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Tuesday, January 25, 2022

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A 401(k) Plan for the Small Business Owner

What Is a Solo 401(okay)?

The 401(okay) plan has gained popularity among small business owners ever since 2001, when some modifications to federal tax legislation made it a greater and extra versatile alternative for his or her wants in contrast with another retirement financial savings choices. These 401(okay) plans are often called solo 401(okay) or self-employed 401(okay) plans.

It’s a retirement financial savings choice for small companies whose solely eligible individuals within the plan are the enterprise homeowners (and their spouses if they’re additionally employed by the enterprise). It may be a wise means for somebody who’s a sole proprietor or an independent contractor to put aside a decent-sized nest egg for retirement.

Key Takeaways

  • A solo 401(okay) plan—additionally known as a self-employed 401(okay)—is for companies whose solely eligible individuals within the plan are its homeowners (and spouses).
  • These plans are sometimes simpler and price much less to arrange.
  • In case you have non-owner workers, they need to not meet the eligibility necessities you choose for the plan.
  • There are two elements to a solo 401(okay) plan: worker elective-deferral contributions and profit-sharing contributions.
  • A solo 401(okay)s can also supply loans, doesn’t require nondiscrimination testing, and permits for the deduction of plan contributions of as much as 25% of eligible compensation.

A 401(okay) by Any Different Title

Not content material with the federal acronym, numerous monetary establishments have their very own names for the solo 401(okay) plan. The independent 401(k) is likely one of the most generic. Different examples embody:

  • The Particular person(okay)
  • Solo 401(okay) or Solo-k
  • Uni-k Plan
  • One-Participant okay
  • Self-Employed 401(okay)

In case you are undecided which title your monetary service supplier makes use of, ask concerning the 401(okay) plan for small enterprise homeowners. The Inside Income Service (IRS) supplies a helpful primer on such plans.

Who Is Eligible for Particular person 401(okay) Plans?

A standard false impression concerning the solo 401(okay) is that it may be used solely by sole proprietors. In actual fact, the solo 401(okay) plan could also be utilized by any small companies, together with corporationslimited liability companies (LLCs), and partnerships. The one limitation is that the one eligible plan individuals are the enterprise homeowners and their spouses, offered they’re employed by the enterprise.

An individual who works for one firm (during which they don’t have any possession) and participates in its 401(okay) may also set up a solo 401(okay) for a small enterprise they run on the facet, funding it with earnings from that enterprise. Nonetheless, the mixture annual contributions to each plans can’t collectively exceed the IRS-established maximums.

Easier Documentation Necessities

For small enterprise homeowners who meet sure necessities, most monetary establishments that provide retirement plan merchandise have developed truncated variations of the common 401(okay) plan to be used by enterprise homeowners who wish to undertake the solo 401(okay). Consequently, less-complex documentation is required to determine the plan. Charges can also be comparatively low. Ensure that to obtain the right documentation out of your monetary companies supplier.

Select Your Eligibility Necessities

As famous above, the solo 401(okay) plan could also be adopted solely by companies during which the one workers eligible to take part within the plan are the enterprise homeowners and eligible spouses. For eligibility functions, a partner is taken into account an proprietor of the enterprise, so if a partner is employed by the enterprise, you might be nonetheless eligible to undertake the solo 401(okay).

If your corporation has non-owner workers who’re eligible to take part within the plan, your corporation might not undertake the solo 401(okay) plan. Due to this fact, when you have non-owner workers, they need to not meet the eligibility necessities you choose for the plan, which should stay inside the following limitations.

Nonresident Aliens

You might exclude nonresident aliens who obtain no U.S. earnings and those that obtain advantages beneath a collective-bargaining settlement.

Years of Service

  • For 401(okay) Worker Elective-Deferral Contributions: You might require an worker to carry out one yr of service earlier than changing into eligible to make elective-deferral contributions.
  • For Revenue-Sharing Contributions: You might require an worker to carry out as much as two years of service with a view to be eligible to obtain profit-sharing contributions. Nonetheless, most solo 401(okay) plans will restrict this requirement to at least one yr.
  • For Plan Functions: An worker is taken into account to have carried out one yr of service in the event that they work no less than 1,000 hours throughout the yr. Whilst you might usually select to require fewer than 1,000 hours beneath a daily certified plan, most solo 401(okay) plans embody a hard-coded restrict of 1,000 hours.

The Flawed Necessities

Setting the mistaken eligibility necessities might end in you being excluded from the plan or non-owner workers being eligible to take part within the plan.

For instance, say you choose zero years of service as a requirement to take part, however you’ve got 5 seasonal workers who work fewer than 1,000 hours annually. These workers can be eligible to take part within the plan as a result of they meet the age and repair necessities. Consequently, their eligibility would disqualify your corporation from being appropriate to undertake the solo 401(okay) plan. As an alternative, you might undertake a daily 401(okay) plan.

