Solo 401k rules small business owners need to know!
For a successful business owner (sole proprietor or owner of an S Corporation, C Corporation or partnership) who has a significant net income and wants to sock away a good deal of money pretax, the Solo 401k deserves serious consideration because of its potential to allow greater contribution amounts than a SEP IRA. Working with a comprehensive financial planner will help you look at all of your retirement planning options.
Although a Solo 401(k) plan is designed for the individual business owner (or self-employed), it is technically available to the spouse of the owner and any shareholder or partner in the business as well. Employees working fewer than 1,000 hours per year may be excluded, and contributions are immediately vested. Unlike traditional 401ks, there are no complicated discrimination tests or IRS Form 5500 filing (until the plan reaches in excess of $250,000).
Like the regular 401k contribution limits for 2015, you can elect to defer up to $18,000 of your pre-tax income in elective contributions. If you are over the age of 50, you can also make a catch up contribution of $6,000, for a total of $24,000. In addition, as the employer you can also make a non-elective profit sharing contribution up to 25% of your pay (based on your W-2). Total Solo 401(k) contributions cannot exceed $53,000 (or $59,000 with a catch up contribution).
For example, for a self-employed 45 year-old making $100,000, both the SEP IRA and Solo 401(k) would allow an employer contribution of $21,175 (25% X $84,700, which is Net Earnings after self-employment tax is deducted). However, the Solo 401(k) allows an additional $18,000 employee contribution not afforded by the SEP IRA, for a total of $39,175.
However, if our business owner is 50 and making $200,000, catch up opportunities and caps come into play. Twenty-five percent of net earnings computes to $42,935. The Solo 401(k) cap would be $59,000 ($53,000 plus $6,000 catch up). Up to $24,000 of employee contributions is possible, but the company contribution and/or the employee contribution would need to be adjusted so the $59,000 cap is not exceeded by their combined total. Although the gap between SEP IRA and Solo 401(k) options is less than the prior example, the Solo 401(k) still provides an additional $17,000 in income deferral (and its accompanying income tax).
Through tax savings and greater savings, early adoption of strategies such as this can mean a significant difference in current and future results. A qualified financial planner can help you decide which retirement vehicle is right for you and your business as your needs change. We have a Solo 401k calculator that can help figure out how much you can contribute. Don’t wait until the end of the year. If you have any questions about your Solo 401k or IRA’s or how you can minimize taxes please contact us at 540-266-3100.