Many self-employed Americans don’t have access to an employer-sponsored 401(k) plan. However, business owners with no employees are eligible to save for retirement in a solo 401(k) plan.
A solo 401(k) plan:
— Allows solo business owners without employees to save for retirement.
— Might allow you to save more for retirement than a traditional 401(k) plan.
— Can be set up as a tax-deferred account or an after-tax Roth account.
— Allows for a small business owner’s spouse to participate in the plan.
What Is a Solo 401(k) Plan?
Also known as a one-participant 401(k) plan, a solo 401(k) is a retirement account for small business owners with no employees. “A solo 401(k) is a retirement plan for the self-employed designed to look and feel like the 401(k) that is typical among large employers,” says Tommy Thompson, a certified financial planner with Innovative Financial Group in Atlanta. “A solo 401(k) can offer traditional and Roth contributions, have a loan provision and allow for both salary deferrals and employer profit-sharing.” A solo 401(k) can be accessed by any business that doesn’t have any employees other than the owner and his or her spouse.
Solo 401(k) Contribution Limits
You can contribute to a solo 401(k) as both an employee and an employer. The solo 401(k) contribution limits as an employee are the same as a traditional 401(k) plan: $20,500 in 2022, plus a $6,500 catch-up contribution for those age 50 and older.
Solo 401(k) plans also offer an employer contribution element. As an employer, you can contribute up to 25% of compensation. Total contributions to the account cannot exceed $61,000 for 2022, not including catch-up contributions.
How To Set Up a Solo 401(k)
If you’re a small business owner with no employees, you may be eligible to set up a solo 401(k) plan. “You can consult a financial professional to help design the best plan for you,” says Gerald Grant, a retirement planning specialist at Equitable Advisors in New York.
Contributions can be taken directly from payroll and deposited into the solo 401(k) account. “The participant in the solo 401(k) will have a menu of investment options or a brokerage account (depending on the custodian for the plan) and can allocate the funds as desired,” Thompson says. “Traditional contributions get a current year tax deduction, and Roth contributions can grow tax-free.”
For many business owners, deciding between a traditional or Roth solo 401(k) comes down to their tax bracket. “If a business owner thinks they’re paying lower taxes now, they often choose a Roth solo 401(k),” Grant says. “If they think they’ll be in a lower tax bracket in retirement, a traditional solo 401(k) may be a better bet.”
[Read: How Much Should You Contribute to a 401(k)?]
Pros of a Solo 401(k)
Compared to traditional 401(k) plans, a solo 401(k) is easier to open and account holders may be able to contribute more money. Solo 401(k) plans have significantly higher contribution limits than a traditional 401(k) plan, which allows you to defer taxes on additional retirement savings. Since solo 401(k) plans typically involve just one or two investors, they’re significantly less complex than traditional 401(k) plans.
A solo 401(k) allows micro business owners to qualify for tax benefits on their retirement savings. “Solo 401(k)s are great for business owners that work with their spouse even part time as they can contribute too,” Grant says.
Cons of a Solo 401(k)
Solo 401(k)s may require some tax paperwork. If a solo 401(k) account exceeds $250,000, the account holder is required to complete a 5500 filing with the IRS.
Perhaps the most significant drawback of a solo 401(k) is that it can only be used by a self-employed individual with no employees and his or her spouse. If you decide to hire employees, you could lose eligibility to participate in a solo 401(k). “Since these plans are designed for the entrepreneur who works for himself, the plan would have to be changed to a full 401(k) should the business owner decide to hire an employee other than his spouse,” says John Shrewsbury, a financial advisor and co-owner of GenWealth Financial Advisors in Bryant, Arkansas.
[Read: Retirement Plan Options for the Self-Employed.]
Who Should Use a Solo 401(k) Plan
There’s a limited audience for solo 401(k)s. “The plans are specifically designed for business owners without any employees,” says Steve Sexton, president of Sexton Advisory Group in Temecula, California. “Since the IRS also allows a business owner’s spouse to have a solo 401(k), it is also ideal for spouses who work together and/or own a business together.”
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What Is a Solo 401(k) Plan? originally appeared on usnews.com
