Understanding Solo 401k Contribution Limits for Self-Employed Individuals

Solo 401k plans are a great option for self-employed individuals looking to save for retirement. The contribution limits for solo 401k plans are quite generous, allowing for up to 20% of net self-employment income to be contributed.

The annual contribution limit for solo 401k plans is $57,000 in 2022, with an additional $6,500 catch-up contribution allowed for those 50 and older. This means that if you're 50 or older, you can contribute up to $63,500 in a solo 401k plan.

To be eligible for a solo 401k plan, you must have self-employment income from a business or freelance work.

Setting up a self-employed retirement plan is easier than you think. You can open a solo 401(k) at most online brokers, though you'll need an employer identification number.

To get started, you'll need to choose a broker that offers solo 401(k) plans. Both large and small brokers may offer these plans, so shop around to find the best fit for your needs.

You'll also need to complete a plan adoption agreement, which your broker will provide. This agreement outlines the terms of your plan and should be signed and returned to your broker.

Once your plan is set up, you can start contributing to it. You can contribute as both the employee and the employer, with total contributions limited to $76,500 for 2024.

Here are the key steps to setting up a solo 401(k):

Keep in mind that you'll need to establish the plan by December 31st if you want to make a contribution for the current year. You can also make employer profit-sharing contributions until your tax-filing deadline for the tax year.

The solo 401(k) contribution limits are a bit complex, but essentially, you can contribute up to $69,000 in 2024 as a self-employed individual. This breaks down into elective deferrals, which are limited to the lesser of 100% of your earned income or $23,000, and employer nonelective contributions, which can be up to 25% of your compensation.

As an employer, you can also make profit sharing contributions to your plan, but the limits depend on your business entity. For S-Corporations, C-Corporations, Partnerships, and Multi-member LLCs, the limit is 25% of your compensation. However, for sole proprietorships and single member LLCs, the limit is effectively around 20% of earned income.

Here's a quick rundown of the contribution limits for different business entities:

Remember, your total contributions, including elective deferrals and profit sharing contributions, cannot exceed $57,000 if you're under 50, or $63,500 if you're 50 or older.

The contribution limits for a solo 401(k) plan are significant, allowing self-employed individuals to save a substantial amount for retirement.

The total contribution limit for an individual's 401(k) account in 2024 is $69,000. This is broken down into elective deferrals and employer nonelective contributions.

Elective deferrals, as an employee, can be up to the lesser of 100% of earned income or $23,000 for 2024.

As a business owner, you can make employer contributions to your solo 401(k) plan, up to 25% of your compensation.

The maximum compensation for the purpose of employer nonelective contributions is $345,000 in 2024.

Profit sharing contributions are also allowed, up to 25% of your compensation, depending on your business entity.

Here's a breakdown of the contribution limits for different business entities:

For sole proprietorships and single member LLCs, the IRS has a more complex calculation for employer contributions, which works out to about 20% of earned income.

If you're under 50, your total contributions may not exceed $57,000. If you've reached 50, your aggregate limit rises to $63,500 with the $6,500 of catch-up contributions.

You can continue contributing to a solo 401k plan as long as you don't have any employees who meet the eligibility requirements in your plan document. If you do, you'll need to either "upgrade" to a traditional 401k or dissolve the plan.

There are some minimum standards your plan must meet. Employees must become eligible if they work 1,000 or more hours per year, are at least 21 years old, and have at least one year of service.

You have some discretion over the eligibility requirements, and you can structure a plan to be more generous than these requirements. You could structure a plan with an hours requirement of 500, an age requirement of 18, and a tenure requirement of six months.

Your plan document governs all, so whatever you choose, you must stick to.

Ongoing Compliance is a breeze with a Solo 401(k) plan, as it requires less administration and compliance compared to traditional company plans.

You'll only need to file an annual report on Form 5500-EZ if your Solo 401(k) has more than $250,000 in assets at the end of the year.

If your Solo 401(k) has less than $250,000 in assets, you're off the hook and don't need to file any annual reports.

A solo 401(k) offers a tax advantage in the form of a traditional 401(k), where contributions reduce your income in the year they are made, or a Roth solo 401(k), which allows for tax-free distributions in retirement.

The IRS has strict rules about when you can tap into the money you put into either type of account, with few exceptions, you'll pay taxes and penalties on any distributions before age 59 ½.

The choice between a traditional and Roth solo 401(k) depends on your income and tax rate. If you have a high income and tax rate, a traditional 401(k) might be a better option, as it allows you to reduce your tax liability right away.

For someone with a relatively low income or tax rate now, a Roth 401(k) might be a better choice, as it defers the tax benefit until retirement, when they might be in a higher tax bracket.

A traditional 401(k) offers an upfront tax benefit, while a Roth 401(k) offers a tax benefit during retirement. Either way, it's better than no tax benefit at all.

Here are some key differences between traditional and Roth solo 401(k)s:

Ultimately, the decision between a traditional and Roth solo 401(k) should be based on your individual circumstances and tax situation.

You have several plan options to consider when it comes to solo 401(k) contributions. One of the most popular options is the SEP IRA, which allows business owners to save a large amount of money for retirement, but requires contributions to employees' accounts if you have employees.

A SEP IRA is similar to a solo 401(k) but is available to business owners with employees. If you have employees and choose to open a SEP IRA, you'll also have to contribute to their accounts. Consider this option if you have employees and want to offer them retirement benefits.

Alternatively, you can consider a Traditional or Roth IRA, which offer tax advantages but have lower contribution limits and don't allow contributions from your business. These accounts are better as a complement to a solo 401(k) rather than as a replacement.

