Contribution Limits of Solo 401K Plans
The annual maximum Solo 401(k) contribution is limited to the dollar amounts listed in the table below, but not exceeding 100% of compensation.
The Solo 401(k) contribution consists of two parts: the salary deferral contribution and the profit-sharing contribution. For 2022, the salary deferral contribution (same as the 401(k)) permits as much as 100% of the first $20,500 ($27,000 if age 50 or over) of compensation as a tax-deductible contribution. The amounts are $22,500 and $30,000, respectively, for 2023. In addition, a profit-sharing contribution is permitted equal to 20% of net self-employment income for unincorporated businesses or 25% of W-2 income for incorporated businesses.
Given sufficient income, a self-employed individual and spouse (assuming the spouse is employed in the same business) may contribute, for 2022, up to $122,000 (2 x $61,000) combined ($132,000 for 2023). Because of the way the contribution is calculated a larger contribution usually can be made into a Solo 401(k) than to a Keogh or SEP IRA at the same income level.
Caution – 401(k) Limit
The $20,500 ($22,500 for 2023) limit on salary deferral contributions to a 401(k) plan applies on a per person, rather than a per plan basis. So, any elective deferral contribution made to a 401(k) plan outside of the Solo 401(k) plan would reduce the otherwise allowable $20,500 ($22,500 for 2023) deductible contribution amount to the “solo” 401(k).
Discretionary Funding
Each year the funding of the Solo 401(k) plan is completely discretionary and flexible. Funding can be increased (within the limits noted above), decreased, or skipped entirely if necessary.
Where Deducted
Subchapter S and C corporations or LLCs electing to be taxed as a corporation can generally deduct the salary deferral contribution from personal W-2 earnings and the profit-sharing contribution as a business expense.
For a sole proprietorship, partnership or an LLC taxed as a sole proprietorship, the owner’s salary deferral and profit-sharing contributions are deductible only from personal income (i.e., on Schedule 1 (2021) of Form 1040 as an adjustment to gross income), not as an expense of the business. (Contributions to a qualified retirement plan on behalf of employees are deductible business expenses.)
Deadlines
Establishing the Plan - The deadline for establishing a Solo 401(k) has long been December 31st for an individual or fiscal year end for corporations. Effective for tax years after 2019, a stock bonus, pension, profit-sharing, or annuity plan adopted after the close of a taxable year but before the extended due date for filing the taxpayer’s return for the taxable year, the taxpayer may elect to treat the plan as having been adopted as of the last day of the taxable year (SECURE ACT Sec 201(a)(2)).
Contributions - For unincorporated businesses the deadline is the tax filing date (generally April 15) of the next year plus extensions. For incorporated businesses the deadline is 15 days after the close of the fiscal year.
Roth Contributions
Solo 401(k) designated Roth contributions fall under the rules for “Qualified Roth Contributions” that are covered in chapter 4.06 of this text. Provided the plan document permits Roth contributions, participants in a Solo 401(k) can elect to make after-tax or Roth contributions with the salary deferral portion of the Solo 401k. The annual maximum salary deferral contribution is $20,500 or $27,000 if age 50 or older for 2022 ($22,500 and $30,000, respectively, for 2023).
CAUTION
Designated Roth contributions in a Solo 401(k) plan are subject to the age 72 (70½ for years before 2020) required minimum distributions (RMD). However, Roth IRAs are not subject to the RMD rules and the Roth contribution can be rolled into a Roth IRA before reaching the mandatory distribution age to avoid the mandatory distributions.
Roth Aging Element - Designated Roth contributions to a Solo 401(k) plan are subject to the normal 5-year aging rules to avoid distribution penalties.
Plan Administrator Responsibilities
The self-employed individual can act as his or her own plan administrator. Responsibilities include making timely payments according to the loan amortization schedule if a loan has been taken and filing Form 5500 if plan assets exceed $250,000.
Plan Loans
Another important distinction between the Solo 401(k) plan versus other self-employed retirement plans is that it permits (if so stated in the plan documents) the small business owner to borrow 1/2 of the funds in the 401(k) ($50,000 maximum) for any reason at any time, tax free and penalty free. For loans taken March 27, 2020 through December 31, 2020, the maximum loan is the lesser of $100,000 or 100% of the vested account balance. The loan generally must be repaid as follows:
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To be repaid over an amortization schedule (established before taking the loan) of 5 years or less, although a 10-15 year payback is allowable for the purchase of a home.
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Regular payments no less frequently than quarterly.
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At a reasonable rate of interest… generally interpreted as prime rate + 1%
There are no tax consequences if loans are repaid on schedule.
Strategy
Using rollover provisions (see below) a Solo 401(k) owner can consolidate his or her other plans and IRAs into the 401(k) plan, making them eligible for the loan provisions.
