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Understanding the Solo 401(k) Employee Deferral Rules

Solo 401(k) Employee Deferral Rules
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The Solo 401(k) Plan, also known, as the Individual 401(k) or Self-Directed 401(k) Plan, is an IRS-approved type of qualified retirement plan which is suited for business owners who do not have any employees, other than themselves and perhaps their spouse. It’s the ideal plan for the self-employed. The Solo 401(k) plan is not a new type of plan. It is a traditional 401(k) plan covering only one employee. The annual Solo 401(k) contribution consists of two parts, an employee salary deferral contribution and an employer profit sharing contribution. For 2021 the total contribution limit (Internal Revenue Code Section 415) for a Solo 401(k) is $58,000 or $64,500 if age 50 or older. The total allowable contribution limits are combined to get the maximum Solo 401(k) contribution limit.

Key Points
  • The Solo 401(k) contribution is made up of two parts – employee deferral and employer profit sharing
  • The Employee Deferral can be made dollar for dollar of compensation up to the annual limit
  • For 2022, the Deferral Limit is increasing $1,000 to $20,500

Employee Elective Deferrals

For 2021, up to $19,500 per year can be contributed by the participant through employee elective deferrals. An additional $6,500 can be contributed for persons who are at least age 50. These contributions can be up to 100% of the participant’s self-employment compensation. Employee deferrals are 100% elective and are not required.

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 self employment compensation (20% in the case of a sole proprietorship or single member LLC). Employer profit sharing contributions can only be made in pretax and are not required.

Total Limit

For 2021, the sum of both employee deferral and employer profit sharing contributions can be a maximum of $58,000 per year ($57,000 for 20201) or $64,500 for persons at least age 50 ($63,500 for 2020).

2022 Contributions Limits

In early November, the IRS released its cost-of-living adjustments for the Solo 401(k) plan. For 2022, you may contribute more to your Solo 401(k)! The employee deferral was increased by $1,000, to $20,500. The total limit was increased a whopping $3,000 to $61,000. The catch-up contribution remains at $6,500. Therefore, if you are at least age 50, you may contribute up to $67,500 to your plan.

Employee Deferrals in Detail

Internal Revenue Code (“IRC”) Section 402(g) limits the amount of employee elective deferrals a participant may exclude from taxable income in the participant’s taxable year. A participant must aggregate all elective deferrals contributed to all of the plans in which he or she participates to determine if the IRC Section 402(g) limit has been exceeded.  For 2021, the maximum IRC 402(g) limit is the lesser of your earned income (Schedule C)  or W-2 or $19,500 ($26,000 if age 50+).  Depending on your plan documents, employee deferrals can be made pretax (tax-deductible) or in Roth. 

In other words, one is not permitted to make employee deferrals in excess of what they earn.  Thus, if one earned $12,000 as a W-2 from a S Corporation, the maximum employee deferral would be $12,000 minus any applicable Medicare and Social Security taxes. 

In order to determine the amount of pretax 401(k) employee deferrals that can be made to the plan, one would need to figure out his or her Medicare and Social Security taxes based on their gross wages. These two federal taxes are not exempt from pretax 401(k) withholding, however, they are tax deductible.   

The easiest way to calculate exactly how much you can contribute to your Solo 401(k) plan is by using our free online employee deferral calculator.

The simplest way to understand how to calculate one’s Solo 401(k) employee deferrals is through an example:

Jen is 45 years old and earned $50,000 from her sole proprietorship business.  In 2021, the maximum employee deferral contribution Jen would be permitted to make is:

  • Net Earnings (before qualified plan deduction): $50,000.00
  • Calculate 1402(a)(12) Deduction: $46,175.00
  • Calculate Medicare & FICA (TWB of 142800): $7,064.78
  • 1/2 of Self-Employment Tax: $3,532.39
  • Self-Employment Income: $46,467.61

Hence, after Medicare and Social Security taxes, Jen’s net 2021 compensation amount available for employee deferral and employer profit sharing contribution is $46,467.61.

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    Employee Deferral Contribution Deadline

    In general, the deadline for making employee deferrals to a Solo 401(k) plan will be dependent on the type of entity that adopted the solo 401(k).

    • Sole proprietorship:  In the case of a sole proprietorship, the deadline for making employee deferrals is the date when IRS Form 1040 is filed, including extensions.  Note – employer profit sharing contributions are also due when the IRS Form 1040 is filed, including extensions.
    • Single-Member LLC.  In the case of a single-member LLC (Schedule C), the deadline for making employee deferrals is the date when IRS Form 1040 is filed, including extensions.  Note – employer profit sharing contributions are also due when the IRS Form 1040 is due to be filed, including extensions.
    • Multiple-Member LLC.  In the case of a multiple-member LLC or partnership, employee deferrals are due by December 31.  Note – employer profit sharing contributions are due when the IRS Form 1065 is due to be filed, including extensions
    • C or S Corporation.  In the case of a C or S corporation, employee deferrals are due by December 31.  Note – employer profit sharing contributions are due when the IRS Form 1120 or 1120S, as applicable, is due to be filed, including extensions

    The Solo 401(k) plan is the best retirement plan for the self-employed or small business owner with no non-owner full-time employees. Unlike a SEP IRA, the Solo 401(k) allows one to make employee deferral contributions as well as employer profit sharing, borrow up to $50,000 tax-free, serve as trustee of the plan, and have the ability to make alternative asset investments.

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