A 401(k) Plan for the Small Business Owner

Aug 07, 2022 By Susan Kelly

For a self-employed business owner and their spouse, a solo 401(k), or individual 401(k), is the best option. You can contribute as an employee (through pay deferrals) and employer (by contributions made by your business) through your business. Employer contributions cannot exceed 25 percent of an employee's compensation for deductible contributions (or 20 percent of your net earnings from self-employment for contributions to your account as an owner-employee). If you are 50 or older and your plan enables catch-up payments, your combined employee and employer contributions cannot exceed $61,000 in 2022.

Employer contributions and plan expenditures can normally be deducted for 401(k) plans for individuals and small enterprises.

Small business 401(k) plans are created specifically for small enterprises that can be set up by corporations, partnerships, and non-profit organizations with employees other than the owner and spouse. Small company 401(k) contribution guidelines are almost identical to individual 401(k)s. There are no limits on how much an employer can contribute in the form of matching or profit-sharing contributions to a retirement plan for employees who qualify as long as their total annual deferrals and employer contributions do not exceed $61,000 in 2022 (or $67,500 if they are at least fifty years old by that year and the plan allows catch-up contributions). For the year 2022, the highest salary for which contributions can be based is $305,000.

Who Is Eligible for Solo 401(k) Plans?

Sole owners are not the only ones who can benefit from the Solo 401(k). Small businesses of various types, including corporations, limited liability companies (LLCs), and partnerships, can take advantage of the solo 401(k) plan. Only business owners and their spouses, if employed by the business, are eligible participants in the plan.

In addition to contributing to their employer's 401(k), individuals who work for a single firm (in which they do not own any stock) can also set up their own 401(k) to fund a side business they run on the side. Both plans have yearly contribution caps set by the Internal Revenue Service (IRS), which must be adhered to.

How to Create a Solo 401k Plan

It is common for financial firms that sell retirement plan products to design abbreviated versions of the normal 401(k) plan for usage by small business owners who want to implement the solo 401(k) (k).

It is, therefore, necessary to establish the strategy with simpler documentation. The costs may be minimal as well. Make sure your financial services provider provides you with all the necessary paperwork.

It should be noted, however, that a solo 401(k) plan can be adopted only by enterprises in which the owners and their qualified spouses are the only participants. An employee spouse is still considered an owner of the business for qualifying purposes. Therefore you can still adopt the Solo401(k) plan even though your spouse works for the company (k).

A solo 401(k) plan cannot be implemented if your company includes non-owner employees qualified to contribute. As a result, non-owner employees must not meet the plan's eligibility standards, which must remain within the following constraints.

In a solo 401(k), nonresident aliens who receive no U.S. income or benefits under a collective-bargaining agreement may be excluded.

401(k) Eligibility Requirements for Solo 401k

If the plan's eligibility rules are set incorrectly, you may be rejected from the plan while non-owner workers are permitted to join.

It's possible to have five seasonal employees who work less than 1,000 hours per year and yet be eligible for the program if you have zero years of service as a condition of participation. Because of their age and length of service, these employees are qualified to join the plan. The Solo 401(k) plan would not be acceptable for your firm because of their eligibility. Instead, you might enroll in a traditional 401(k).

Additional restrictions are required for some solo 401(k) programs. Check with your financial services provider before establishing a solo 401(k) plan.

Requirements for a Contribution

You may have to wait a year before allowing an employee to make 401(k) elective-deferral contributions. At least two years of service with the company is required before a worker is eligible to receive profit-sharing payments. Solo 401(k) plans, on the other hand, often limit this to one year.

Having worked at least 1,000 hours in a calender year counts as one year of service for benefit purposes. Even while in a typical qualified plan you can choose to demand less than 1,000 hours, most solo 401(k) plans have a fixed limit of 1,000 hours.

Contribution Limits for Solo 401(k)s

Profit-sharing and employee elective-deferral contributions comprise the solo 401(k) plan's two components. A cap on what employees can contribute As long as you don't exceed the annual contribution limit, you can contribute up to 100% of your earnings to your 401(k). It was $19,500 in 2021, and it's $20,500 if you're above 50 in 2022.

The Bottom Line

Check with your tax advisor to see if the solo 401(k) is an option for your situation if you own many businesses (k). If you operate another firm that provides insurance to anyone beyond the owner's workers, you may be unable to enroll in this plan.

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