One of the major advantages of using a Solo 401K retirement plan over an IRA is the high annual contributions that one can make on an annual basis. Unlike an IRA, a Solo 401k plan allows a plan participant to make up to ten times the annual contributions to the Plan. The contributions can be in the form of pre-tax or Roth type contributions (after-tax).
Prior to 2002, most self-employed individuals tended to use a SEP IRA or SIMPLE IRA as a retirement vehicle. However, in 2002 the Economic Growth and Tax Reconciliation Act of 2001 (EGTRRA) became effective and generally provided the small business owner with no employees or the self-employed the same advantages/benefits of a conventional 401(k) Plan.
The annual Solo 401k contribution consists of two components, an employee salary deferral contribution and an employer profit sharing contribution. In 2012 the total contribution limit for a Solo 401k Plan participant is $50,000 or $55,500 if age 50 or older. The total allowable contribution limits are combined to get the maximum Solo 401k contribution limit.
With respect to the employee deferral component, a Solo 401K Plan participant can contribute up to $17,000 per year to the plan. In addition, an additional “catch-up” contribution of $5,500 can be contributed for persons over age 50. Note – the employee deferrals can be made in pre-tax or Roth (after-tax). Also, there is no requirement that an employee deferral contribution be made each year.
With respect to the employer profit sharing contribution component, the employer – not the individual – is permitted to make a tax-deductible contribution on behalf of the employee equal to an amount up to 25% of the participant’s self- employment compensation. Note – the percentage is actually 20% in the case of a solo proprietorship and a single member LLC once the tax return calculations are complete. Also, like the employee deferral, the employer is not required to make employer profit sharing contributions, however, if a contribution is made, the contribution percentage must applies to all employees (i.e. husband and wife).
Below is a link to a calculator that will help you calculate the annual solo 401(k) contributions: