Contribution Limits for Solo 401k
Or how much can I contribute each year?
There are a lot of great retirement and investment plans out there, but almost all of them suffer from the same problem: a low annual contribution limit.
When it comes to investing, whether for retirement or any other reason, the more you can put in sooner the more you can get out– period.
That’s just one reason why the Solo 401k is such a powerful retirement account, it has an annual contribution limit that is 5-10 times that of your average retirement vehicle.
However, with a Solo 401k, you’re also afforded flexibility as to how you make those contributions as well.
Let’s first talk about the contribution limits for a Solo 401k plan.
Solo 401k contribution limits
With your average self-directed IRA, you’re only allowed to contribute a paltry $5,500 per year.
What does that get you? With $5,500 a year at an average return, even starting all the way back at the young age of 30, you’d be lucky if you received more than $1,000 in monthly distributions from your account at the age of 65.
However, in contrast, as of 2018 a Solo 401k allows for a maximum annual contribution of up to $55,000 (and more if you’re over 50).
Types of contributions
While the contribution limit on a Solo 401k is impressive, the added features are just as much so. The flexibility in how those contributions are made is a prime example of this.
A Solo 401k allows two types of contributions:
- Employee deferral contributions
- Profit-sharing contributions
Both profit-sharing and employee deferral contributions combine towards the $55,000 maximum annual contribution.
1. Employee deferral contributions
As of 2018, the maximum employee deferral contribution for a Solo 401k is $18,500 annually.
The easiest way to understand the difference between the two contribution methods is this: one is a contribution you make as the business owner or employer (profit-sharing) while the other is a contribution you make as an employee.
As the name implies, consider this the “employee” side contribution for your Solo 401k.
2. Profit-sharing contributions
With a Solo 401k, you can contribute up to 25% of your annual business income (with no limit on how much this can be up to the maximum contribution of $55,000).
Think of this as the “employer / business owner” contribution in contrast to the employee deferral contribution being the employee-side.
Keep in mind that both contributions together go towards the maximum combined contribution of $55,000. With an $18,500 employee deferral contribution and $36,500 profit-sharing contribution, for example, you’d be effectively maxing out the annual contribution on your Solo 401k.
However, as mentioned a moment ago, you could trade a smaller employee deferral contribution for a higher profit-sharing contribution and still hit the annual contribution limit.
While those are the basics of both the contribution limit and methods for a Solo 401k, it’s important to keep in mind a few important notes about Solo 401k contributions:
The Profit Sharing % Varies Based On Incorporation Status
The formula for determining your maximum profit sharing contribution varies based on your incorporation status. This is largely to account for the difference in how self-employment taxes are handled in pass-through versus non-pass through entities.
If your company is a non-pass through entity (S Corp, C Corp, or Schedule F) your maximum profit sharing contribution is 25% of your net W-2 wages.
However, if you are a sole proprietor - or if you have an LLC that elects to be taxed as a pass-through entity - the formula is more complicated. While the full details of the formula are available in IRS Publication 560, the easiest way is to use the online contribution calculator included with your Maverick account.
As of 2018, if you’re over 50 you qualify to take advantage of a catch-up contribution of $6,000.
This contribution is an increase in the employee deferral contribution, bringing the employee deferral contribution limit up from $18,500 to $24,500.
Multiple 401ks Are Allowed
If you have a 401k through an employer and a Solo 401k through a separate business, it’s important to keep in mind that contributions made to both accounts go towards a single employee deferral contribution of $18,500.
However, the good news is that the employer contribution in one 401k does not affect the amount the other employer can contribute on your behalf.
For example, if your day job matches your maximum individual contribution of $18,500, then a total of $37,000 can be contributed to the 401k provided by your day job.
However, if you have also opened a Solo 401k for your side business that generates $220,000 in net income, you can still contribute up to 25% of that income. So your side business could contribute $55,000 in your name to the Solo 401k as well.
Put together, that’s $92,000 of tax-deferred retirement savings in one year.
You can designate Roth contributions
To add to the flexibility of Solo 401k contributions, with a Solo 401k you can make your contributions both pre-tax or after-tax (Roth).
This adds an incredible amount of flexibility to the Solo 401k as Roth, or after-tax, contributions can be distributed tax-free.
Contributions must be from self-employment activity
One final important note, this one less of a feature and more of something to look out for.
Any contributions you make to your Solo 401k plan must be from self-employment activity. What this means is you can’t take money you’ve earned from your job and use it to make a contribution into your Solo 401k.
Now with everything laid out, let’s cover some examples so you get an idea of how this can play out. For simplicity, we’ll assume all of our examples pay themselves via W2 so we can use the non-pass through entity contribution rate of 25%.
Example 1: John
In 2017, John brought home $100,000 of self-employment income with his business online. He was able to make an $18,000 employee deferral contribution as well as a $25,000 profit-sharing contribution (25% of his $100,000 income being $25,000).
John makes a total contribution of $43,000 to his Solo 401k for 2018.
Example 2: Jane the employee and employer
Jane makes $125,000 at her job with a law firm while bringing in an additional $50,000 in income from a side-business she runs selling digital products and services.
Jane contributes $18,000 into a 401k at her job through an employee deferral contribution. She then makes an additional $12,500 profit-sharing contribution from 25% of her $50,000 of self-employment income for a grand total of $30,500.
Example 3: Mark the late saver
Mark is a 50-year-old serial entrepreneur who is late to get the retirement savings ball rolling. Luckily, he makes $250,000 and was smart enough to get a Solo 401k.
Mark makes a $24,500 annual employee deferral contribution in addition to a (capped) $36,500 profit-sharing contribution for a total of $61,000.
Maximize your contribution power with a Maverick 401k
For solo entrepreneurs and small business owners who are serious about maximizing their investment, the Solo 401k’s high contribution limit and additional contribution features add flexibility and power, making it the perfect retirement vehicle.
If you’re ready to experience the power and flexibility of your very own Solo 401k account, click here to set up an account or contact us here with any questions you may have and we’ll be happy to help.