Solo 401(k)

Solo 401k Limit

How much can you legally contribute to a Solo 401(k)? Here is everything you need to know about the Solo 401(k) limit, and the type of contributions you can make.

3 min read

If you are self-employed and looking for a flexible retirement plan with generous tax breaks and a high annual maximum contribution, you should consider opening a Solo 401(k) account. This retirement plan is ideal for small businesses with no employees, and you can open an account at a broker of your choice. A solo 401(k) does not have age or income restrictions, and you can open an account to enjoy high and flexible contribution limits.

An individual can contribute up to $58,000 to a Solo 401(k) in 2021. Individuals who are aged 50 and older can make additional contributions of $6,500 in catch-up contributions, which adds up to $64,500 annually. This contribution amount includes the amount you contribute both as an employee and employer in your business.

Types of Contributions Made to a Solo 401(k)

A Solo 401(k) allows individuals to make the following two types of contributions to the account:

Employee Deferrals

Employee deferrals are the contributions made by an employee to a retirement plan. For 2021, an individual can contribute up to $19,500 through employee deferrals. If you are 50 and older, you can contribute up to $26,000, which includes $6,500 in catch-up contributions. A Solo 401(k) allows participants to contribute up to 100% of their salary or W-2 compensation.

Employer Contributions

The employer contribution is also known as the profit-sharing contribution. If the business is a corporation, the maximum employer contribution is 25% of the self-employment compensation. For a single-member LLC or sole proprietorship, the maximum profit sharing contribution is 20% of the self-employment compensation. The cumulative sum of employee deferrals and employer contributions cannot exceed $58,000 in 2021 or $64,500 for those age 50 or older.

Solo 401(k) Limit If You Contribute to Another 401(k) Plan

If you have a Solo 401(k) and another 401(k) account at a second job, the contributions you make are applied per person and not per plan. This means that the contributions you make are cumulative across all plans, and you could be penalized for exceeding the annual IRS contribution limits. For elective deferrals, you can only contribute up to $19,500, or $26,000 if you are 50 and older, across all the 401(k) plans.

However, the case may be different for employer contribution limits, which are based on the retirement plans. If you have two 401(k) plans, each employer can contribute up to the maximum employer contribution limit. For example, each employer can contribute up to 25% of your self-employment compensation up to $58,000 (64,500 for those 50 and older) in 2021.

Covering Your Spouse under Your Solo 401(k)

Although a Solo 401(k) is available to businesses with no employees, there is one exception: spouses involved in the business. If a spouse of the business owner is involved in the business and derives an income from the business, he/she qualifies to make elective deferrals as an employee of the business. In essence, this means that you can double the amount you contribute as a married couple.

The spouse can make elective deferrals as an employee up to the IRS contribution limit of $19,500, plus an additional $6,500 in catch-up contribution if he/she is above 50. As the business owner/employer, you can contribute up to 25% of the self-employment compensation. This means the business owner and the spouse could cumulatively contribute up to $116,000 in Solo 401(k) contributions.

Is Solo 401(k) Tax Deductible?

One of the benefits of contributing to a Solo 401(k) is the flexibility to choose when to pay tax obligations. When you opt for a traditional Solo 401(k), all contributions you make to the plan will be tax-deductible, and you won't owe any taxes until the money is withdrawn. The elective deferrals reduce your taxable income for the year, and the money will grow tax-deferred. You can opt for a traditional Solo 401(k) if you expect your income in retirement to be lower than what you are currently earning, hence a lower tax bracket.

If you opt for a Roth 401(k), you will pay tax when you contribute to the retirement plan. While you won’t get a tax break when you contribute, you won’t owe taxes on withdrawals made after age 59 ½ as long as you’ve completed 5 years since opening the account. If you withdraw money before you are 59 ½, the amount withdrawn will be subject to income taxes and penalties. A Roth Solo 401(k) is a good option if your income in retirement will be higher than your current income.

Is a Solo 401(k) Worth It?

If you are self-employed and looking for an attractive retirement plan, you should consider opening a Solo 401(k). This retirement plan offers greater flexibility to small business owners and sole entrepreneurs, and it allows these individuals to maximize their contributions more efficiently. It provides a wide range of investment options, lower fees, participant loans, and minimal management requirements.