The Individual 401k is a self employed retirement plan that is sometimes referred to as an "Individual(k)", "Solo 401k", "Single(k)" and "Self Employed 401k".
What is an Individual 401k?
The Individual 401k is the newest and most exciting retirement plan to benefit the self employed, thanks to the recent tax law created by the Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA). This tax law became effective beginning January 1, 2002 and provides significant advantages to small businesses whose only employee is the owner or the owner and their spouse. These self employed business owners can establish an Individual 401k plan and take advantage of this powerful retirement savings tool.
What makes the Individual 401k unique is that compared to other self employed retirement plans greater contributions may be made at identical income levels, therefore maximizing retirement contributions and valuable tax deductions. The 2015 Individual 401k contribution limits are $53,000 and $59,000 if age 50 or older (2014 limits are $52,000 and $57,500 if age 50 or older).
Also, an Individual 401k allows the flexibility to borrow against the value of your 401k. Tax free loans (up to 50% of the total 401k value with a $50,000 maximum) are permitted in an Individual 401k plan.
Self employed business owners may be well suited for an Individual 401k if their objective is to maximize their retirement contributions or if they would like to borrow from their retirement plan using their 401k balance as collateral via a tax free Individual 401k loan.
Individual 401k Plan Benefits
The Individual 401k plan has several benefits for small business owners and the self employed.
- Higher Contribution Limits
- Tax Deductible Contributions
- Tax Deferred Growth
- Contribution Flexibility
- Access to Tax Free Loans
- Cost Effective Administration
- Retirement Plan Consolidation
Individual 401k Contribution Limits
Compared to other retirement plans you may be able to make greater contributions at identical income levels, therefore maximizing retirement contributions and valuable tax deductions.
Individual 401k contribution limits are $52,000 in 2014 or $53,000 in 2015 ($57,500 in 2014 or $59,000 in 2015 if age 50 or older). The annual Individual 401k contribution consists of 2 parts a salary deferral contribution and a profit sharing contribution. The total allowable contribution adds these 2 parts together to get to the maximum Individual 401k contribution limit.
Individual 401k contribution calculation for an S or C corporation or an LLC taxed as a corporation
- Salary Deferral Contribution
In 2015, 100% of W-2 earnings up to the maximum of $18,000 or $24,000 if age 50 or older can be contributed to an Individual 401k (2014 limits are $17,500 and $23,000 if age 50 or older).
- Profit Sharing Contribution
A profit sharing contribution up to 25% of W-2 earnings can be contributed into an Individual 401k.
Individual 401k contribution calculation for a sole proprietorship, partnership or an LLC taxed as a sole proprietorship
- Salary Deferral Contribution
Although the term salary deferral is used, these businesses do not provide a W-2 salary to the business owner. For businesses of this type, the salary deferral contribution is based on net adjusted business 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. In 2015, 100% of net adjusted business profits income up to the maximum of $18,000 or $24,000 if age 50 or older can be contributed in salary deferrals into an Individual 401k (2014 limits are $17,500 and $23,000 if age 50 or older).
- Profit Sharing Contribution
A profit sharing contribution can be made up to 20% of net adjusted businesses profits. 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. You will want to ask your tax professional for assistance with this calculation.
Roth Individual 401k
Individual 401k salary deferral contributions can be made as Roth 401k (after tax) or Traditional 401k (pre-tax). The basic difference between a Roth 401k and a Traditional 401k is that the Roth 401k is funded with after-tax contributions while the Traditional 401k is funded with pre-tax contributions. In other words, with a Roth 401k you pay taxes today in return for a tax-free withdrawals in retirement. Traditional 401k contributions are tax deductible and are made pre-tax so you save taxes today, but withdrawals are taxed in retirement.
Learn more about a Roth Individual 401k.
Individual 401k Calculator
To determine the annual retirement contribution you could make based on your income use the Individual 401k calculator.
Tax Deductible Contributions
Individual 401k retirement plans may provide significant tax savings because in general, you can deduct 100% of contributions made into an individual 401k from your taxable income. Incorporated businesses can generally deduct the salary deferral contribution from W-2 earnings and the profit sharing contribution as a business expense. Unincorporated businesses such as sole proprietors can generally deduct contributions made to an individual 401k from personal income.
