How a solo business owner can save big in a Solo 401k
A Solo 401k let’s an entrepreneur to save over $50,000 per year. That is $50,000 per year deferred from income taxes. This can be done for an out-of-pocket expense of as little as $500 per year. If you are a husband-and-wife team, the IRS still allows you to have a solo 401k and you are able to contribute a combined $100,000 plus per year.
A solo 401K is essentially just like a normal 401K. The only difference is that there is just one person in the plan or a husband and a wife together. The main advantage is that since there are no employees in the plan, there are no top-heavy test to worry about. This means no restrictions on how much you are able to contribute based on what your employees put in.
There are some other big advantages that a solo 401K has over a traditional multi employee 401k. Since it is just you, you have a greatly reduced amount of liability related to maintaining the plan. One of the biggest risks with a multi employee plan is a lawsuit by a participant. Since you are not going to see yourself… Obviously the largest litigious risk is eliminated.
But there are a few restrictions and requirements surrounding how much you can contribute. To get to the $50,000 per year mark you must have a combined 401k and profit sharing plan. For the 401K portion of the plan, you may contribute up to $18,000 per year. For the profit-sharing portion, you may contribute up to $35,000 per year. But you are capped at 25% of earnings for the profit sharing. So if your business earnings are below $130,000 per year, you will not be able to max out the profit-sharing portion of the plan.
But for those of you who are able to max out the profit-sharing portion, it is a very effective tool to help reduce current taxes and save for retirement.
How much in taxes will I save per year?
This will depend on your individual tax rate. But to make the math easy… If your combined income tax rate is 30%, and you contribute $50,000 to your solo 401k, that would be a $15,000 savings on income taxes for the year.
What if I want to contribute more than just $50,000 per year?
This is possible to do by layering on what is called a cash-balance plan. This is essentially a type of defined benefit pension plan that is designed to coordinate with a 401K plan. This will often allow for an individual to contribute over $100,000 per year tax-deferred.