Saving for retirement as a self-employed individual can be difficult. Without an employer setting up and contributing to a 401(k) or similar plan, retirement savings often fall off the radar. But if you are self-employed without employees, you and your spouse have access to one of the most powerful and underutilized retirement planning tools available: the “One-Participant 401(k) Plan.” These are also referred to as Individual 401(k), Solo 401(k), or Uni-k.
Higher contributions
The Solo 401(k) is powerful for a variety of reasons including high contribution limits, tax advantages, and low administration/costs. The features of this plan are similar to 401(k) plans: Contributions are made pre-tax (not taxed) and investments grow tax-deferred until they are withdrawn at ordinary income tax rates. Just like many corporate plans, you also have the ability to make ROTH employee contributions, which are contributed after tax but withdrawn tax-free. The employee contribution limits to a Solo 401(k) are the same as corporate plans ($18,500 per year plus a $6,000 catch-up contribution for those age 50 and over in 2018), but you also have the ability to control your profit share. As the owner of the company, you can contribute 25% of compensation as defined by the plan. This means that in 2018, a 55 year-old sole-proprietor making $100,000 would be able to contribute $43,087. As a single filer, this would save about $9,479 in 2018 income tax. The total contribution amount in 2018 will be capped at $55,000 ($61,000 for age 50+).
Fewer costs, more control
Costs and administration of the Solo 401(k) account are similar to an IRA. You will be subject to fees associated with a custodian holding your account and the underlying investments you choose, but will avoid administration costs typically found in corporate 401(k) plans. Avoiding third party administrator, custody, and revenue sharing fees associated with corporate retirement plans could save $3,500 a year. Essentially, you have the ability to pay only for the services you find valuable. A Solo 401(k) also enables you to choose the investments that are right for you – unlike a corporate 401(k) plan in which you are typically limited to the investment choices offered by that particular plan. The Solo 401(k) plan doesn’t have any testing or reporting requirements until assets reach $250,000. Once assets cross this threshold, you are required to submit Form 5500-SF or 5500-EZ to the IRS.
Having employees other than your spouse will typically disqualify you from being able to set up a Solo 401(k) unless the employees are under age 21, work less than a 1,000 hours a year (owner and spouse exempt), or operate as independent contractors.
More savings options
A Solo 401(k) can also be used to open the door for other planning strategies. An employee who already participates in a 401(k) plan through work, but also operates a side business could open a Solo 401(k) to reach the combined contribution limits. Those with income too high to contribute to a ROTH IRA could transfer IRA accounts into the Solo 401(k) allowing them to make Backdoor ROTH IRA contributions without being subject to the pro-rata rule. The Solo 401(k) can also allow for in-plan ROTH conversions providing another financial planning tool to control when taxes are paid.
If you are self-employed without employees and looking for a tax-advantaged savings tool, ask your financial advisor about a Solo 401(k). It may just be your ticket to retirement success.
| Eligibility | Business owner and spouse without any eligible employees. |
|---|---|
| Employee Contributions | $18,500 Elective Deferral plus $6,000 catch up contribution for age 50+ |
| Contribution Deadlines | Sole Prop. or LLC must elect by Dec 31 and contribute by tax filing. C-Corp or S-Corp deferral contribution must be made when income is earned |
| Employer Contributions | Lesser of 25% of Compensation as defined by plan and $55,000. |
| Contribution Deadlines | Employer profit sharing contribution must be made by tax filing deadline. |
| Annual Contribution Limits | Combined contributions can’t exceed $55,000. Age 50+ limit is $61,000 |
| Non-Discrimination Testing | None |
| Annual Report | Form 5500-SF or 5500-EZ. Exempt until assets reach $250,000 |
| ROTH option | Yes, Employee Contributions Only. |
| Loans Allowed | Yes, if allowed by the plan. Lesser of $50,000 or 50% of account value |
| Set up Deadline | December 31 st for calendar year employers |
W. Devin Wolf, CFP® is the Chief Investment Officer and leads the 401(k) branch at Financial Plan Inc. He partners with business owners, CEOs and executives to create comprehensive financial solutions tailored to their individual goals. Learn more at: https://financialplaninc.com/ .
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