Tax Deferred Growth of Investment Earnings
Assets in an Individual 401k grow tax-deferred, meaning you won't pay taxes on the dividends and investment earnings until you withdraw the assets. Tax deferred earnings growth can have a powerful effect over time. Money can be withdrawn after age 59 ½ without penalty. When money is withdrawn after age 59 ½ income taxes will be paid only on the amount that is withdrawn and the remaining balance in the Individual 401k continues to go tax deferred. If you should withdraw money prior to age 59 ½ you will pay income taxes and it's likely that you will incur an additional 10% IRS penalty for a premature withdrawal.
For some self employed investors, saving in a tax advantaged retirement plan such as an Individual 401k provides a significant benefit. Investors are able to make tax deductible contributions during their working years and are able to earn many years of tax deferred growth on the dividends and investment earnings. Once retired and potentially in a lower tax bracket, you can withdraw the money as needed from your Individual 401k.
Each year the funding of your individual 401k retirement plan is completely discretionary. You can increase or decrease your salary deferral and/or profit sharing contributions depending on the profitability of your business.
Individual 401k Loan - Access to Tax Free Loans
An Individual 401k loan is permitted at any time using the accumulated balance of the 401k as collateral for the loan. Individual loans are permitted up to 1/2 of the total balance of the 401k up to a maximum of $50,000. A loan from an Individual 401k is received tax free and penalty free. There are no penalties or taxes due provided loan payments are paid on time.
Generally, Individual 401k loans have a 5 year maximum repayment term. Individual 401k loans used for the purchase of a primary residence may extend the loan repayment term up to 10-15 years. Loans must be repaid according to the terms of the loan amortization schedule which is provided when a loan is initiated. Failure to repay the loan according to these terms may result in a loan default causing taxes as well as IRS penalties. Loans are not permitted with Traditional or Roth IRAs, SEP IRAs, or Keogh (Money Purchase/Profit Sharing Plans).
Loan payments are made monthly or quarterly. Loan payments of principal and interest are repaid back into your own Individual 401k. Because of this an Individual 401k loan may be a favorable option compared to other loans where interest is paid to the bank or lending institution.
The proceeds from an Individual 401k loan can be used for any purpose and there are no income or credit qualifications to receive the loan. The ease of an Individual 401k loan is attractive because start up businesses and self employed business owners often run into difficulties with qualifying for a self employed loan through banks and lending institutions.
Learn more about an Individual 401k loan.
Cost Effective Administration
Compared to traditional 401ks, the Individual 401k plan is easy, flexible and inexpensive to maintain because administration is minimal, and complex discrimination tests are not required. Fees vary depending on the level of administrative services provided by the Individual 401k administrator. Loans may have an additional administrative fee. If an Individual 401k is greater than $250,000 IRS form 5500 needs to be filed and the administrator may charge a fee for its completion or you could elect to complete the form yourself.
Retirement Plan Consolidation
An important feature of the Individual 401k plan is the opportunity to consolidate retirement assets into one account. This includes Traditional IRAs, SEP IRA Plans, 401k Plans, Money Purchase Plans, SIMPLE IRAs, Profit Sharing Plans, Defined Benefit Plans, 403b Plans and IRA Rollovers. Consolidating retirement accounts is particularly important if you would like to use the loan provision. Other advantages of rolling over and consolidating your retirement plans into your individual 401k are improved financial organization and ease of monitoring your retirement portfolio.
Individual 401k Eligibility
The Individual 401k is available to self-employed individuals or business owners with no employees other than a spouse. Sole proprietorships, partnerships and corporations (including both subchapter S and C corporations) would qualify.
A business that employs part-time W-2 employees may be able to exclude them from plan participation. Independent contractors (1099 employees) employed by your business are excluded from the plan and would not disqualify you from having an Individual 401k. 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.
Individual 401k FAQs
What is an Individual 401k?
The Individual 401k is sometimes referred to as a "Solo 401k", "Single(k)", “Uni-k”, “Personal 401k” or "Self Employed 401k".
The Individual 401k is a powerful retirement savings plan for the self employed. This 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 Individual 401k is for owner-only businesses or owner and spouse businesses. The business can be incorporated or unincorporated. Sole proprietors, S corporations, C corporations, partnerships and LLCs qualify.
