In 2001, the government gave self-employed workers a gift: a 401(k) plan that allows for greater amounts of tax-deferred income with less hassle to set up than any other retirement plan.
The plan, mostly called a Solo 401(k) or a Solo-k or one-participant plan beats traditional corporate 401(k)s in higher savings limits and in the ability to invest in a variety of options. With this plan, you are both an employee and an employer and make contributions for each.
You are an excellent candidate for a Solo-k if:
- You are a business owner or self-employed person.
- You have no employees, except for a spouse.
- You can and want to save a lot of money in certain years. You don’t have to make the same level of contribution
Up to $55,000 in 2018 (plus $6,000 catch-up contribution for those 50 or older) or 100% of earned income, whichever is less.
- In your capacity as the employee, you can contribute up to 100% of your compensation or $18,500 (plus that $6,000 catch-up contribution, if eligible), whichever is less.
- In your capacity as the employer, you can make an additional contribution of up to 25% of compensation.
- There is a special rule for sole proprietors and single-member LLCs: You can contribute 25% of net self-employment income, which is your net profit less half your self-employment tax and the plan contributions you made for yourself.
- The limit on compensation that can be used to factor your contribution is $275,000 in 2018.
All contributions are pre-tax. If you take withdrawals before age 59 1/2 tax is due as well as a 10% penalty. You must take RMD’s (Required Minimum Distributions starting at age 70 1/2.
If your spouse works in the business, you can potentially contribute up to $55,000 plus catch-up if age-eligible, doubling the contribution.
Other things to know:
- Once the 401(k) reaches more than $250,000 you have to file paperwork with the IRS.
- You can open a 401(k) at almost all custodians.
- The contribution limits are annual, per person, so if there are other 401(k)’s it will limit the solo-k contribution.
- You can also choose a solo Roth 401(k) which follows most of the same rules as the Roth IRA (except for the income limits, there are no income limits for a Roth 401(k).