How Do Solo 401(k) Plans Work?

Although there are many advantages of self-employment, one major disadvantage is not having access to a retirement plan that is sponsored by an employer, such as a traditional 401k. Luckily, there is a solo 401(k), which was specifically made for self-employed workers and has a lot of the features in an employer-sponsored plan without having to work for the employer.

What is a solo 401k plan?

It is a retirement plan which has been approved by the IRS and entails the same requirements and rules as a traditional employer-sponsored retirement plan. However, it is an individual retirement plan that is best suited for business owners who haven’t employed any workers. According to IRS rules, you cannot use this retirement plan if you have full-time employees.

The plan’s contribution limits

This retirement plan’s contribution limit is $61,000 in 2022 and there is a catch-up contribution of an additional $6,500 for a self-employed individual who is 50 years old and above. In addition, the plan allows the business owner to contribute annually to the plan as both an employer and an employee, which increases the annual maximum contribution limit. Thus, in order to fully understand this plan’s contribution rules, you need to think of yourself in two roles: as your own employer and as your own employee. As an employee, you can contribute $20,500 in 2022 and an additional $6,500 if you are 50 years old and above. On the other hand, as the employer, you can contribute a profit-sharing amount up to a maximum of twenty-five percent of your compensation.

Is it tax deductible?

The great thing about this retirement plan is you have the option to choose your tax advantage. For instance, under the traditional plan, the contributions are deducted from the employee’s paycheck before income taxes are calculated and deducted. However, with a Roth plan, the contributions are deducted from the employee’s salary after taxes have been subtracted from it.

Am I eligible for this plan?

If you own a business and you do not have full-time employees or earn income from self-employment, then you can open this account through one of many reputable solo 401k providers.

Can my spouse also make contributions?

Although there is a no-employees rule on this individual retirement plan, the IRS permits one exception; if your spouse earns from your business, he or she can also contribute to the plan. This is very beneficial because it can double the amount you can contribute as a family, depending on both of your incomes from the business. For instance, your spouse can make deposits up to the contribution limit of $19,500, plus the additional catch-up provision if they are 50 years old and above. Then, as the employer, you can contribute a profit-sharing sum for your employed spouse, amounting up to 25% of compensation.

Conclusion

This individual retirement program offers many benefits to the participants, such as the ability to make higher contributions, and engage in investments like real estate and stock, it offers stronger creditor protection compared to individual retirement accounts and is cost-effective.