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Set Up a Solo 401(k)

Sandy Botkin
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What is a Solo 401K, you ask? Good question. Most people never heard of this. This allows you to put away more money than a typical SEP or other defined contribution plan. Here is the “skinny” on a solo 401K

With a normal defined contribution plan, you can put the lesser of 25% of your wages (or net income if you are self employed) or $56,000. In contrast, an employee participating in a traditional 401K plan can make an elective deferral contribution to the plan with the annual limits and the employer may patch part of the contribution, usually up to a single digit percentage of your salary.

A solo 401(k) offers even more. For 2019, you may defer up to $19,000 of compensation to your account, plus an extra catch-up contribution of $6,000 if you are age 50 or greater. This is the same as with elective deferrals for a normal 401(k). However, here is the kicker: Elective deferrals to a solo 401(k) don’t count towards the 25% cap. So you can combine an employer contribution with an employee contribution for greater savings.

Let’s take an example:

Let’s say that you are a sole employee of your company and under age 50 and you receive an annual wage of $125,000. The maximum deductible contribution to a SEP would be $31,250, which is the lesser of 25% of your salary or $56,000. If, however, you set up a solo 401(k), you can defer $19,000 to the account in addition to keeping the maximum $31,250, which would be the employer’s contribution. Thus, your total contribution would be in this case $50,250. Moreover, if you are the only employee of the company, you don’t have to worry about making contributions for anyone else. 

Note: If your business isn’t incorporated,such as being self employed, the 25% compensation cap is reduced to 20%. because of the way contributions are calculated for self employed. Thus, if your self employed net income is $125,000, you can stash away $49,000 which includes the $19,000 deferral plus another 20% of net income which is $30,000.

So what’s the catch? There is always some gotcha. First, if your business has any other employees, you may have to cover then under the plan. Secondly, you have to deal with the hassle and cost of running the plan. However, due to the increased number of business getting into managing these plans, such as Fidelity and Smith Barney, the cost of setup is only about $100 and the annual cost of administration is from $50-$250.

Bottom line: Very few people are aware of this new solo 401(k). It can be a great plan for self employed folks such as Realtors and owners of home based businesses and other independent contractors. Please pass it on to your friends and family.

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Sandy Botkin

Sandy is a CPA, Tax Attorney, and former IRS trainer. He has authored many helpful books on the subject of taxes, including 7 Simple Ways to Legally Avoid Paying Taxes ( Click Here ), Lower Your Taxes: Big Time ( Click Here ), and Real Estate Tax Secrets of the Rich ( Click Here ).

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