The Solo 401(k) Plan – The Facts
The Solo 401(k) Plan is essentially a regular, plain-old, vanilla 401(k) plan that has one participant, who is a self-employed individual, or that person and his or her spouse. There is some misinformation being disseminated about these plans and we would like to set the record straight. We want to let you know what is fact and what is fiction according to the Internal Revenue Service.
A 401(k) plan for a self-employed individual is a new kind of plan.
The “one-participant 401(k) plan” is not a new type of plan. It is a traditional 401(k) plan covering only one employee. The plans have the same rules and requirements as any other 401(k) plan. The surging interest in these plans is a result of the EGTRRA tax law change that became effective in 2002. The law changed how salary deferral contributions are treated when calculating the maximum deduction limits for contributions to a 401(k) plan. This change created an opportunity for some people to put away additional amounts toward their retirement. The Solo 401(k) Plan is best suited for business owners who do not have any employees, other than themselves and perhaps their spouse.
I can make up to $59,000 of contributions to my 401(k) Plan as employee and employer each year.
The annual Solo 401k contribution consists of 2 parts, an employee salary deferral contribution and an employer profit sharing contribution. In 2016 the total contribution limit for a Solo 401k is $53,000 or $59,000 if age 50 or older. The total allowable contribution limits are combined to get the maximum Solo 401k contribution limit.
Under the 2016 Solo 401(k) contribution rules, a plan participant under the age of 50 can make a maximum employee deferral contribution in the amount of $18,000. That amount can be made in pre-tax or after-tax (Roth). On the profit sharing side, the business can make a 25% (20% in the case of a sole proprietorship or single member LLC) profit sharing contribution up to a combined maximum, including the employee deferral, of $53,000.
For plan participants over the age of 50, an individual can make a maximum employee deferral contribution in the amount of $24,000. That amount can be made in pre-tax or after-tax (Roth). On the profit sharing side, the business can make a 25% (20% in the case of a sole proprietorship or single member LLC) profit sharing contribution up to a combined maximum, including the employee deferral, of $59,000.
Employee Elective Deferrals
Under the 2016 Solo 401(k) contribution rules, a plan participant under the age of 50 can make a maximum employee deferral contribution in the amount of $18,000.
For plan participants over the age of 50, an individual can make a maximum employee deferral contribution in the amount of $24,000. That amount can be made in pre-tax or after-tax (Roth).
Employer Profit Sharing Contributions
Through the role of employer, an additional contribution can be made to the plan in an amount up to 25% of the participant’s K-1 or self-employment compensation (20% in the case of a Sole Proprietor or Schedule C Tax Payer).
In 2016, the maximum solo 401(k) plan contribution limitation is $53,000 and $59,000 for plan participants over the age of 50.
If the business owner’s spouse elects to participate in the Solo 401(k) and earns compensation from the business, the spouse is allowed to make separate and equal contributions increasing the couples’ annual total contribution to $106,000 for 2016 or $118,000 if both spouses over age 50.
Solo 401k contributions are flexible. Both the salary deferral and the profit sharing contributions are optional and can be changed at any time based on business profitability.
A Solo 401k participant can contribute to the plan as an employee and as employer.
As a Trustee of the Solo 401(k) Plan I can make investments in traditional and non-traditional investments, such a real estate.
A Solo 401(k) offers a self-employed business owner the ability to use their retirement funds to make almost any type of investment on their own, including real estate, tax liens, and precious metals without requiring the consent of any custodian or person.
Unlike an IRA, I can use a nonrecourse loan to purchase real estate with my 401(k) Plan?
When an IRA buys real estate that is leveraged with mortgage financing, it creates Unrelated Debt Financed Income (a type of Unrelated Business Taxable Income) on which taxes must be paid. A Solo 401(k) plan is exempt from UDFI pursuant to Section 514.
I can borrow the lesser of $50,000 or 50% of my 401(k) account value for any purpose?
A solo 401k loan is permitted at any time using the accumulated balance of the solo 401k as collateral for the loan. A Solo 401(k) participant can borrow up to either $50,000 or 50% of their account value - whichever is less. This loan has to be repaid over an amortization schedule of 5 years or less with payment frequency no greater than quarterly. The interest rate must be set at a reasonable rate of interest - generally interpreted as prime rate as per The Wall Street Journal. As of 12/21/15 prime rate is 3.50%, which means participant loans are to be set at a very reasonable interest rate. The Interest rate is fixed based on the prime rate at the time of the loan application.
As a self-employed individual I can defer $18,000 in pre-tax deferrals and $18,000 in after-tax deferrals (Roth).
The answer is “No.” There is one limit per person for all types of elective deferrals. However, the $18,000 can be split in any ratio between the Roth and the pre-tax elective deferrals.
Employer contributions to a 401(k) Plan are due when the employer’s tax return is due.
Employer contributions are not required to be made until the due date of the employer’s tax return, plus extensions. So, in the case of a sole proprietor, this is when the 1040 is due – October 15, if an extension was filed.
If I have two jobs, I can contribute the maximum to both company’s plans.
The 402(g) limits are by person, not by plan. For example, Steve, aged 40, is employed by Company X, and participates in Company X’s 401(k) plan. Steve defers the most allowed by Code section 402(g) for 2016, $18,000. He also has his own business with a 401(k). He will not be able to defer anything in the self-employed 401(k) for 2016. This is because the Code section 402(g) limit applies to the individual and he has already deferred the maximum allowed for the year.
If I am the only participant and have a 401(k) plan, I don’t have to file any annual Form 5500 returns.
A Form 5500-EZ (or Form 5500) does not have to be filed for a plan year (other than the final plan year) that begins on or after January 1, 2011, if you have one or more one-participant plans that separately or together had total assets of $250,000 or less at the end of that plan year. In other words, if the assets of the plan or plans exceed $250,000, a Form 5500-EZ is required for a one-participant plan. The IRA-based plans almost never have an annual Form 5500 filing requirement, regardless of the value of the IRA assets.
If additional employees are hired, they don’t have to be covered under a 401(k) plan for self-employed individuals.
Just because the plan is called Solo 401(k), it doesn’t mean that if the business is expanded and employees are added, the plan is only for one employee. If the new employee meets the eligibility requirements under the plan, then he or she will be required to enter the plan and be eligible for salary deferrals. Assuming that the new employee is a non-highly compensated employee, the plan is now subject to nondiscrimination testing, known as the ADP and ACP tests.
Please contact one of our IRA Experts at 800-472-0646 for more information.