Are you self-employed?
If your business has no employees and produces substantial net self-employment income, implementing a solo 401(k) is a great tool to help you build a nest egg for retirement.
A solo 401(k) allows you to make substantial, deductible annual contributions to your retirement account. This plan allows you to take advantage of both an employee deferral and an employer contribution to your retirement account.
It is important to note that a solo 401(k) cannot be used if you have employees. There are three exceptions to this rule.
- Your Spouse
- Employees under the age of 21
- Employees working < 1,000 hours during any 12-month period during the 401(k) coverage plan
To include your spouse on your solo 401(k) plan you need to make them a compensated employee and you will have to issue them a W-2 annually.
For 2022, the maximum “elective deferral contribution” (employee deferral) you can make is $20,500 of your net self-employment (SE) income. This limit is increased to $27,000 if you are over the age of 50 on December 31, 2022. This additional $6,500 is known as a “catch-up” contribution for older business owners who are closer to retirement. Note: for 2023 the deferral is increased to $22,500 + $7,500 catch up for a total of $30,000!
Additionally, an employer profit sharing contribution of up to 20% of your net SE income is allowed. It is important to note, your deductible employee deferral does not decrease your net SE income for calculating the 20% allowable employer contribution. The combined contribution limit is $61,000 ($67,500 if you are over 50 on December 31, 2022) or 100% of your net SE income.
There are pros and cons to any retirement strategy
One major advantage to the solo 401(k) is the flexibility the plan provides year to year. There is no set contribution amount – it’s entirely discretionary. You can max out your contribution in one year and in the next year you contribute zero to your retirement plan. Another advantage is that, unlike other retirement accounts, you can borrow against your retirement savings without early withdrawal penalties. The maximum amount you’re allowed to borrow is the lessor of $50,000 or 50% of the account balance.
Setting up a solo 401(k) can be complex, it’s best to consult with your financial advisor to help you comb through the initial setup paperwork and annual filing requirements. Another administrative item is the required annual filing of Form 5500-EZ with the IRS once your account balance exceeds $250,000.
If you are considering starting or making changes to an existing retirement plan, please contact a Wegner CPAs professional and they would be glad to assist you in determining the right plan for you and your business.