Solo 401k Plan Limits for Self Employed Indidividuals

by Chris Butterworth on June 20, 2011

So called Solo 401k plans function very similarly to traditional 401k plans offer by large corporations.  Both plans are tax-favored defined contribution savings plans in which participants contribute a portion of their pre-tax earned income to a qualified savings plan. The “solo” aspect of this variation of a 401k plan refers to the fact that either one person (and spouse if appropriate) or both partners (and spouses if appropriate) of a partnership participate in the retirement arrangement. They provide significant benefits to self employed people and sole proprietors by allowing them to have tax advantaged savings opportunities for retirement — you don’t have to work for a big corporation to have a big retirement benefits package!  Many of these plans can be established easily and conforming plans are offered by most retail investment banks.

Contribution Limits

These plans have the same contribution limits  as traditional 401k plans.  A business owner as an “employee” in their own small business in 2011 can choose (elect) to defer up to $17,000 of 2012 earned compensation toward a designated retirement fund in a Solo 401k plan. If a participant is 50 years or older at the end of the tax year, they can add (catch up) an additional $5,500 in deferrals toward their retirement savings for a total of $22,500 in savings.

The assumption here in creating a variation on the typically larger business programs or profit sharing plans is the absence of other employees.  The tax-favored benefits of a Solo 401k are the contribution limits including matching funds available to even the self-employed or small business sole proprietor.  A business owner(s) as the “employer” can choose in a Solo 401k plan to contribute employer matching funds to their own “employee” elective deferral portion of their retirement contribution. These funds can total up to an additional 25% of total compensation but must not exceed total earned income of $250,000.Self-employed earnings should be calculated as income less 1/2 of the self-employment (SE) tax (net self-employment earnings) less the contribution to retirement. Alternatively, use 20% rather than 25% of the total amount including the contribution.   IRS Publication 560, Retirement Plans for Small Business has a deduction worksheet that will assist in calculating the maximum contributions in a Sole 401k plan.  Seek an adviser or tax professional to assist you in determining the correct 401k limits.

Maximum Contributions

Total annual contributions in a Solo 401k plan which include both the “employee” and “employer” portions must not exceed the lesser of either 100% of earnings for the year or $49,000. Catch up amounts should not be included in the calculation of 401k annual contributions.  Catch up allocations are however limited to the excess amount of the plan participant’s compensation over the amount of the base $17,000 elected deferrals (non-catch up funds).

Are there any important differences in a Solo 401k distribution?

-As a self employed person you will have more control over your plan arrangements, including choosing investment vehicles and other details.

-If you are the owner of a sole proprietorship, you can choose how well your business will fund your retirement, essentially allowing you to save more for retirement tax free if you choose.

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