Who Can Open an Individual 401(k)?
The Individual 401k is the newest and most exciting retirement plan to benefit the self employed, thanks to the recent tax law created by the Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA). This tax law became effective beginning January 1, 2002 and provides significant advantages to small businesses whose only employee is the owner or the owner and their spouse. These self employed business owners can establish an Individual 401k plan and take advantage of this powerful retirement savings tool.
What makes the Individual 401k unique is that compared to other self employed retirement plans greater contributions may be made at identical income levels, therefore maximizing retirement contributions and valuable tax deductions.
You can contribute the lesser of 25% of your income OR $56,000 for 2019 ($57,000 for 2020). Be sure to check with your tax professional to determine your max contribution. The annual Solo 401k contribution consists of 2 parts: 1) a salary deferral contribution and 2) a profit sharing contribution. The total allowable contribution adds these 2 parts together to get to the maximum Solo 401k contribution limit.
Solo 401k contributions are flexible. Both the salary deferral and the profit sharing contributions are discretionary and can be changed at anytime based on business profitability.
The contribution limits can be doubled for husband and wife businesses. Businesses with a spouse on the payroll can also contribute to the Solo 401k. There would be one Solo 401k for the business with two participants.
The Secure Act, passed in January 2020, allows 401(k) plans adopted by the tax-filing due date (including extensions) for year to be treated as, in effect, as of close of year. This is applicable to plans adopted for taxable years beginning after December 31, 2019. This means there is no longer a year-end deadline to set up a plan to make a prior-year contribution.
Please Discuss Contributions with Your Tax Advisor
Self employed business owners with no W-2 employees may be well suited for an Individual 401k if their objective is to maximize their retirement contributions or if they would like to borrow from their retirement plan using their 401k balance as collateral via a tax free Individual 401k loan.