News & Events

Solo 401(k)s Offer Singular Advantages

November 09, 2009

For self-employed individuals and owners of certain small businesses, several retirement plan options are available. One option that offers a number of singular advantages is the Solo 401(k).

High contribution limit

A Solo 401(k) is a type of profit-sharing plan designed for just one person. Perhaps its biggest advantage is that it may allow you to contribute more than you could to other defined contribution plans, such as a Simplified Employee Pension (SEP) or a traditional profit-sharing plan. Specifically, you can fund a Solo 401(k) with a salary deferral of as much as 100% of the first $16,500 (for 2009) of your compensation, just as you could with an ordinary 401(k).

But you also can make an “employer” profit-sharing contribution of up to 25% of compensation or, if you’re a sole proprietor, 20% of your self-employment income (not including the salary deferral).

The maximum contribution limit — combining both the salary deferral and the employer profit-sharing contribution — has gone up to $49,000 in 2009, with an additional “catch up” contribution of $5,500 for those age 50 or older.

Let’s look at an example. Say your self-employment income is $100,000 in 2009. In this case, you could make a 401(k) salary deferral contribution of $16,500, plus contribute 20% of the $83,500 balance, or $16,700. This total of $33,200 is far greater than the $20,000 available with just a traditional profit-sharing or SEP plan.

Bear in mind, however, that, as self-employment income increases, the contribution limit advantage of a Solo 401(k) over SEPs and regular profit-sharing plans is reduced and eventually eliminated. This is because the $49,000 maximum applies to all three — except in the case of taxpayers age 50 or older, where the $5,500 catch-up contribution still gives Solo 401(k)s an advantage over SEPs, which don’t allow this additional amount.

Additional pluses

Another attractive feature of Solo 401(k)s is their flexibility. Because you aren’t committed to contributing a particular amount each year, in bad years you can reduce your contributions if you need to. Additionally, if you have another retirement plan in place, you can likely roll it over to the Solo 401(k) so you have only one plan to manage.

And you can control your investments by choosing self-directed funds with a reputable custodian. You can even hold life insurance, real estate or other nontraditional investments within the plan.

Still another intriguing aspect of Solo 401(k)s is the potential availability of plan loans. Participants can borrow up to 50% of the account balance, up to a maximum of $50,000. Just remember that you must repay the loan with level payments made at least quarterly, based on a market rate of interest, and the interest paid generally won’t be deductible.

Something to consider

Solo 401(k)s have other limits as well. Perhaps the most significant is that you can’t set one up if you have employees who’d be eligible to participate in a “qualified” retirement plan. You’d then need a 401(k) plan that covers them as well. Nonetheless, many self-employed individuals and owners of very small businesses have put these plans to good use in recent years, so they’re absolutely worth considering.

« Back to News | Back to the top

---

The content in our Web site's news articles is intended to review and explain business issues, trends and ideas to business owners, executives and individuals. We hope this article, publication and web site will help you deal more effectively with a variety of management, tax and business planning issues; it is not intended, however, to provide accounting, legal or other professional advice. For more information about the ideas presented in this news article, please call our offices at (314) 962-0300.