How to Calculate Solo 401(k) Contribution Limits

How To Calculate Solo 401k Contribution Limits

Solo 401k plans have many aliases: solo-k, uni-k, and one-participant-k, among others.  Whatever you want to call it, the retirement plan is one of my very favorite for small business owners without eligible participants.  They’re easy to set up, inexpensive to operate, and simple to maintain.

One of the few downsides of solo 401k’s is that they do have one murky intricacy: determining the maximum amount you can contribute in a given year.

This post will cover how to calculate solo 401k contribution limits.  We’ll cover the contribution calculations, the deadlines, and everything else you need to know about the accounts.

 

So What Is a Solo 401(k), Exactly?

One of the big misunderstandings about solo 401k’s is that they’re a “special” type of retirement plan by design.  They’re not.

With all qualified retirement plans (401k, cash balance, defined benefit, etc.), the IRS affords us some pretty neat tax advantages in order to incentivize us to save for our own retirement.  In the case of 401k plans, these tax advantages apply to both the business operating the plan and it’s participants.

In order to prevent businesses from structuring 401k plans that benefit ownership & management (and not rank and file employees), 401k plans are usually required to undergo compliance testing each year.  If the plan is considered “top heavy”, where too great a portion of the contributions are made on behalf of executives, ownership is compelled to deposit additional funds on behalf of everyone else.

So, in the eyes of the IRS, businesses may take advantage of a wonderful tax saving opportunity, but only if it’s beneficial all the participants.

solo 401k plan is just like any other 401k plan.  But since there are no employees in the plan, there’s no compliance testing required.  You can establish a plan for free at any major brokerage firm, using their boilerplate materials and plan document.

 

Solo = No Eligible Employees

Just like traditional 401k plans, solo 401k’s are required to have a plan document that describes how the plan is to be operated.  Eligibility requirements are included in this document.  So long as you don’t have any employees who meet the eligibility requirements in your plan document, you can continue contributing to a solo 401k plan.  If you do, you’ll need to either “upgrade” to a traditional 401k, or dissolve the plan.

While you have some discretion over the eligibility requirements, there are some minimum standards your plan must meet.  Employees must become eligible if they work 1,000 or more hours per year, are at least 21 years old, and have at least one year of service.  Plan documents may also exclude certain union employees and nonresident aliens.  Fail any of these three, and a plan document may exclude them from eligibility if you choose.

You may structure a plan to be more generous than these requirements, though.  You could structure a plan with an hours requirement of 500, an age requirement of 18, and tenure requirement of six months.  So long as your plan’s eligibility standards are not more restrictive than the minimums, you should be in good shape.  Just remember that your plan document governs all.  Whatever you choose, you must stick to.

 

No W-2 Income?  No Problem!

One way to get around hiring eligible employees is to hire contractors in a 1099 capacity, as opposed to full on W-2 employees.  This might be a good alternative, but keep in mind that the IRS has strict definitions of who should be considered a W-2 employee and who should be considered a contractor.

Before circumventing W-2 employees, make sure you’re not bending the IRS interpretation.  This is a hot button item under audit, so be warned if you do decide to stretch the rules.

 

What If I Have a Solo 401(k) But Want To Hire Employees?

If you think you might want to hire employees in the next year or two, the solo 401(k) might not be for you.  As soon as you have employees who meet the eligibility requirements in your plan document, you must include them in the plan (or risk facing the wrath of the department of labor and/or the IRS).

Now, this doesn’t mean that your solo 401(k) evaporates or turns into a pumpkin if you hire someone.  It only means that you’ll have to perform the annual non-discrimination testing and jump through other hoops once you have eligible employees in the plan.

One of the solo 401(k)’s main benefits is it’s simplicity and low administration costs.  Add the wrinkle of compliance testing and all of a sudden administration isn’t so simple.  When this happens other small business retirement plans (think SEP-IRA or SIMPLE IRA) are often more appealing.  Fortunately, terminating your solo 401(k) and starting a SEP or SIMPLE is relatively easy.

 

Other Eligibility Issues

The bar for being eligible to contribute to a solo 401k is actually pretty low: as long as you have self-employment income you may contribute to a solo 401k.  This could be work as a 1099 independent contractor, or any income as a sole proprietorship, partnership, or LLC.

Solo 401k plans are most often used by sole prop’s and single member LLCs.  Since having eligible employees prevents businesses from using them, most people who do have relatively small companies.

