What is a Solo 401K?

If you are self-employed, then you might want to establish a Solo 401k. It is a retirement savings option available to people who work for themselves. If you own your own business and your only other “employee” is your spouse, then you still qualify for a Solo 401K. However, if you have your own business with additional employees, then you do not qualify for this plan.

A Solo 401K By Any Other Name

The IRS explains that the Solo 401K may also be known as a one-participant k plan, a Solo-k, or a Uni-k. However, it’s not the same as other plans to which it is similar. For example, it is not the same as a 401(k) or any IRA. A 401k plan is a retirement savings plan that’s offered by your employer when you are not someone who is self-employed. If you are self-employed, then you can create various types of IRA accounts for your retirement savings. These, too, differ from the Solo 401K.

You Are Both Boss and Employee

When you own your own business, you are the boss. You are also a worker. Therefore, you play two different roles in the business. One of the advantages of the Solo 401K is that you can contribute to your retirement savings in both roles. You can use your income as an employee to determine how much you are allowed to contribute. Plus you can also add additional contributions as the employer.

Annual Contribution Limits for Solo 401K

There are annual limits on how much money you can contribute to any retirement savings plan. In the case of the Solo 401k, there are limits for your contributions as an employee and additional rules for you as an employer.

The 2019 tax limit for employee contributions, also called “elective deferrals” is $19000. However, there are some exceptions:

  • If you are over age 50 then you can contribute up to $25,000 annually.
  • If you earn less than the annual limit, you can contribute up to the amount that you earned.

As an employer, you are required to contribute 25% of the employee’s earned compensation to the retirement plan. However, there are many caveats to this. A person’s total contribution, including both employee and employer contributions, is $56,000 annually, unless you are allowed catch-up contributions because you are age 50+. Moreover, there are additional calculations to be done to make exact determinations for your self-employed business.

Here is an example of how this might play out:

  • You own your own business and as an employee of that business you earn $100,000 this year.
  • Therefore, you pay $19,000 from your own personal money to max out your elective contribution.
  • Your business account contributes 25% of the $100,000 that you earned, which is $25,000.
  • $19,000 + $25,000 is a total of $44,000 for the year, which is less than the $56,000 annual cap, so you’re good to go.

Solo 401K vs IRA Plans

If you own your own business then you have a few different options for retirement accounts. The Solo 401K is for people who own their own business and do not have any other employees. If you have other employees then you would need to like at IRA plans instead. If you qualify for a Solo 401K then you can still opt for a SEP IRA instead, if you prefer that option.

In both cases, you are allowed a maximum annual contribution of $56,000 (or $59,000 if you are over age 50.) The different is that in the case of the SEP IRA, the business makes the entire contribution. In contrast, you as an employee make part of the contribution with the Solo 401K. Which plan is best for you really depends on your unique financial situation and the structure of your business. If you currently have no employees but believe that you will hire some soon, then a SEP IRA makes more sense.

You might also want to consider that the Solo 401K allows you to contribute to an individual Roth IRA if you so choose. In contrast, the SEP IRA doesn’t allow for that, although there are ways to convert a SEP IRA to a Roth IRA. Also, most Solo 401K plans have loan options whereas SEP IRA plans do not. Read the details of all plans that you are considering carefully to make sure you understand the options and their limitations.

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