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 plan for the self employed. This retirement 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 only available for owner-only businesses, owner and spouse businesses or if the business is a partnership that employs only the partners and has no W-2 employees.
What’s special about the Individual 401k?
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 2023 Individual 401k contribution limit is $66,000 and $73,500 if age 50 or older.
Also, the Individual 401k allows the flexibility to borrow against the value of your 401k. 401k loans up to 50% of the total value of the 401k up to a $50,000 maximum are permitted. 401k loans are received tax-free and provided loan payments are received on time, then there are no taxes due. 401k loans up to 50% of the total value of the 401k up to a $50,000 maximum are permitted. 401k loans are received tax-free and provided loan payments are received on time, then there are no taxes due.
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 via an Individual 401k loan.
Note: Consider a defined benefit plan if you want to contribute more than the limits of the Individual 401k. Also, a 401k plan and a profit sharing plan can be combined with a defined benefit plan to maximize annual contributions. Total contributions can be $100,000 to $200,000 or more. We provide more information about them on our website www.definedbenefitplan.com.
What investments can be selected in an Individual 401k?
The investments that can be selected within an Individual 401k plan depend on the Individual 401k provider and can be divided into 3 general categories:
- Individual 401k with one mutual fund family.
- Individual 401k with multiple mutual fund families and stock trading.
- Individual 401k investing in real estate, tax liens, gold and other alternative investments.
Learn more about Individual 401k Providers.
What type of Individual 401k does BCM setup for clients?
If you search online you will find that several types of Individual 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 Individual 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 an Individual 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. An Individual 401k that uses mutual funds as the investment option can be inexpensive administratively. BCM works with several Individual 401k providers, however the Individual 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. Contact us and we would be happy to provide more information about this Individual 401k.
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 small business owner with W-2 employees is eligible for an Individual 401k provided each W-2 employee works less than 1,000 hours per calendar year. A small business owner is ineligible for an Individual 401k if they have W-2 employees who work more than 1,000 hours per year. Business owners and their spouse do not apply to this 1,000 hour threshold.
Independent contractors (1099 employees) employed by your business are excluded from the Individual 401k plan and as a result would not disqualify you from having an Individual 401k regardless if they work more than 1,000 hours in a calendar year.
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.
Learn more about Individual 401k Eligibility.
Individual 401k Plan Benefits
The Individual 401k plan has several benefits for small business owners and the self employed.
Individual 401k Contribution Limits
The 2023 Individual 401k contribution limit is $66,000 and $73,500 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 2023, 100% of W-2 earnings up to the maximum of $22,500 or $30,000 if age 50 or older can be contributed to an Individual 401k.
- 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. 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 50% of the self employment tax. In 2023, 100% of net adjusted business profits income up to the maximum of $22,500 or $30,000 if age 50 or older can be contributed in salary deferrals into an Individual 401k.
- 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 50% of the self employment tax. You will want to ask your tax professional for assistance with this calculation.
Individual Roth 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.
Note: Only the salary deferral portion is eligible for a Roth contribution. The 2023 Roth 401k salary deferral limit is $23,500 and $30,000 if age 50 or older.
Learn more about the Individual Roth 401k.
Individual 401k Calculator
The calculation of how much can be contributed to the Individual 401k is dependent on whether your business is taxed as a corporation and you receive a W-2 or net adjusted business profits if you are taxed as a sole proprietorship. 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.
If a self employed individual elects to make a Roth 401k contribution with the salary deferral portion of the Individual 401k then the contribution is not tax deductible, but withdrawals are tax free when withdrawn during retirement.
Tax Deferred Growth of Investment Earnings
Contributions made pre-tax 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 can 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 401k Loans
An Individual 401k loan is permitted using the assets in the 401k as the capital for the loan. Individual loans are permitted up to 50% 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.
The proceeds from an Individual 401k loan can be used for any purpose. Since you are using your Individual 401k's balance for the loan, you are automatically approved for the 401k loan and there are no income or credit qualifications. 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. Many self employed individuals are getting loans up to $50,000 using an Individual 401k loan as a small business loan because 401k loans are fast, easy to obtain and have favorable interest rates.
Business Loan Rates – Small Business Loan Interest Rates
Individual 401k loan interest rates are low, usually Prime rate plus 1% or 2%. Because you are borrowing your money, the interest and principal is repaid back to yourself. 401k loan payments are paid back into your Individual 401k (not to a bank).
Learn more about the 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.
One example of an Individual 401k we recommend to our clients uses mutual funds as the investment choice within the 401k. $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.
Individual 401k Rollover - Retirement Plan Consolidation
An important feature of the Individual 401k plan is the opportunity to consolidate retirement assets into one account via a rollover or transfer. This includes a Traditional IRA, SEP IRA, 401k Plan, Money Purchase Plan, SIMPLE IRA, Profit Sharing Plan, Defined Benefit Plan, 403b Plan and Rollover IRA. Advantages of rolling over and consolidating your retirement plans into your Individual 401k include improved financial organization and ease of monitoring your retirement portfolio. Also, consolidating retirement accounts is particularly important if you would like to use the Individual 401k loan provision. By rolling over your existing retirement plans you build the 401k balance quickly and then can use its value to receive a larger 401k loan.
Learn more about the Individual 401k Rollover.
Individual 401k Frequently Asked Questions
For FAQs, rules and information about the Individual 401k visit our Individual 401k Rules section.