Self-Employed 401k is a Dream Retirement Plan (Save $60,000 K)

The dream retirement plan (Solo 401k) for self-employed people!

I set up my financial planning practice in Glen Ellyn back in 1996. One of my first concerns was how I would save for retirement as an entrepreneur. At the time, the best plan for me was a SEP IRA. The SEP IRA allows me to set aside 25% of my “net” income. Several years ago a new rule was created allowing me to set up an Individual 401k. This plan lets me make a 25% of “net” profit sharing contribution to my retirement plan each year in addition to a 401k salary deferral contribution.

How the SOLO 401k works:

Also called “Individual” or “One Participant” 401(k)s, they are available to free-lancers, independent contractors (get a 1099 rather than a w-2), and sole proprietors, as well as business owners with no employees other than a spouse.

You can set up an individual solo 401(k) if you have a regular job, but also have self-employment income on the side.

If this describes you or somebody you know keep reading.

By definition, you are both the employer and the employee. Therefore, you can contribute to the plan in two ways. As an employee, you can contribute up to 100% of your compensation, up to a limit of $23,000 in 2024. If you are 50 years old you can make a plus a catch-up contribution of $7,500, for a total of $30,500.

As the employer, you can also contribute up to 20% of your net self-employment earnings—or 25% if your business is incorporated. IRS calculation website link.

In 2024. Total contributions from both employer and employee can be maxed out at $69,000, or $76,500 if you are 50 or older!

For the purposes of determining the amount you can contribute as a sole proprietor. “Compensation” is defined as your gross income minus business expenses, minus one-half of your self-employment taxes. That is Social Security and Medicare taxes, which in 2020 total 13.3% of the first $137,700 of income. (Social Security taxes are capped at that level this year.)

So, for example, if you are over 50 and have a net unincorporated self-employment income of $200,000, you could contribute a maximum of 30,500 as an employee as your 401k salary deferral, plus the maximum employer contribution of $37,887, for a total of $60,000.

Generally, you can deduct your contributions from your net business income, which is the amount you report on Schedule C. If your business is incorporated, you can deduct the salary deferral from W-2 earnings and the employer contribution as a business expense. Always confirm with your tax advisor.

Also, you can use Roth 401k contributions to your plan. Those are not tax-deductible, but come out tax-free after retirement. The employer contribution is always tax-deductible going in so it comes out as taxable income at distribution

The limits on elective deferrals are calculated by person, not by plan. So, if you have contributed $10,000 to another employer’s 401(k), you can contribute only $9,000 to your individual 401(k) in 2020.

One of the best things about the Solo 401k, is that there are not any setup fees or annual IRA filings to deal with. You can set this up with most custodians and you can choose almost any investment that the brokerage account makes available.

Lastly, there is a 12/31 deadline for setting up these plans. You have until your tax filing deadline, the following April 15th, to make your contribution.

Yes, I can help you if you need it with tax-saving strategies.

This video uses 2022 figures:

Summary

For self-employed – can include spouse if they work with you.
Small or no cost to set up.
Maximum contribution 2022 $69,000 or $76,500 if over age 50. SOLO 401K CALCULATOR
Contribute to 401k and make SEP contribution.
Invest in most investment vehicles, stocks, bonds, mutual funds and ETF’s.
Can make Roth 401k contribution.
Must set up prior to 12/31.
Have until following 4/15 to contribute.