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As a sole proprietor, you have flexibility in how you take income from your business. When it comes to saving for retirement with a solo 401k plan, a common question is whether you need to pay yourself a W-2 salary for making Solo 401k contributions. The short answer is no – with some caveats.
As discussed in the video linked above, there is no requirement for a sole proprietor to take a W-2 salary to make solo 401k contributions. The key is having eligible earned income, which for a sole proprietorship comes from self-employment income reported on Schedule C.
Specifically, you can use the net profit amount from line 31 of Schedule C, less one-half of the self-employment tax. This self-employment income is then used as the compensation base for calculating Solo 401k contributions including elective salary deferrals (employee contributions), discretionary profit-sharing (employer) contributions to your solo 401k, and/or voluntary after-tax (Mega Backdoor Roth) Solo 401k contributions.
With a plan like our Solo 401k plan, you have flexibility in making Pre-tax, Roth, and/or Voluntary After-Tax (Mega Backdoor Roth) Solo 401k contributions from this income. Pre-tax deferrals help lower your current year tax liability, while Roth/Mega Backdoor Roth Solo 401k contributions don’t provide an immediate tax benefit but offer potential future tax-free growth.
Of course, if you decide to make pre-tax solo 401k contributions, be sure to report that on your tax return to get the tax deduction for the year.
In summary, as a sole proprietor, you can contribute to a solo 401k without needing W-2 wage income. Just be sure to use your eligible self-employment income, properly calculated, as the basis for your contributions. This provides flexibility in saving while also lowering your tax bill.
