Starting a small business can be an exciting prospect for anyone seeking career and financial independence. However, the planning and processes required to achieve those goals can be quite daunting. Entrepreneurs should be concerned with not only how they will make money today, but how they will save enough to ensure a successful retirement for themselves in the future. One option to consider is the solo 401(k) plan.
Solo 401(k) plans are retirement-savings accounts specifically created for business owners who do not have any full-time employees. They provide the individual business owner and his or her spouse with the same benefits of a traditional 401(k) plan without the administrative costs and complexities. In fact, solo 401(k) plans can provide business owners with additional tax-advantaged savings opportunities that they would not have as employees. For example, business owners can contribute more to solo 401(k)s as both the employee and the employer.
For 2021, the maximum employee contribution to a solo 401(k) is $19,500, or $26,000 for those individuals age 50 and above. Business owners may be limited to contributing less when their net compensation is below these amounts. However, business owners receive the added benefit of making employer contributions to their solo 401(k)s of as much as 20 percent of net self-employment income or 25 percent of W-2 earnings. In terms of total contributions as both employee and employer, a business owner may contribute up to $58,000 in pre-tax dollars to a solo 401(k) plan in 2021, or $64,500 when the business owner is older than 50 years of age.
To put these rules to use, consider Tom, a 35-year-old sole proprietor with $100,000 in net adjusted business profits in 2021. Tom can make a $19,500 employee contribution to his solo 401(k) plan and an additional $20,000 (20 percent of net income) as an employer contribution for a total of $39,500 for 2021. If Tom’s business is structured as a C corporation or an S corporation and he earns $100,000 in W-2 wages, the employer profit-sharing portion of his contribution can be as high as $25,000 (25 percent of wage income) for a total of $44,500.
Although a business owner with just one non-family member employee will not qualify for a solo 401(k) plans, the IRS does allow his or her spouse to participate in the plan and make salary deferrals, but only when the spouse earns income from the business. In this scenario, both the business owner and his or her spouse will be able to contribute to their respective retirement plans using pre-tax dollars that they may deduct from their combined taxable income in the years they make contributions. The business owner may also make a profit-sharing contribution to his or her spouse’s plan of up to 25 percent of the spouse’s wages, subject to income limitations.
With solo 401(k) plans, business owners also have the option to make their 401(k) contributions as Roth deferrals. These contributions can be made with after-tax dollars, but all future withdrawals are income-tax-free provided the taxpayer meets certain holding period and age requirements. In addition, business owners who want to increase their retirement savings have the option to make annual, non-deductible, after-tax contributions to their plans, up to certain limits. Those contributions made to a business owner’s or a spouse’s plan will be taxed as income in the year of contribution and distributed tax-free in retirement. Under these circumstances, however, the business owner and spouse will be liable for income taxes on the earnings growth, interest and dividends generated by their initial contributions.
Solo 401(k)s offer business owners a powerful and flexible retirement-savings option, especially when they are part of a tax-efficient estate plan carefully crafted under the guidance of experienced financial advisors.
About the Author: Sean Deviney is a CFP®* professional, a retirement plan advisor and a director with Provenance Wealth Advisors (PWA), an independent financial services firm affiliated with Berkowitz Pollack Brant Advisors + CPAs. For more information, call (954) 712-8888 or email info@provwealth.com.
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Sean Deviney is a registered representative of and offers securities through Raymond James Financial Services, Inc., Member FINRA/SIPC. Raymond James is not affiliated with and does not endorse the opinions or services of Berkowitz Pollack Brant Advisors and Accountants. PWA is not a registered broker/dealer and is independent of Raymond James Financial Services. Investment Advisory Services offered through Raymond James Financial Services Advisors, Inc., and Provenance Wealth Advisors.
This material is being provided for information purposes only and is not a complete description, nor is it a recommendation. Any opinions are those of PWA and not necessarily those of Raymond James. You should discuss any tax or legal matters with the appropriate professional. The information contained in this report has been obtained from sources considered to be reliable, but Raymond James does not guarantee that the foregoing material is accurate or complete.
401(k) plans are long-term retirement savings vehicles. Withdrawal of pre-tax contributions and/or earnings will be subject to ordinary income tax and, if taken prior to age 59 1/2, may be subject to a 10% federal tax penalty. Investments mentioned may not be suitable for all investors. There is no guarantee that these statements, opinions or forecasts provided herein will prove to be correct.
* Certified Financial Planner Board of Standards Inc. owns the certification marks CFP®, CERTIFIED FINANCIAL PLANNER™ and federally registered CFP (with flame design) in the U.S., which it awards to individuals who successfully complete CFP Board’s initial and ongoing certification requirements.
Posted March 31, 2021
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