When you’re ready to start saving for your retirement years, you are going to learn that there are many retirement plans to choose from. You will certainly read about IRAs and traditional 401k plans, but if you’re a business owner, you will want to learn about the individual or solo 401k. This is because this plan is specifically geared toward the retirement needs of business owners who do not have any employees except for possibly a spouse. The individual 401k limits make this type of retirement plan very popular when compared with IRAs because they are much higher. In addition, individual 401k plans have other benefits that make them an attractive retirement savings choice.
What is an Individual 401k?
An individual 401k plan is very similar to a traditional 401k plan. You make contributions to your retirement account every time you get paid on a pre-tax basis. Your contributions are withdrawn from your paychecks automatically and because you don’t pay tax on the amount you put in your account, your take-home pay is increased. This doesn’t mean your earnings are entirely tax free, though. You will have to pay taxes on the amount in your 401k when you start taking payments after retirement.
One of the best benefits of a solo 401k is that self-employed individuals can receive identical tax benefits to people who have traditional 401k plans, but they are not subject to ERISA (Employee Retirement Income Security Act of 1974) rules that established minimum standards for employer pension plans. The only qualifications someone must have to get an individual 401k are to claim self-employed income and to have no full-time employees. The business owner’s spouse can work for the company and without affecting its eligibility for the plan.
What are the Individual 401k Limits?
Individual 401k limits are the same as the limits for traditional 401k plans. There is a profit-sharing contribution limit that applies to the employer and a salary deferral contribution limit that applies to the employee. However, with a solo 401k, the plan participant is acting as both the employer and employee, which makes the contribution limits a little more complex. If the company is a sole proprietorship or a single-member LLC, the individual 401k limits are capped at 20 percent of the claimed self-employed income plus $17,500. Employer contributions can be no more than 25 percent of the business’s income that is subject to self-employment tax.
If the company is a Schedule C sole proprietorship, there is an additional limit, which brings that 25 percent down to 20 percent of earned income. It may be necessary to complete the IRS’s worksheet to calculate the contribution limits regardless of the type of company you have, since it can get quite complicated.
Business owners that are 50 years old or older can contribute an additional $5,500 per year on top of the standard limits. This extra money is called a “catch-up” contribution and is aimed at helping workers who are nearing retirement get more money in their accounts. In all cases, the contribution limits for an individual 401k are calculated based on the amount of self-employment income that is reported on year-end tax forms.
No matter what kind of company you have, though, the IRS has set the maximum contribution limit at $52,000 for people who are under age 50 and $57,500 for those who are age 50 or older. This limit applies not only to the solo 401k but also to any other 401k plans in which you might participate. This means if you are still contributing to a traditional 401k plan through an employer and are contributing to a solo 401k plan as a sole proprietor, you cannot exceed the contribution limit when you add your deposits for both plans together.
An individual 401k is an excellent retirement plan alternative to an IRA because you are allowed to contribute significantly more money toward your future. In addition, there are other features of a 401k plan that may be attractive to a business owner, including the ability to take out a loan if your company goes through some financial difficulties. However, the individual 401k limits are by far the best reason to consider participating in this type of plan because you can put a lot more money aside and allow it to grow in time for your golden years.
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