Posted by Fred Lake

A Closer Look at the Solo 401(k)

A Closer Look at the Solo 401(k)

Self- employment indeed offers plenitude perquisites but it also does have its disadvantage: you will lose an employer-sponsored retirement plan like a 401(k).

Set foot in the Solo 401(k) or the so-called one- participant 401 (k) of the Internal Revenue System. This account simulates numerous features of an employer-sponsored plan designed for self-employed workers without the drag of working for the man.

What is a Solo 401(k)?

As the name itself entails, Solo 401k is designed for the owner of a business that doesn't have employees. As a matter of fact, the IRS by laws states that if you have employees, you are not allowed to pitch into a Solo 401(k). However, the plan can be used to cover both you and your spouse.

Solo 401(k) Contribution Limits

The sum total solo 401(k) contribution coverage is raging up to $56,000 in 2019. 

There is an engross contribution of an extra $6,000 for those ages ranging from 50 or older.

For you to fully grasp the Solo 401(k) contribution rules, put yourself in the shoes of two different individuals: an employer (of yourself) and an employee (yes, still of yourself). Within that overall $56,000 contribution limit, there will be additional limits for your contribution in each role:

  • As the employee, you can have your contribution up to $19,000 in 2019, or 100% of compensation, whichever is less for you. An additional amount of $6,000 is added here for those who are 50 or older.
  • As the employer, you can generate an additional profit-sharing contribution of up to 25% from your compensation or net self-employment income, which is composed of your net profit less half your self- employment tax and the plan contributions you generated for yourself. The amount used to factor your contributions is $280,000 and this will be the basis of your compensation limit in 2019.

In side-gigging, bear in mind that 401(k) limits is by plan and not by a person. This means that if you're also participating in 401k during your day job, the limits will be applied to contributions across all plans and not on each individual plan.

Solo 401(k) Tax Advantages

What is very pleasing in Solo 401(k) is that you can freely pick and choose your own tax advantage. The traditional 410(k) will give you the option under which contributions reduce your income in the year they are generated. So with this, distributions in retirement will be taxed as ordinary income.

If you want an offer of no initial tax break and that moves you forward to take distributions in retirement tax -free, then take the alternative, the Roth Solo 401(k). Generally, if you are looking for a better option as you expect your income to be higher in retirement, then a Roth is a better choice. And if you think your income will decrease in retirement, then choose for the tax break today with a traditional 401(k).

Arising because of these tax advantages, the IRS has imposed strict bylaws about when you can tap the money you put into whatever type of account: consequently, you’ll pay taxes in different distributions as you age 59 and a half.

Are you seeking for more info? You can find it through this in-depth comparison of Roth and Traditional 401(k) below.

Covering your spouse under your solo 401(k)

Just for instance if your spouse earns income from your business, the IRS permits one exception to the no-employees rule on the Solo 401(k)

With that, you can potently double the amount you can contribute as a family but of course, it will depend on your income. 

Your spouse would make discretions as your employee, up to the $19,000 employee contribution limit (plus the 50-and-older catch-up provision, if applicable). And as an employer, you can then create the plan’s profit-sharing contribution for your spouse, of up to 25% of compensation.

How to Open a Solo 401(k)

In opening a Solo 401(k), you’ll need an Employer Identification Number to be given to your trusted online broker. Through the broker, a plan adoption agreement for you to complete will be provided for you as well as an account application. Once done with the initial steps, you can set up your contributions already. The broker will give you access to many of the investments offered covering mutual funds, index funds, exchange-traded funds, individual stocks, and bonds. 

If you wish to generate a contribution for this year, then you must substantiate the plan by December 31 and create your employee contribution by the end of the calendar year. In the usual way, you can create employer profit-sharing contributions until your tax-filing deadline for the tax year.

Take note !once the plan has already started, it may ask some additional paperwork — like if your 401(k) plan has $250,000 or more in assets at the end of a given year, the IRS will ask an annual report on Form 5500-SF as a requirement.

Fred Lake
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