What is a Self Employed 401k?
The Self Employed 401k is an exciting new retirement plan option for the self employed created by the Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA). Businesses employing only the owner or owner and spouse can now benefit from extremely beneficial retirement planning and tax saving options via a Self Employed 401k. Businesses qualifying for this favorable treatment in the tax code include Sole Proprietors, C and S Corporations, Partnerships and LLCs.
What is special about the Self Employed 401k?
High 2020 contribution limits of $57,000 and $63,500 if age 50+ as well as the ability to borrow retirement plan assets tax free and penalty free before retirement age using a Self Employed 401k loan are features that make this self employed retirement plan unique.
Each year the funding of the Self Employed 401k plan is completely discretionary and flexible. Funding can be increased, decreased, or skipped entirely if necessary. The contribution flexibility of a Self Employed 401k eliminates potential funding worries if there is a bad business year.
For those age 50+ there is a generous $6,000 "catch up" salary deferral contribution and a maximum 2020 Self Employed 401k contribution limit of $63,500.
How much can be contributed to a Self Employed 401k?
In 2020 the maximum Self Employed 401k contribution limit is $57,000 or $63,500 if age 50 or older. If the spouse is employed by the business and provided there is adequate income, the contribution limits can potentially be doubled.
How is the Self Employed 401k contribution calculated?
A Self Employed 401k contribution consists of two parts, an employee salary deferral contribution and an employer profit sharing contribution. In 2020 the maximum allowable salary deferral contribution is $19,500 and $26,000 if age 50+ (not to exceed 100% of pay). In addition, a profit sharing contribution is permitted equal to 20% of net self employment income for unincorporated businesses or 25% of W-2 income for incorporated businesses. In 2020 the maximum Self Employed 401k contribution limit is $57,000 or $63,500 if age 50 or older.
What is the Self Employed 401k contribution calculation for an S or C corporation or an LLC taxed as a corporation.
- Employee Salary Deferral Contribution: In 2020, 100% of compensation up to the maximum of $19,500 or $26,000 if age 50 or older can be contributed to a Self Employed 401k.
- Employer Profit Sharing Contribution: A profit sharing contribution up to 25% of compensation can be contributed into a Self Employed 401k.
View examples of Self Employed 401k contribution limits for an S or C corporation or an LLC taxed as a corporation.
What is the Self Employed 401k contribution calculation for a sole proprietorship, partnership or an LLC taxed as a sole proprietorship.
- Employee Salary Deferral Contribution: These business organizations do not provide a W-2 salary to the business owner. The employee salary deferral contribution is calculated by taking gross self-employment income and then subtracting business expenses and then subtracting 1/2 of the self-employment tax (this is termed net adjusted business profit). In 2020, 100% of net adjusted business profits income up to the maximum of $19,500 ($26,000 if age 50 or older) can be contributed as employee salary deferrals into a Self Employed 401k.
- Employer Profit Sharing Contribution: An employer profit sharing contribution can be made up to 20% of net adjusted businesses profit. Net adjusted business profit is calculated by taking gross self-employment income and then subtracting business expenses and then subtracting 1/2 of the self-employment tax
View examples of Self Employed 401k contribution limits for a sole proprietorship, partnership or an LLC taxed as a sole proprietorship.
How much can I contribute to a Self Employed 401k based on my income?
To determine the annual retirement contribution you could make based on your income use the Self Employed 401k calculator.
Are Roth 401k contributions permitted in a Self Employed 401k?
Yes, provided the 401k plan document permits Roth contributions. Participants in a Self Employed 401k can elect to make after-tax or Roth contributions with the salary deferral portion of the Self Employed 401k. The 2020 salary deferral contribution limit is $19,500 or $26,000 if age 50 or older. Roth contributions are not permitted with the profit sharing portion of a Self Employed 401k.
Learn more about a Self Employed Roth 401k.
Who is eligible for a Self Employed 401k?
Businesses whose only full time employees are the owner or the owner and spouse, whether incorporated or unincorporated including partnerships and LLCs are eligible. A business is eligible if the business has employees who each work less than 1000 hours per calendar year or utilizes independent contractors or if all employees are age 21 or less.
Are Self Employed 401k contributions 100% tax deductible?
Yes, salary deferral and profit sharing contributions are generally 100% tax deductible. Roth 401k contributions made with the salary deferral portion of a Self Employed 401k are not tax deductible.
