- Solo 401(k) plans are for the sole employee of businesses that have no other employees.
- The participant’s spouse can also participate.
- Individual contribution limits and distribution rules for the Solo 401(k) are the same as the standard 401(k).
- Employer contribution limits for the Solo 401(k) must be calculated separately.
Being self-employed can be extremely rewarding but, going it alone can often mean forfeiting certain perks available to employees of larger companies. Fortunately, 401(k) participation is not just for large companies. The IRS has opened up a Solo 401(k) option, which is designed specifically for small businesses with no employees other than the owner.
Solo 401(k) Basics
First, don’t be confused by the fact that the Solo 401(k) is known by a number of names. All of the following refers to the same type of retirement plan:
- Self-employed 401(k)
- Individual 401(k)
- One-participant 401(k)
- One-participant k
All of these names refer to a 401(k) plan that is exclusive to individuals who own a company with no other employees. The owner’s spouse is also able to participate.
Other than eligibility for the plan, Solo 401(k) plans are governed by the same set of rules as traditional 401(k) plans. Contributions are tax-deferred, which means no taxes are paid on deposits into the account and regular income taxes are assessed on withdrawals.
Contribution Limits for a Solo 401(k)
While contributions to Solo 401(k) plans are handled in the same way as those to traditional 401(k) plans, some of the contribution limits are slightly different. Solo 401(k) participants can contribute up to 100% of earned income or up to the annual contribution limit, whichever is lower. The current annual contribution limit is $18,000, with an additional $6,000 catch-up contribution permitted for those age 50 and older. This is the same as the contribution limits that apply to traditional 401(k) plans.
The primary difference comes from employer contributions. Participants who are self-employed must calculate the employer contribution based on the company’s net earnings after subtracting half of the self-employment tax and elective deferrals. Note that the total company and employee contributions cannot exceed the limits set by the IRS.
In 2016, contribution limits remain unchanged from 2015:
|Maximum Elective Contribution||$18,000||$18,000|
|Catch-Up Contribution (age 50 and older)||$6,000||$6,000|
|Maximum Individual + Company Contribution||$53,000||$53,000|
|Maximum Individual + Company Contribution with Catch-Up||$59,000||$59,000|
Solo 401(k) Withdrawals
Taking withdrawals from the Solo 401(k) follow the same rules as traditional 401(k) plans. Participants can withdraw funds at any time after the age of 59 ½, at which time regular income taxes apply to the total amount of the distribution. Under limited circumstances, distributions can be taken before the age of 59 ½, although the funds might be subject to a 10% tax penalty in addition to the regular income taxes.
Note that under most circumstances, participants must begin taking required minimum distributions (RMD) at the age of 70 ½. The amount of the RMD is calculated based on the participant’s life expectancy and, in some cases, her spouse’s life expectancy. It is important to withdraw the correct amount, as any portion of the RMD that should have been taken but was not is subject to a 50% tax penalty. Tools to calculate your specific RMD are available from the IRS.
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This article is not intended as tax advice, and Wealthfront does not represent in any manner that the outcomes described herein will result in any particular tax consequence. Prospective investors should confer with their personal tax advisors regarding the tax consequences based on their particular circumstances. Wealthfront assumes no responsibility for the tax consequences to any investor of any transaction. Investors and their personal tax advisors are responsible for how the transactions in an account are reported to the IRS or any other taxing authority.