on employer payroll taxes can get ugly. Please get help with this.
Hi Jeff,
Regarding Solo401k, I am Realtor in CA, simultaneously I work as a consultant in IT earning W2. Can I open Solo401k as Realtor and move my previous employer 401k funds/IRA funds to new Solo40k opened. Also can my spouse (just helping me on real estate research and not working anywhere) contribute her previous 401k/IRA funds in to the same solo 401k funds that I open as trust. If so Can we both together invest in real estate transactions like buying together fixer uppers and fix and sell and contribute back all profits back to the same solo401k tax free?. Please suggest.
Thanks
Hi DK – You’ve got a lot going on there so I’d definitely consult with a CPA before doing anything. But I think you can set up the solo 401k for your realtor business, and then move your current retirement balances there. Your spouse could do the same if also participating in the plan through the real estate business. You can contribute what ever the legal limit is based on your real estate income. But as I said, consult with a CPA for all that you’re trying to do.
Excellent article on the benefits of the solo 401k. I am a conservative saver, and have had an IRA since I was 16, but had no idea this option was open to me! My question is WAGES vs COMPENSATION. Assume an S-corp earns $136,000 a year, and pays $36,000 in W-2 wages to the owner and sole employee, with the remaining $100,000 in distributions (not subject to payroll taxes). What are the contribution limits?
A) Flat $18,000 employee contribution and B) the employer contribution is 25% of what? $36,000 (WAGES) or $136,000 (TOTAL COMPENSATION)?
Also to me the huge advantage of going this route is that the $18,000 can be a fully tax-free ROTH account! Would be nice to emphasize that in the article. Even if one doesn’t take the employer contribution, the ability to sock away $18,000 in a Roth account is amazing!
Hi Pat – The contributions would be based off of your $36,000 in W-2 wages. That includes both the $18,000 employee contribution and the 25% employer contribution. The $100,000 distribution is considered to be a dividend, and therefore unearned income. Under IRS regulations, it doesn’t qualify to base contributions on. But this provision is unique to S corporations.
I don’t believe that you’re right about $18,000 going entirely to a Roth account. I believe that the maximum for the Roth is $5,500, with the rest of the contribution going into your regular account.
Hi,
I am the sole owner of an LLC and just starting out with saving for my retirement. I am 34 years old and earn on average about 70-80k a year from my business. I am thinking of starting a Roth IRA & a Solo 401k account. My question is, who or rather which investment firms are most trusted and respected in the industry to establish these accounts with? Thank you, Katie
Hi Katie – There’s no simple answer to that question! It really depends on what you’re looking for. For example, are you looking for a fully managed investment account, or do-it-yourself? You might call around to the various investment brokers and see if what they have to offer will work for you.
Fidelity has the best no fee simple 401k plan (no loan option and no Roth 401k option). Fidelity funds have no transaction fees and some funds have very low expense rations (FUSEX/FUSVX). Etrade has a more robust option with no upfront fees and a loan and Roth 401k option, but you will be paying more transaction fees as you will be paying fees for mutual fund transactions. Capital one solo 401k (called Spark 401k) charges an asset management fee and other fees which total under 1% a year but this is still a lot, and can be a considerable drag. But they do all the investments for you.
Check out the blog white coat investor, solo 401k for more info. I chose Fidelity. Choose what’s right for you.
Good Luck.
Let’s say you have a one person S-corp that has a good year 1 and makes $200K net profit. They pay out $60K in salary, $40K in distributions and the company keeps $100K of this money in the corporate bank account as retained earnings. (They pay various taxes on the full $200K of course.)
In year two, the company only makes $10K net profits, but there is enough in the corporate bank account to still pay the sole employee a salary of $60K.
My question is: In year two, could the employee with $60K in W2 income still make an $18K Solo 401K contribution with a $15K company match? (This would be paid from the retained earnings the year before.)
The reason I’m confused is you can only make contributions from Net Income. In year two, the company didn’t make enough in Net Income to cover the salary, let alone the matching. But the employee would have W2 income…
Hi MM – That’s an excellent theory question to ask your CPA! I’m not a CPA, but I’m going to guess that it will be based on your net personal income from the S corp, which you of course are the owner of. You MAY be able to make the full employee contribution, but then again you might also have to net out the business loss (which will flow to your 1040 by a K-1 from the S Corp) from your salary. That’s why you need to ask your CPA about this. The IRS regs give an overview but they don’t address specific situations such as yours.
Hi – great questions and comments. I’ve learned a lot.
My husband has 1099 income for a sole proprietorship. We file joint taxes. We both have other jobs with 401k, or in my case a pension annuity. We opened a solo 401k last year to move an ira I received through a divorce in order to do other types of investments, mainly promissory notes).. I do not now, and do not plan on making contributions to this account other than dividends from payments. Do I need to be on a w2 payroll? My assumption from reading through comments is that I do not need to be, but I want to be sure I am in compliance.
Hi Fran – Since you don’t plan to make ongoing contributions you shouldn’t need to be on the payroll. But I think you will need some other “connection” to the business to roll the money into the plan. Please consult with an accountant to make sure you get this right.
Jeff, thanks for the great info and advice. I took it and created an individual 401(k) account in 2016. I own a sole proprietorship business and in addition to my contributions to my traditional IRA, I’d like to make a 2016 pre-tax contribution to my individual 401(k). Where do I report this on my tax forms so that I get a deduction?
