The Solo(k) -- A 401(k) Plan for the Solo Business Owner
An Overview
The Solo(k) works like a regular 401(k), except that they are limited to one-person firms with no employees other than a spouse, or partners and their spouses. The Benefit to the SolThe Benefit to the Solo Ownero Owner In many cases, the amount of money a one-person firm can save for retirement is significantly higher than can be saved using either a SEP IRA or Simple IRA Plan. Because there are no other employees, the discrimination testing and top heavy minimum contributions that apply to regular 401(k)’s are not applicable.
How Much Can Be Saved Each Year
For 2005, the solo business owner can make a salary deferral of the lesser of 100 percent of pay, or 14,000 into their Solo(k) account. In addition to the salary deferral, catch up contributions are allowed for people who are over age 50. For 2005, the catch up is an additional $4,000, bringing the total allowable salary deferral up to $18,000.
On top of the salary deferral, an employer profit sharing contribution of up to 20 percent of earned income for an unincorporated business or 25 percent of W-2 compensation may also be made to the plan.
If the solo owner’s spouse works for the owner, they may also make deferrals from their paycheck, and receive employer profit sharing contributions.
The sum of these two types of contribution may not exceed $42,000 for employees under age 50 or $46,000 for employees over age 50.
The maximum contribution to a SEP IRA is 20 percent of earned income for an unincorporated business or 25 percent of W-2 compensation. The maximum contribution to a SIMPLE IRA is $10,000 for people under age 50 or $12,000 for people over age 50, plus a small additional employer contribution.
Investing the Money
Investing the Money You may invest your Solo(k) account at any brokerage house or bank, providing that the account is set up in the name of the Solo(k) plan, not in the individual’s name. Copies of all investment statements must be provided to Century Benefits Consulting on an on-going basis.
An Example of How the Solo(k) Really Works
The Facts: Jane owns a company, and her husband Bob works part time for her. Jane’s W-2 income is $90,000 per year, and Jane pays Bob $50,000 per year. Both Jane and Bob are over age 50.
Jane is able to defer $18,000 for 2004, consisting of $14,000 in regular salary deferrals, and $4,000 in catch up contributions. Bob is also able to defer $18,000 for 2004. Jane’s company is able to make a profit sharing contribution of $35,000, of which $22,500 goes into Jane’s account, and $12,500 goes into Bob’s account.
For 2005, Jane is able to save $40,500, and Bob is able to save $30,500 toward their retirement. Jane and Bob each save federal and state income tax withholding on their $18,000 salary deferrals. Jane’s company is able to claim a $35,000 expense for the profit sharing contribution, thus reducing the amount of income tax the business will pay.
If Jane’s company sponsored a SEP IRA instead, then her company would only be able to deduct the $35,000, because there would be no salary deferrals. The additional $36,000 Jane and Bob want to save for their retirement would need to come from other sources, and would most likely be in taxable accounts, not from pre-tax deferrals.
How Are These Accounts Taxed
How Are These Accounts Taxed The contributions to a Solo(k) are deposited on a pre-tax basis. If you have an unincorporated business, the amount you defer is deducted on your 1040. If you are a W-2 employee, the amount you defer comes out before Federal and State income tax is withheld. The money grows tax-free until you withdraw it, at which time it is taxed as ordinary income. The 10 percent penalty on withdrawals before age 59 1⁄2 also applies.
Additional Requirements
The Solo(k) is a qualified retirement plan, subject to the annual filing requirements of the government.
In addition:
- The Plan must be established using a written plan document that outlines the plan’s terms, and meets certain IRS requirements.
- If the employer hires employees other than spouses or other owners, the nondiscrimination requirements and top heavy minimum contributions will apply.
Establishing a Solo(k) Plan
Century Benefits Consulting will establish the Solo(k) plan for the employer, provided the employer meets the requirements to maintain such a plan. Our fees are $850 for the first year, and include preparation of the Plan Document, and the first year’s annual IRS Filing. Our fees are $50 per month on an on-going basis.
Contact us for more information.