Subchapter S and C corporations or LLCs electing to be taxed as a corporation can generally deduct the salary deferral contribution from personal W-2 earnings and the profit sharing contribution as a business expense.
A sole proprietorship, partnership or a LLC taxed as a sole proprietorship can generally deduct salary deferral and profit sharing contributions from personal income.
Can I get a 401k loan with a Self Employed 401k?
Yes. IRS rules permit 401k loans with a Self Employed 401k, however not all Self Employed 401k providers allow loans.
Provided the 401k plan document has a loan provision you are permitted to have a 401k loan. 401k loans are permitted with a Self Employed 401k up to 50% of the total 401k value up to a maximum of $50,000. Most 401k loans are paid back monthly over a 5 year term. The loan payments (including the interest) are repaid back to your retirement account. 401k loans are received tax free and provided 401k loan payments are received on time then there are no taxes due. Failure to make the loan payments will cause a 401k loan default causing taxes and IRS penalties on the remain balance of the 401k loan.
Learn more about the Self Employed 401k loan.
Can my spouse contribute to the Self Employed 401k?
If a spouse is on the payroll and receives a W-2 then they are eligible to contribute to a Self Employed 401k. Owner and spouse businesses are one of the biggest beneficiaries of the Self Employed 401k in 2020 because with sufficient income they can potentially contribute $114,000 total or $126,000 if both are age 50 or older.
What happens if my business grows and I need to hire full time employees?
If you anticipate hiring W-2 employees with more than 1000 hours of service in a calendar year this year, then a Self Employed 401k may not be the appropriate retirement plan for you. If all employees are under age 21 or if the business employs independent contractors the business is eligible.Contact a BCM advisor to discuss your retirement options.
What is the deadline for establishing a Self Employed 401k?
The deadline for establishing a Self Employed 401k is December 31st of the year in which you would like to receive the tax deduction or fiscal year end for corporations.
What is the deadline for making salary deferral contributions?
For unincorporated businesses the deadline is the tax filing date of April 15 of the next year plus extensions. For incorporated businesses the deadline is 15 days after the close of the fiscal year. For instance if December 31 ends the fiscal year, make contributions by January 15 of the next year.
What is the deadline for making profit sharing contributions?
For unincorporated businesses the deadline is the tax filing date of April 15 (or October 15 if an extension was filed). For incorporated businesses the deadline is corporate tax filing deadline March 15, plus extensions.
What are the responsibilities of the plan administrator?
The plan administrator (usually the business owner) must make contributions prior to the deadlines, make timely payments according to the loan amortization schedule if a loan has been taken, and file Form 5500 if plan assets exceed $250,000.
Can other retirement plans be rolled over into a Self Employed 401k?
Yes. This includes IRA, Rollover IRA, 401k, SEP IRA, Keogh Plans (including Profit Sharing and Money Purchase), Defined Benefit Plans and 403b Plans. By consolidating multiple retirement plans retirement assets can be easily monitored and a greater selection of investment choices may be gained. Another advantage of rolling over retirement accounts into a Self Employed 401k is these assets become eligible for a loan.
Rollovers are a fast way to build assets in the Self Employed 401k, assets which then become loan eligible, up to a limit of $50,000 or half of plan assets, whichever is less.
Learn more about a Self Employed 401k Rollover.
What type of Self Employed 401k does BCM setup for clients?
If you search online you will find that several types of Self Employed 401k plans that are available. Some of these self directed 401k plans allow investors to invest in alternative investments like gold, tax liens and real estate. Some Self Employed 401k plans allow you to do complex transactions in which you can buy shares of stock in your business. These 401k plans are complex, very expensive (sometimes thousands of dollars to setup and have high annual maintenance fees) and may have potential complications with the IRS.
A simple alternative to these complex plans would be to set up a Self Employed 401k that uses mutual funds as the investment choice within the 401k. US corporations traditionally have had mutual funds as the investment vehicle within their 401k plan and 401k participants are usually familiar with this type of investment option. A Self Employed that uses mutual funds as the investment option can be inexpensive administratively. BCM works with several Self Employed 401k providers, however the 401k we recommend most frequently to our clients costs $0 to setup and $15 annual fee (the $15 fee waived with a $50,000 balance). The 401k loan fees are $50 application fee and an annual fee of $25. Through this 401k there are over 50 mutual funds to choose from ranging from conservative bond mutual funds to aggressive stock mutual funds to accommodate investors based on their age, time horizon and personal risk tolerance. Complete the form below and we would be happy to provide you with information about this Self Employed 401k.