Hi Doug – You should be able to report the contribution on Line 28 of your 1040 page 1, “Self-employed SEP, SIMPLE, and qualified plans”. If you use a tax software package it should go there automatically.
I did a calculation for a 62 year old sole proprietor with no employes earning 65,278. The Solo IRA came out to be 36,133. Can I deduct that whole amount in the 1040 Line 28?
Hi Ernie – It may be right, but I’d check it with an accountant first. It’s a big deduction and it will draw IRS attention. They do have some weird algorithm to calculate it, so it’s best to be absolutely certain before filing.
I made an investment (business loan) with an LLC operated by my sons to buy condos. Is there a way this can be considered income for the purpose of using a Solo 401K?
I am currently not working for anyone else, so no 401k option.
Thanks, great information!
Hi Darin – The rules as to what constitutes self-employment income for a solo 401k are pretty liberal. Since it was a business venture, the profit you earned could be considered business income. I’d discuss the best way to handle this with a CPA, since it largely depends on personal circumstances and the tax presentation.
er 50.
I am contributing $24,000 under 403b. I am contributing $24,000 under 457.
If I have Schedule C income (separate job) of $80,000, given the above, how much can I contribute to a solo 401k?
And can I still make a non-deductible Traditional IRA contribution of $6,500?
Thanks in advance.
Hi Vernon – You’re limited to a maximum of $54,000 total from all plans, so you may not be able to make the full IRA contribution. Discuss this with your CPA.
What happens to the Solo401K when you stop being self employed, i.e., retire.
Can you keep it open (like an employer 401K) or does it have to be rolled over to something else like an IRA?
Hi Ron – You should be able to continue to keep the 401k open even after you retire. You’re the owner of the plan. Now if you liquidate the company, you may also need to distribute the 401k proceeds. You may want to talk to a CPA if that’s the case.
Hello,
I have an LLC for which I am the sole proprietor and I am thinking about opening a Solo 401k. I am also starting another LLC with a friend (not a spouse) this year. We are both owners. Can I can open the 401K under my new business with my partner (would be beneficial as the second business will bring in more income thus allowing for maximum contributions/yr) or do I have to be the solo owner of the business?
Hi Tivere – You should be able to under the original LLC for which you are a sole owner. As to the second business, I believe that it is ineligible for a Solo 401k since there are two of you. But you can open a regular 401k for that business. But either way, your contributions will still be limited to $54,000 per year ($60,000 if you’re over age 50) in all plans in total.
Hi, Thanks for a great article! I’ve been doing lots of “research” (Google) on this subject. According to this website https://www.401kcheckbook.com/checkbook-control/checkbook-control-401k/ having partners does not disqualify you from having a Solo 401k. Any updates on this?
Hi S – That’s correct. You can qualify for a Solo 401(k) based on income from a partnership. But as far as I know, you can’t do it if the partnership sponsors the plan. It has to be your income individually.
Thanks for this thorough article and question replies Jeff.
I am setting up an LLC (taxed as a partnership) and have two questions about setting up a solo401k in the future.
The members of the LLC will be me and a C-corp I control, and perhaps also my wife. Does anything about the ownership structure affect the use of a solo401k that both my wife and I could make contributions to?
At present I don’t plan for either of us to have a W2 salary from the business. Do you have to have W2 income to make solo401k contributions or can you do so based on net profit distributions to each partner? If she were not an LLC member/partner is there still a way for her to make contributions to a solo401k? [ok, i guess that makes it three questions…]
Hi Jeff – The set up with the C corp is a complication, and I recommend you consult with a CPA about it. The IRS MAY view the corp as a “third person”. If so, you can probably just set up a regular 401k instead. But that’s why you need to speak with a CPA.
Hi Jeff,
Thank you for great article. I have a scenario for you – I have a LLC business opened back in 2012 and until 01/2017 I was employed.
Employer had a 401k plan.
Now in 2017 my business is my 100% income /contracts 1099/. We were thinking to put my wife and me on payroll. Can my wife and I open solo 401k and contribute /deducting from payroll/? Is the payroll good idea?
Not planning to have more employees just two of us.
Thank you
Hi Peter – You should be OK with the solo 401k if it’s just you and your wife. Payroll is the easier way to contribute. You can use it to contribute up to $18k per year, or $24k if you’re 50 or older.
Hi Jeff,
If my salary is $18,000 and I am contributing entire $18,000 as an employee to solo 401K.
Do I still have to pay employ portion of FICA taxes on $18,000? If so do I add15% of FICA tax ~$2700 to $18,000 and make paycheck $20,700?
You must still pay the FICA taxes. The contribution defers the regular income tax, but not the FICA portion. As to the amount of the contribution, the IRS has a matrix-like calculation provided on its website that you’ll have to see to believe.
Question: I am an independent contractor, first year in business, so I have not paid any taxes yet on my earnings yet. I will end the 2016 year making $14,000,. If I set up a solo 401k before 2017, could I put in the whole $14,000 and avoid taxes on it? I have a home office and internet/cell phone deductions I was planning to take on the business, but should I just put in the entire $14,000, or take the deductions and put in the leftover amount? I was under the impression that I had to pay social security and medicare payroll taxes no matter what, is that not true with a solo 401k?
Thanks!