Solo 401k Retirement Plan for the Self-Employed
Today we’ll wrap up our look at various retirement plans ideal for small business owners and the self-employed with the one that inspired the series – the Solo 401k. So far, we’ve looked at the SEP-IRA and the SIMPLE IRA.
Solo 401k Overview
A Solo 401k combines the characteristics of a regular 401k plan with a profit-sharing plan. A Solo 401k can only be established by self employed individuals or small business owners with no other employees or just one employee – the owner’s spouse. For most people with no employees the Solo 401k will maximize the allowable contributions you can make to a retirement plan in a given year.
Solo 401k Basics
- Coverage: A Solo 401k is only established for the business owner and the business owner’s spouse if he is an employee.
- Contributors: Solo 401ks are funded by both the employee and the business. The employee contribution is deferred compensation while the business contribution is a portion of profits.
- Contribution limits: In 2009, an employee can defer up to $16,500 to a Solo 401k. Employees who are 50 or older at the end of the year may make a “catch-up” contribution of an additional $5,500. The total amount allowed is reduced by any contributions to a 401k, 403(b), or 457 at another employer. In addition to the employee deferral limit, the business can make a contribution of up to 20% of your total income (25% of earned income, which is total income reduced by self-employment taxes). The total employee and employer contributions must not exceed $49,000 in 2009, or 100% of your income.
- Deadlines: You must establish the plan by December 31 of the calendar year for which you first want to contribute. Contributions, however, can be delayed until the tax-filing deadline for that year, including extensions. For most people this is October 15 of the following calendar year.
- Taxation: Both individual and business contributions to a Solo 401k are deductible from the employer’s income, and are not included as employee income at the time of the contribution. Taxes on withdrawals are explained below.
- Vesting: There is no vesting period for Solo 401k contributions. Note that this is different from most tradtional 401k plans.
- Withdrawals: Solo 401k withdrawals are subject to the same withdrawal rules as regular 401ks. All withdrawals will be subject to income tax. Penalties may apply if taking withdrawals before the age of 59 1/2. A unique feature of Solo 401ks as opposed to other self-employed retirement options is that loans may be available depending on how the plan is set up.
- Once the plan reaches $250,000 in assets, you must complete a Form 5500.
- A Solo 401k can accept rollovers from many other retirement plans, making it easy for you to consolidate accounts in one place before beginning withdrawals in retirment.
- Contributions are discretionary, so you can choose not to contribute in years where your business has low revenue and increase contribution if you want to minimize taxes.
Establishing a Solo 401k
There are no regulations governing the establishment of a Solo 401k. You can open one with most major financial institutions, including Vanguard and Fidelity.
Solo 401k Pros
The biggest advantage of a Solo 401k is that it typically allows for the largest contribution when compared to other self-employed plans.
Solo 401k Cons
You cannot use a Solo 401k if you have any employees other than a spouse.
Stay tuned Madison’s wrap-up of this series: an analysis of which self-employed retirement plan is best, in Solo 401k Versus SEP-IRA.
You stated “Taxation: Both individual and business contributions to a Solo 401k are deductible from the employer’s income, and are not included as employee income at the time of the contribution. ” I am self employed with no employees. I do not pay myself through payroll but I take a monthly withdrawal. Is my deferred contribution to my solo 401k deductible?