Some solo 401(okay) merchandise, by definition, require additional exclusions. Earlier than you resolve to determine a solo 401(okay) plan, you’ll want to examine together with your monetary companies supplier relating to its provisions.

Solo 401(okay) Plan Elements

There are two elements to the solo 401(okay) plan: worker elective-deferral contributions and profit-sharing contributions.

  • Worker Contribution Limits: You might make a salary-deferral contribution of as much as 100% of your compensation however not more than the annual restrict for the yr. For each 2021, the restrict is $19,500 ($20,500 for 2022), plus $6,500 for folks age 50 or over.
  • Employer Contribution Limits: The enterprise might contribute as much as 25% of your compensation (20% within the case of a sole proprietor or a Schedule C taxpayer) however not more than $58,000 for 2021 ($61,000 for 2021). An worker age 50 or above can nonetheless contribute an extra $6,500 for 2021 and 2022.

Solo Contributions vs. Different Plans

Compared with different standard retirement plans, the solo 401(okay) plan has excessive contribution limits as outlined above, which is the important thing part that pulls homeowners of small companies. Another retirement plans additionally restrict the contributions by employers or set decrease limits on salary-deferred contributions.

The next is a abstract of contribution comparisons for the employer plans usually utilized by small companies.

Account Elective Deferral Most Employer Contribution Catch-Up Contribution
Solo 401(okay) $19,500 for 2021 ($20,500 for 2022) 25% of compensation or 20% within the case of a sole proprietor or a Schedule C taxpayer $6,500 for 2021 and 2022
SEP IRA Not Allowed 25% of compensation or 20% of modified internet revenue for unincorporated enterprise homeowners Not Allowed
Revenue-Sharing or Cash-Buy Pension Plan Not Allowed 25% of compensation or 20% of modified internet revenue for unincorporated enterprise homeowners Not Allowed
SIMPLE IRA $13,500 for 2021 ($14,000 for 2022) 3% of compensation/earnings $3,000 for 2021 and 2022

The Calculation

As talked about earlier, you could make worker elective-deferral contributions of as much as 100% of your compensation however not more than the elective-deferral restrict for the yr. Revenue-sharing contributions are restricted to 25% of your compensation (or 20% of your modified internet revenue if your corporation is a sole proprietorship or partnership).

The whole solo 401(okay) contribution is the worker elective-deferral contribution plus the profit-sharing contribution of as much as $58,000 for 2021 and $61,000 for 2022.

If your corporation is a company, the profit-sharing contribution relies on W-2 wages you obtain. If you happen to obtain $70,000 in W-2 wages, for example, your profit-sharing contribution may very well be as much as $17,500 ($70,000 x 25%). When added to a salary-deferral contribution of $19,000, the overall can be $36,500.

If your corporation is a sole proprietorship or partnership, the calculation will get a bit of extra concerned. On this case, your profit-sharing contribution relies in your modified internet revenue and is restricted to twenty%. The IRS supplies a step-by-step system for figuring out your modified internet revenue in IRS Publication 560.

Different Advantages of the Solo 401(okay)

There are a selection of different advantages that include the Solo 401(okay).

Loans

As with different certified plans, you may be able to borrow from the solo 401(k) as much as (1) the better of $10,000 or 50% of the steadiness or (2) $50,000, whichever is much less. Examine the plan doc to find out if another limitations apply. 

5500 Submitting Could Not Be Required

As a result of the plan covers solely the enterprise proprietor, you is probably not required to file Type 5500 collection return until your steadiness exceeds $250,000.

No Nondiscrimination Testing

Typically, sure nondiscrimination testing have to be carried out for 401(okay) plans. These assessments make sure that the enterprise homeowners and higher-paid workers don’t obtain an inequitably excessive quantity of contribution in comparison with lower-paid workers.

Such assessments might be very complicated and will require the companies of an skilled plan administrator, which might be expensive. As a result of the solo 401(okay) plan covers solely the enterprise proprietor, there is no such thing as a one in opposition to whom you’ll be able to discriminate, so these assessments should not required.

Deducting Contributions

Just like different employer plans, the solo 401(okay) lets you deduct plan contributions of as much as 25% of eligible compensation. For plan functions, compensation is restricted to $290,000 in 2021 and $305,000 in 2022. Earnings over that quantity are disregarded for plan functions.

Different Concerns

If you happen to personal multiple enterprise, you will need to examine together with your tax skilled to find out whether or not you might be eligible to adopt the solo 401(k). Possession in one other enterprise that covers workers aside from the enterprise proprietor might end in your being ineligible for this kind of plan.

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