As a business owner, you know you must plan for retirement, but who has time?
Three things about that:
1) It does not take much time compared to the tax savings and value you will receive for doing it.
2) Contributing to your retirement is as important as managing your day-to-day operations, because you DO want to retire someday!
3) There is a simple solution for you:
The Solo 401(k) offers a way to maximize your retirement contributions, while reaping significant tax benefits.
What Is a Solo 401(k)?
The Solo 401(k) (also called a Solo-k, Uni-k, and One-participant-k) is specially tailored for self-employed individuals or business owners with no employees or for that owner and their spouse. However, the owner’s spouse can only participate in the plan if they work in the business and receive a W-2 (it can be full or part-time).
Here is the power of the Solo 401(k)
This plan allows you to contribute to your retirement in two ways:
as an employee and as an employer,
maximizing the amount you can set aside for the future without having to take a super large W-2.
These plans have the same rules and requirements as any other 401(k) plan. It might be wise to read this government publication on 401(k) plans.
Spouse Rules: If the spouse is an employee, they are eligible to be part of the Solo 401(k) plan, but the spouse can also receive the 25% employer profit-sharing contribution just like the owner/taxpayer does.
IRS’s Solo 401(k)” Guidelines for 2024 and 2025
2024 Contribution Limits
- Employee Contributions: As the employee, you can contribute up to $23,000. If you’re 50 or older, you can make an additional catch-up contribution of $7,500, bringing the total to $30,500.
- Employer Contributions: As the employer, you can contribute up to 25% of your compensation, capped at $69,000 (or $76,500 for those aged 50 or older), reduced by the amount you contributed as the Employee above.
Without the 401k element of this plan, you would have to have earned income/W-2 of $345,000 order to contribute the maximum cap of $69,000. But with the Solo 401(k), you are able to achieve a large portion of your tax-deductible retirement contribution through your payroll, leaving the remaining, smaller portion as the 25% multiple of your earned income/wages.
Taking a smaller W-2 can save you payroll taxes, also. Remember, you must always take what is considered a reasonable wage for the services you perform. But this Solo 401(k) allows you to achieve a higher total tax-deductible retirement contribution without forcing a larger W-2 than would otherwise be reasonable for your situation, and over-paying in payroll taxes.
2025 Contribution Limits
- Employee Contributions:
- Deferrals to 401(k) retirement is $23,500, up from $23,000 in 2024.
- NOTE: Under a change made in the Secure. 2.0 Act, for 2025, the higher catch-up contribution limit for employees who participate in these plans and are aged 60,61, 62, and 63, the limit is $11,250 instead of $7,500.
- Employer Contributions: 25% of your compensation, capped at $70,000; up from $69,000 in 2024.
Calculating Contributions for the Self-Employed
If you’re self-employed as a sole proprietor, calculating your contributions can be a bit tricky due to the need to determine your “plan compensation.” This involves adjusting your net earnings from self-employment by:
- Deducting the deductible portion of your self-employment (SE) tax.
- Subtracting your own retirement plan contributions.
This calculation is circular because your plan compensation depends on your contribution, which, in turn, is based on your plan compensation. The IRS provides worksheets in Publication 560 to help navigate this complexity.
EXAMPLES
A. If you are an S-Corp owner with no employees, your Solo 401(k) contribution can be maximized as follows:
- Employee contribution of $23,000 (through a 401(k) payroll deduction)
- Plus employer contribution at 25% of gross wages of $184,000=$46,000
Total Contributions= $69,000
These figures will change for 2025
It is important to discuss the best compensation strategy with your tax advisor.
Having a Solo 401(k) as an S-Corp owner means you will reach your $69,000 statutory maximum faster because you need less profit and only $184,000 in wages.
B. If you are a sole proprietor, the calculation is a little more involved.
Reaching the maximum depends on your self-employment (SE) tax rate and other figures required in the IRS Publication 560. Worksheet examples to guide you in the calculations start on page 34 of Publication 560. LSL CPAs can help with these forms, as they often work with small businesses to complete Form 1040 Schedule C, Schedule F, etc., for the overall tax return.
Note: The IRS Forms are subject to updating. Some publications posted on the IRS website are for 2023, with additional directions for the 2024 tax year inserted within the publication. You have to look for them. Please check the IRS site for new rulings for 2025 or contact LSL CPAs to make sure you are using the most current forms.
Additional Considerations
- Contribution Limits: Keep in mind that if another retirement plan covers you, the limits for elective deferrals/401(k)s are capped at $23,000 (2024) per year by person, not by plan.
- Plan Administration: If your Solo 401(k) has $250,000 or more in assets at year-end, you are required to file an annual tax return Form 5500-EZ. Your brokerage firm may notify you of this requirement, but it is your responsibility to ensure the form is filed.
- Plan Options: While many brokerage firms offer no-fee Solo 401(k) plans, you might also consider a custom-designed plan through a third-party provider to tailor the features to your specific needs.
The Bottom Line
A Solo 401(k) is a powerful tool for self-employed individuals and business owners wanting to maximize their retirement savings while minimizing tax liabilities. By taking full advantage of employee and employer contribution limits, you can set yourself up for a comfortable retirement while making smart tax planning decisions.
As with any retirement strategy, working with a financial advisor or tax professional is essential to ensure you’re making the most of the available options and staying compliant with IRS regulations. Some of the rules are tricky, and over-contributing can be a problem. There is a 6% penalty per year on the amount that was overcontributed.
Good News: There’s still time to set this up in 2024, and it’s an excellent time to start planning for your retirement contributions for 2025, where that catch-up contribution for specific age groups jumps from $7,500 to $11,250.
Please reach out to us if you would like guidance in this critical aspect of business ownership.
