The Solo 401k rules are straight forward when compared to other retirement plans such as defined benefit plan and government plans.
While Solo 401k Plan is referred by many names such as individual 401k, Solo K, Self-Directed Solo 401k, Individual k and owner-only 401k, it is basically a traditional 401k plan but for the self-employed with no full-time employees besides the owners of the business that sponsors the Solo 401k
Solo 401k Annual Contribution Limits
The Solo 401k rules allows the business owner to make two types of contributions: employee and employer
Employee Contribution—up to 100% of earned income not to exceed the annual limits.
- 2012: $17,000 or $22,500 if age 50 or older
- 2013: Not yet determined
Employer Contributions—also referred as profit sharing
- 2012: This amount cannot exceed $50,000
- If a business type is Corporation, the maximum is 25% of gross income
- If business type is Sole Proprietor/Partnership, the maximum is 20% of net income
However, when added together the employee and employer contributions cannot exceed the annual limit of $50,00 for 2012 or $55,000 if you are age 50 or older.
Calculating the Solo 401k Annual Contribution
Only income from self-employment, not passive income, may be applied towards calculating annual solo 401k contribution. Net income is net earnings after you deduct:
o One-half of your self-employment tax
o Contributions made on your behalf
o Use our Solo 401k Calculator to easily calculate the employee and employer Solo 401k contribution types.
How to Qualify for Solo 401k
The following two (2) rules will qualify you for Solo 401k:
o Generate Self employment activity
o Have no full-time employees
It’s commonly understood that Self Employment constitutes the intention of producing income from services performed with the intention of making contributions to the Solo 401k plan.
Types of Companies that May Open Solo 401k
The following business types can Open Solo 401k:
o Sole Proprietorship
o Limited Liability Company
o C and S Corporation
o Limited Partnership
Not All Employees Have to be Offered Solo 401k
Following employees may be excluded from participating in Solo 401k:
o Those under age 21
o Those that work less than 1000 hours per year
o Union employees
o Nonresident alien employees
Testing Solo 401k for Nondiscrimination
Because the Solo 401k rules do not allow for common-law employees (known as full-time employees), annual nondiscrimination testing does not apply. However, in the event that the owner-only business employees common-law employees on a full-time basis, nondiscrimination testing may apply and thus the Solo 401k will need to be updated to a Safe Harbor 401k, a plan used when full time employees are employed. Therefore, make sure to notify your Solo 401k Provider if you hire full-time employees so that your plan can be updated to a safe harbor plan.