Rollover Provisions
The Solo 401(k) is a qualified plan and rollovers that meet the normal rollover requirements can be made to and from a Solo 401(k). This includes IRA, Rollover IRA, 401k, SEP IRA, Keogh Plans (including Profit Sharing and Money Purchase), Defined Benefit Plans and 403b Plans.
Strategy
The maximum amount of a traditional IRA distribution that can be rolled over to an eligible retirement plan may not exceed the part of the amount distributed that would be includible in gross income if it weren't rolled over (Code Sec. 408(d)(3)(A)(ii)). Thus, if a taxpayer has an IRA that includes non-deductible contributions, the taxpayer can roll over the taxable portion into the Solo 401(k) leaving the already taxed funds in the IRA that can then be converted into a Roth IRA. Note that there are no Roth conversion AGI limits.
Turnkey Plans
The Solo 401(k) plan is useful where a small employer has no non-highly compensated employees. The plan documents are generally drafted with the assumption that the goal is to maximize contributions and that there will not be any eligible non-highly compensated employees. In addition, most turnkey plans are established as low-cost plans requiring little, if any, professional administration and without nondiscrimination testing.
Caution – Potential Employees in the Future
Care should be taken to provide for the potential that the business may grow and non-highly compensated employees may in fact one day become eligible to participate in the plan, at which time the employer may be obligated to make significant contributions for unanticipated participants.
Most financial firms offer turnkey plans. Consult a broker dealer or search “solo 401(k)” on the Internet.
Caution - Employer Aggregation Rules
An employer that is part of a controlled group of corporations, partnerships, proprietorships or affiliated service groups under Code Sec. 414(b), (c), or (m) must continue to take into consideration employees of those related entities for purposes of determining whether the Solo 401(k) satisfies the applicable qualification requirements, including the minimum coverage requirements.
Example #2 – Full-Time Employer Plan - What if the taxpayer also had a 401(k) arrangement with his employer? The annual maximum applies to all plans of a taxpayer. Therefore, if Kevin makes an elective $18,500 contribution to his full-time employer’s plan, the maximum he can contribute to his own plan would be $4,000 ($22,500 - $18,500). Thus, in the example above, Kevin’s contribution to his own self-employed combo plans would be limited to $5,859 ($1,859 + $4,000).
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Example #3 – Taxpayer Age 50 or Older – What if Kevin were age 50 or older? Taxpayers age 50 and older are allowed an additional catch-up contribution of $7,500 for 2023. In Example #2, he could make an additional deductible catch-up contribution of $7,500 for 2023 bringing his total contributions to $12,359 (1,859 + 4,000 + 7,500), which is more than his net SE income of $9,293, so his contributions are limited to net SE income. In Example #1 the additional catch-up contribution amount will not benefit him since he is already contributing his entire net SE income and IRC § 414(v)(2)(A) caps total contribution at no more than “compensation,” the SE net income in this case.
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Example #4 – Incorporated Business – Susan Lewis, age 49, is the sole employee of an incorporated business. Her earned income is $100,000 in 2023. Under the law, Susan can contribute $25,000 to a SEP-IRA ($100,000 x .25). She can also contribute $18,500 ($15,500 plus 3% of $100,000) to a Simple IRA or $25,000 to a profit sharing or money purchase plan. However, she can contribute $47,500 to a Solo 401(k) plan ($25,000 employer contribution plus $22,500 employee deferral), still under the $66,000 maximum for the year. If Susan were age 50 or over, she could also make a catch-up contribution of $7,500, increasing her Solo 401(k) contribution total to $55,000.Note: Generally, 401(k) plan contributions for an unincorporated business will be slightly lower than the above amounts. For unincorporated businesses, compensation is net profit minus the applicable percentage of self-employment taxes deductible as an adjustment on Form 1040 minus employer contributions.
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Business Owner and Spouse
Although single-participant 401(k)
plans are limited to the business owner and his or her spouse, business owners
should note the added benefits of having his or her spouse as the business’s
only other employee. Having the spouse
on the payroll gives the business owner the opportunity to shelter some or all
of his or her income by having the spouse make an elective deferral to a 401(k)
plan in addition to the business making a profit-sharing contribution. Although
the spouse and the business would be responsible for their respective share of
employment taxes on the salary, combined employer and employee contributions
can be up to the lesser of $61,000 for 2022 ($66,000 for 2023) or 100% of
compensation. This limit applies separately to the business-owner and spouse,
thus allowing a combined total of up to $122,000 for 2022 ($132,000 for
2023). In addition, if age 50 or over,
each individual could defer an additional $6,500 for 2022 ($7,500 for 2023).
