Self-employed? A Solo 401(k) Plan may be Right for You

If you are a small business owner, retirement planning may seem like a daunting task.  But if you don’t have any employees and have steady self-employment income, a solo 401(k) might be the right option for you. This strategy is great for self-employed people, such as sole proprietors, members of single-member limited liability companies, and those who run other one-person businesses.

Solo 401(k) Contributions

You may be able to make sizable annual deductible contributions to a retirement account with a solo 401(k) plan.

You can make an “elective deferral contribution” up to $20,500 of your net self-employment (SE) income to a solo 401(k) plan for 2022.  If you will be 50 years of age or older as of December 31, 2022, the maximum contribution for elective deferrals is increased to $27,000, which includes an additional $6,500 catch-up contribution.

For solo 401(k)s, an additional contribution of up to 20% of your net SE income may be made on top of your elective deferral contribution. Although there isn’t really an employer when you work for yourself, this is referred to as an “employer contribution.” (The percentage is 25% for employees.) Your elective deferral contribution is not deducted from your net SE income when determining the employer contribution.

The sum of the employer contributions and elective deferrals for the 2022 tax year may not exceed:

• $61,000 (or $67,500 if you turn 50 or older by December 31, 2022)

• Your entire net SE income.

Net SE income is equal to the business’s net profit as reported on Schedule C, E, or F of Form 1040 less the deduction for the business’s share of the self-employment tax, which is 50%.

Solo 401(k) Benefits

Another benefit of a solo 401(k) is that contributions are optional. If money is scarce, you can give a little or nothing.

In addition, provided the plan contract permits it, you may borrow money from your solo 401(k) account. The maximum loan amount is  50% of the account balance or $50,000, whichever is less.  Loans are not permitted under some other plan options, including SEPs.

The major drawback of solo 401(k)s is how complicated administration of the plan is. Adopting a written plan document and figuring out how and when elective deferral contributions will be collected and paid into the owner’s account are among the significant upfront paperwork and continuing administrative tasks that are needed. Additionally, you must submit Form 5500-EZ to the IRS every year if your account balance exceeds $250,000.

You cannot operate a solo 401(k) plan if your company has one or more employees. Instead, you are required to have a multi-participant 401(k), with all the difficulties it entails. You might have to make contributions for those employees in accordance with the tax laws. There is a crucial exception, though: You can deny 401(k) plan coverage to workers who are under 21 or who haven’t worked at least 1,000 hours in a calendar year.

A solo 401(k) can be a wise retirement plan decision for a one-person business if:

• You have the funds and want to make large annual deductible contributions,

• Your net SE income is substantial, and

• You are 50 years of age or older and are eligible for the additional catch-up contribution.

Setting up a plan

Consider the benefits and drawbacks of other retirement plans before setting up a solo 401(k), especially if you are 50 or older. Although solo 401(k)s aren’t simple, they allow you to make sizable, tax-deductible contributions to a retirement fund. To find out what’s best for your case, get in touch with us or one of our Landmark Financial advisors before enrolling. The deadline to set up some plans is approaching soon.