What is a Self Employed 401k?
The Self Employed 401k is a powerful retirement savings plan available to the self employed, independent contractors, sole proprietors, partnerships and small business owners. Known more formally as an Individual 401k, the Self Employed 401k can also be referred to as a Solo 401k, Single (k), Uni-k or Personal 401k.
This Self Employed 401k plan is available due to the Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA) that went into effect on January 1, 2002. The Self Employed 401k is for owner-only businesses or owner and spouse businesses. The new law made several changes to the existing rules of 401k plans. These changes made the Self Employed 401k attractive to certain small business owners. Prior to this law going into effect a self employed business owner would frequently setup a SEP IRA or Keogh plan since they could make a comparable retirement contribution with less administrative expense.
Who is eligible for a Self Employed 401k?
An owner only business, an owner and spouse business and partnerships are eligible for a Self Employed 401k. Independent contractors, self employed individuals and small business owners frequently setup Self Employed 401k plans. Sole proprietorships, partnerships, LLCs and corporations (including both subchapter S and C corporations) would qualify. You are eligible to establish a Self Employed 401k for a side business even if you participate in a 401k, 403b or 457 plan through your primary employer.
In order to qualify for a Self Employed 401k a business owner can not employ salaried, W-2 employees who work more than 1,000 hours in a calendar year.
Business owners and their spouse do not apply to this 1,000 hour threshold.
Also, a business owner can hire independent contractors who work more than 1,000 hours in a calendar year and it will not impact eligibility for a Self Employed 401k.
A business owner who employs part-time W-2 employees may be able to exclude them from plan participation. Generally, under federal law you are permitted to exclude the following types of employees:
- Employees under age 21.
- Employees with less than one year of service.
- W-2 employees who work less than 1000 hours per year.
- Certain union employees.
- Certain nonresident alien employees.
What are some of the benefits of a Self Employed 401k?
- Contribution Limits - In 2020 the maximum contribution is $57,000 and $63,500 if age 50 or older.
- Flexible Annual Contributions - Self Employed 401k plan contributions can be increased or decreased or stopped on a year by year basis.
- 401k Loan - Tax free 401k loans are permitted with a Self Employed 401k plan. Loans up to 50% of the total value of the Self Employed 401k up to a maximum of $50,000 are permitted. IRS rules do not allow loans with IRAs, SEP IRAs, or Keogh (Money Purchase/Profit Sharing Plans).
- Tax Deferred Growth - Contributions and investment earnings grow tax deferred. After age 59 ½ withdrawals can be withdrawn without penalty. Federal and state taxes if applicable will apply.
- Roth 401k - There is an option to make Roth 401k contributions with the salary deferral portion of the Self Employed 401k. Contributions into a Self Employed Roth 401k are not tax deductible, but withdrawals are tax free after age 59 ½.
- Rollover - You can rollover your 401k, 403b, 457 retirement plan from a previous employer. You can transfer a Rollover IRA, Traditional IRA, SEP IRA, Simple IRA and Keogh plan.
- Calculator - Use the interactive 401k calculator to determine the annual retirement contribution you could make based on your income.
Self Employed 401k Advantages
There are 2 primary advantages of the Self Employed 401k versus other self employed retirement plans.
- Potentially greater retirement contributions at the same income level, therefore maximizing retirement contributions and valuable tax deductions.
- The option of a tax free loan using the Self Employed 401k's balance as collateral for the loan.