If your spouse earns income from your business, they can be covered under your solo 401(k) as an employee, allowing you to potentially double the amount you can contribute as a family.

This exception to the no-employees rule is a great opportunity to boost your retirement savings. Your spouse can make elective deferrals as your employee, up to the employee contribution limit.

The employee contribution limit is a key factor here, as it determines how much your spouse can contribute to the plan. Plus, if your spouse is 50 or older, they may be eligible for the 50-and-older catch-up provision, which can increase their contribution limit.

As the employer, you can then make the plan's profit-sharing contribution for your spouse, of up to 25% of their compensation. This can add significantly to your overall retirement savings.

Solo 401(k) plans offer a wide range of investment options, giving you complete control over your investments.

This is a major benefit compared to employer-sponsored plans, where you're typically limited to a few mutual funds and ETFs.

With a solo 401(k), you can choose from all the securities offered by your online broker, providing endless possibilities for diversifying your portfolio.

Building a diversified portfolio is crucial to mitigating risk and reaching your retirement goals.

By selecting a mix of low-risk and high-risk investments, you can balance your portfolio and potentially earn higher returns over time.

Investing in a variety of asset classes, such as stocks, bonds, and real estate, can also help spread out your risk and increase your chances of success.

To open a solo 401(k) plan, you'll need an employer identification number (EIN), which you can apply for directly on the IRS website. You can then choose a broker that offers solo 401(k) plans, such as most online brokers.

To set up your solo 401(k), you'll need to complete a plan adoption agreement and an account application. Once you've completed these forms, you can set up your investments and start contributing to your account. You can invest in a wide variety of investments, including individual stocks and bonds, mutual funds, exchange-traded funds, and more.

You can make manual investments or set up automatic recurring investments to ensure consistency. You can also contribute on behalf of your business. If your account's year-end balance is more than $250,000, you might be required to file one of the forms in the IRS 5500 series for tax reporting.

Here's a summary of the steps to open a solo 401(k) plan:

As the plan administrator, you'll need to keep detailed records of your contributions and investments. You can also consider engaging an online planning service, such as Facet Wealth or Personal Capital, to help you manage your funds and make informed investment decisions.

Solo 401(k) plans with a loan provision allow you to take a loan from the plan.

Loans are limited to 50% of the total 401(k) value, or a maximum of $50,000.

A 5-year maximum repayment term is standard, although loans for a primary residence can extend the term to 10-15 years.

The loan interest rate is typically the Prime Rate, or Prime plus 1% or 2%, depending on the Solo 401(k) provider.

Failing to repay the loan according to the terms can trigger taxes and early withdrawal penalties.

The IRS considers an unpaid loan an early distribution from the retirement account.

As the business owner and employee of yourself, you have the opportunity to make employer contributions to your solo 401(k) plan. These contributions are limited to 25% of your compensation, which is considered your net earnings minus one-half of your self-employment tax and your employee elective deferrals.

The maximum compensation for the purpose of employer nonelective contributions is $345,000 in 2024. This limit applies to S-Corporations, C-Corporations, Partnerships, and Multi-member LLCs. However, for sole proprietorships and single member LLCs, the limit is slightly more complex and is calculated using a step-by-step worksheet found in publication 560.

Here are some examples of employer contributions:

Kyle, a 58-year-old business owner, earned $75,000 in W-2 wages from his S-corp. His business could contribute up to $18,750 in profit sharing contributions, totaling $44,750 in annual contributions. This is a great way to save even more for retirement, and it's essential to keep in mind that these limits apply to all 401(k) plans you participate in.

Kyle, who is 58 years old, earned $75,000 in W-2 wages from his S-corp and was able to contribute up to $18,750 in profit sharing contributions, totaling $44,750 in annual contributions.

The profit sharing limit for Kyle is based on his W-2 compensation, which is $75,000. This means that his business could contribute up to 25% of his compensation, or $18,750.

If Kyle's W-2 income were $275,000, his profit sharing contribution would be limited to $68,750 (25% of $275,000), not $37,500 as mentioned in the previous example. However, this would exceed the aggregate limit of $63,500.

Here's a breakdown of Kyle's contributions:

As an employer, you're entitled to make profit sharing contributions to your solo 401(k) plan. This is where the structure of a solo 401(k) plan comes in handy.

You can make profit sharing contributions for yourself only, up to the IRS limits. These limits depend on your business entity, and they're limited to 25% of your compensation for S-Corporations, C-Corporations, Partnerships, and Multi-member LLCs.

For sole proprietorships and single member LLCs, profit sharing contributions are slightly more complex. The IRS states that employer contributions are limited to 25% of the business owner's income that's subject to self-employment tax. However, because sole props and single member LLCs are entitled to deduct half of their total self-employment tax, not all self-employment income will be subject to self-employment tax.

To sort this out, sole proprietors and single member LLC owners need to perform an additional calculation, which effectively works out to about 20% of earned income instead of 25%. You can use the IRS worksheet in publication 560 or a calculator like the one on Bankrate.com to help with this calculation.

The total contributions limit is $57,000 if you're under 50 years old, and $63,500 if you've reached 50, including catch-up contributions. This limit impacts contributions to other 401(k) plans too, if you have multiple businesses.

Here are the limits for employer contributions to a solo 401(k) plan:

Let's take a look at some examples of employer contributions to solo 401(k)s.

A solo 401(k) plan allows business owners to contribute up to 20% of their net self-employment income to their retirement account.

You can also contribute up to 100% of your net self-employment income up to a maximum of $57,000 in 2023.