Your Solo 401(k) is a powerful investment tool especially because of it’s ease-of-use, but that doesn’t mean it’s totally free from necessary maintenance tasks. Here’s a look at some annual maintenance your account still needs.
(Please click here for this year’s contribution limits.)
Annual Contributions – the annual Solo 401(k) contribution limit is currently $58,000 (or $64,500 if age 50 or older). Before explaining how the annual contributions are made, it is important to note that as a self-employed individual, you are both the employee and employer. That being the case, the annual contributions into a Solo 401(k) consist of two parts: 1) an employee contribution, known as the salary deferral contribution, which may be pre-tax (Regular) or after-tax (Roth), and 2) an employer contribution, known as the profit-sharing contribution. Although it is not necessary to make contributions of either type every year, the tax laws require that contributions be “recurring” (made in at least some years) and “substantial.”
Salary Deferral Contribution – 100% of compensation (your salary) up to a maximum of $19,500 (or $26,000 if age 50 or older) can be contributed in salary deferrals.
For businesses taxed as a sole proprietorship (e.g. an LLC, partnership, sole proprietorship, etc.) compensation is based on self-employment income
For a corporation, compensation is based on W-2 wages.
Profit Sharing Contribution – For sole proprietorships, a profit sharing contribution can be made up to approximately 20% of net self-employment income, capped at $58,000, reduced by the Salary Deferral Contributions you actually made. For example, if you make a salary deferral contribution of $19,500 ($26,000 if age 50 or older) you can then make a profit sharing contribution of up to $38,500.
For corporations, the profit sharing contribution is based on W-2 wages and can be made up to 25% of W-2 compensation, subject to the same dollar cap as for sole proprietorships. (For an example of this, please see above.)
Important Contribution Notes:
The Solo 401(k) salary deferral contribution (the $19,500, or $26,000 if age 50 or older) can be made as a Traditional 401(k) (pre-tax) contribution or as a Roth 401k (after tax) contribution. The difference is that Traditional 401k contributions are tax-deductible when made, so you save taxes today, but withdrawals are taxed in retirement. While with Roth 401k contributions, you pay the taxes today in exchange for a tax-free withdrawal at retirement.
The Ultimate Solo 401(k) allows for Traditional contributions as well as Roth Contributions, however, you must keep track of both types of contributions separately, along with their corresponding gains and losses. This can be accomplished by either maintaining two separate checking accounts or by keeping track of it in the back of your binder.
Salary Deferral Contributions (whether Traditional or Roth) must be made:
For unincorporated businesses, by the tax return deadline, including extensions obtained, for the year to which the contribution relates, but the written salary deferral election must be signed by December 31 of the applicable year. For example, the Salary Deferral Contribution for a sole proprietorship for the 2018 year may be made as late as April 15, 2019 (September 15, 2019 if a tax return filing extension is obtained), but the election as to the Salary Deferral amount for 2018 must be in writing and signed by December 31, 2018. These are the deadlines, however the actual Salary Deferral Contributions can be made throughout the applicable year (2018 in this example.)
For incorporated businesses, within 7 business days after the date of the paycheck from which the Salary Deferral Contribution is made. For an incorporated business, Salary Deferral Contributions can be made only from paychecks received after the salary deferral election is made.
Profit Sharing Contributions (and the decision as to whether/ how much of a contribution will be made) for both unincorporated and incorporated businesses must be made by the tax return deadline, including extensions obtained, for the year made. For example, the Profit Sharing Contribution for a sole proprietorship for the 2020 year may be made as late as April 15, 2021 (September 15, 2021 if a tax return filing extension is obtained). There is no form necessary for the Profit Sharing Contribution.
If your spouse works together with you, he/she can also make contributions based on the income he/she receives from the business. Combined, your annual contribution limit could be as much as $116,000 (or $129,000 if both of you are age 50 or older).
Required Minimum Distributions – Once you reach age 72, you must take the annual Required Minimum Distribution (RMD) from your Solo 401(k). Your first RMD must be taken by April 15th following the year in which you reach age 72. Your accountant can calculate your RMD for you.
Annual Reporting – Solo 401(k)s that have assets in excess of $250,000 will need to file form 5500-EZ annually for reporting purposes only. (Assets of any other plan of the same business are taken into account in determining whether the $250,000 threshold is met.) This filing does not require any payments. Form 1099R needs to be filed in each year that you take a distribution from your Solo 401k. The reported distributions will be taxable unless the distributions are of after-tax amounts or are tax-free Roth distributions. Additionally, if your plan had Unrelated Business Income, in excess of $1,000 during the previous year it must file form 990T to report and pay the amount of the Unrelated Business Income Tax (UBIT) that is due.
Amendments – Being that the Ultimate Solo 401(k) is an IRS approved Qualified Retirement Plan, it is required to be updated and amended annually to keep up with all of the latest government legislation and laws. Our staff therefore sends out amendments to each client (typically annually), which must be signed by the business owner and added to the Amendment section of your binder to keep the plan qualified.
Loans – You may take a loan from your Solo 401(k) for any purpose up to 50% of the Solo 401(k) account balance, capped at $50,000. This loan must be paid back within five years, with quarterly payments of principal and interest, using the loan forms contained in this binder.
Prior to reaching 72 – If you have a Roth component in your Solo 401(k), you may want to roll over your Roth Solo 401(k) funds into a Roth IRA because Roth IRA’s are exempt from RMDs (while Roth Solo 401(k)s are still required to take RMDs).