How does an Individual 401k work?
The Individual 401k retirement plan consists of 2 parts, a salary deferral and a profit sharing contribution. Both contributions are generally tax deductible and grow tax deferred until withdrawn after age 59 ½. Withdrawals after age 59 ½ are taxed as ordinary income. Withdrawals prior to age 59 ½ may incur an IRS 10% premature withdrawal penalty as well as income taxes.
How much can I save in an Individual 401k?
In 2015 the maximum Individual 401k contribution limit is $53,000 and $59,000 if you are age 50+. If you are age 50+ an additional $6,000 of salary deferral, referred to as a "Catch-up" contribution, is permitted so the maximum contribution limits is increased from $53,000 to $59,000. (The 2014 contribution limit is $52,000 and $57,500 if age 50+.)
Are contributions to an Individual 401k tax deductible?
Incorporated businesses can generally deduct the salary deferral contribution from W-2 earnings and the profit sharing contribution as a business expense.
Unincorporated businesses such as sole proprietors can generally deduct salary deferral and profit sharing contributions made to an individual 401k from personal income.
Can I establish an Individual 401k if my business has employees?
In order to qualify for an Individual 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 an Individual 401k.
Can my spouse who works with me also contribute to the Individual 401k?
Yes, however in general the spouse would need to be on the payroll and receive a W-2 salary.
What happens to my Individual 401k if I hire full-time employees?
If you anticipate hiring W-2 employees with more than 1000 hours of service in a calendar year in the future, then an Individual 401k may not be the appropriate retirement plan for you. 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 an Individual 401k. Speak with a BCM financial advisor to learn more about your retirement options.
What is the deadline for establishing an Individual 401k?
The deadline for establishing an Individual 401k is December 31st of the year in which you would like to receive the tax deduction or fiscal year end for corporations.
Can I borrow against the Individual 401k assets?
Yes. Provided the plan document has a loan provision so you are permitted to have a loan. Tax free loans are permitted in an Individual 401k up to 50% of the total 401k value up to a maximum of $50,000. The loan is repaid according to the loan amortization schedule that is provided when the loan is initiated. The loan payments (including the interest) are repaid back to your retirement account. Failure to make the loan payments may cause a loan default causing taxes and IRS penalties.
Questions and answers about an Individual 401k loan.
Is there a deadline to make salary deferrals into the Individual 401k?
Sole proprietorship, partnership or a LLC taxed as a sole proprietorship - the deadline for depositing salary deferrals into the Individual 401k is generally the personal tax filing deadline April 15 (or October 15 if an extension was filed).
S or C corporation or a LLC taxed as a corporation - salary deferrals must be made into your Individual 401k within 15 days of the period in which you are paying yourself. For 401(k) contributions made at the end of a calendar year, they need to be deposited by January 15 at the latest.
When must profit sharing contributions be made into the Individual 401k?
Sole proprietorship, partnership or an LLC taxed as a sole proprietorship - the deadline to fund the profit sharing contribution is the personal tax filing date of April 15 (or October 15 if an extension was filed).
S or C corporation or an LLC taxed as a corporation - the deadline to fund the profit sharing contribution is the corporate tax filing deadline March 15, plus extensions.
What are my responsibilities to properly maintain my Individual 401k?
You are responsible for submitting the salary deferral and profit sharing contributions by their required deadlines. If you have a loan, you are required to make the loan repayments according to the terms of the loan amortization schedule or risk a loan default. When the total assets in your plan reach $250,000, the IRS requires that IRS Form 5500 is completed and submitted to them annually.
Can I roll my other retirement plans into an Individual 401k?
Yes. An important feature of the Individual 401k plan is the opportunity to consolidate retirement assets into one account. This includes Traditional IRAs, SEP Plans, 401k Plans, Money Purchase Plans, Profit Sharing Plans, Keogh plans, Defined Benefit Plans, 403b Plans and Rollover IRAs. A Roth 401k from a previous employer may be eligible to be rolled over into an Individual Roth 401k provided the 401k plan document permits Roth 401k contributions and rollovers. Roth IRAs can’t be rolled over into an Individual Roth 401k.