Even so, solo 401(k)s can also be used in partnerships, multi member LLCs, S-corporations, and C-corporations as long as there are no qualifying employees.

 

How To Calculate Solo 401k Contribution Limits

This is where many business owners get tripped up.  The exact amount you’re allowed to contribute to a solo 401(k) plan depends on a few different factors.  Mainly, your business entity and net income from self-employment.

 

Employee Contributions

When you maintain a 401(k) plan (solo or other), you technically wear two hats.  One as the business owner and sponsor of the plan, the other as an employee.  As an employee, you’re entitled to defer up to 100% of your compensation (or “earned income) up to $19,000 to a 401(k) plan in 2019.  This number creeps up every few years to keep pace with inflation.  If you’re 50 or older, you can also make “catch up” contributions of $6,000, totaling $24,000 in elective deferrals.

 

Employer Contributions

As an employer, you’re also entitled to make profit sharing contributions to your plan.  Again, this is where the structure of a solo 401(k) plan comes in handy.  If you have eligible employees, profit sharing contributions must be made to all participants, based on age/tenure/comp/etc. as specified in your plan document.  With no employees you’re free to make profit sharing contributions for yourself only, up the IRS limits.

These limits depend on your business entity.  They’re limited to 25% of your compensation for:

  • S-Corporations
  • C-Corporations
  • Partnerships
  • Multi-member LLCs

Profit sharing contributions for sole proprietorships and single member LLCs are slightly more complex.  The IRS states in code 401(a)(3) that employer contributions are limited to to 25% of the business owner’s income that’s subject to self-employment taxAnd remember – because sole props and single member LLCs are entitled to deduct half of their total self employment tax.  Thus, not all self-employment income will be subject to self-employment tax.

To sort all this out, sole proprietors and single member LLC owners are required to perform an additional calculation.  The IRS has a step-by-step worksheet for this calculation in publication 560, found here, but effectively the math works out to about 20% of earned income instead of 25%.  Bankrate.com also has a decent calculator that may be helpful.

Between your employee deferrals and employer profit sharing contributions, your total contributions in 2019 may not exceed $56,000 if you’re under 50 years old.  If you’ve reached 50, your aggregate limit rises to $62,000 with the $6,000 of catch up contributions.

Keep in mind that this limit impacts contributions to other 401k plans too, if you have multiple businesses.  You may make elective deferrals of up to $19,000 ($25,000 if you’re over 50) across all the 401k plans you participate in.  There’s not limit the number of plans you make profit sharing contributions to, so long as they’re unrelated plans & entities and you stay under the $56,000 limit.

 

Spouses

Although you’re not able operate a solo 401(k) while having eligible employees, spouse earn an exception in the eyes of the DOL and IRS.  As long as your spouse is your only employee, you may continue using a solo 401(k) without jeopardizing your plan’s status.  Your spouse can even contribute to the plan too, if they wish, up the annual limits.  This can be extremely convenient, as could potentially boost your household contribution limit to $112,000 per year – without any compliance testing!


[Click Here to Download The Definitive Small Business Guide to Retirement Planning]


 

Implementing & Maintaining A Solo 401(k) Plan

Implementing a solo 401(k) plan is pretty straight forward, and most brokerage firms offer them at very low annual costs.  If you’re establishing a brand new plan, it must be done by December 31st of the tax year you’d like to contribute for.  Fortunately, as long as you establish the plan by that date, you have some flexibility over when your contributions are actually deposited.

Elective deferrals may be deposited any time before your tax filing deadline.  This is usually April 15th for sole prop’s, single member LLCs, and C-Corps, and March 15th for multi-member LLCs, partnerships, and S-Corps.  This deadline includes extensions too, which could push your deadline out another six months to September 15th or October 15th.

Although your contributions may be deposited any time before your tax filing deadline, they need to be reported on your W-2 (in the case of an S-Corp or C-Corp) by January 31st.  Since your employee deferrals will show up as a deduction from your wages in box 12, this notifies the IRS that you’re electing to defer a portion of your comp, and will have the deposit made by your tax filing deadline.  Logistically, best practice is to let your bookkeeper or accountant know that you’d like to make a contribution.  They can then handle the reporting for you on your books and payroll files.

As for profit sharing contributions, they may be made any time before your tax filing deadline, plus extensions.  You’ll claim the deduction for the contribution on either your business or personal return.

Once opened, solo 401(k)s are pretty simple to maintain.  Plans with assets over $250,000 must file form 5500 SF (short form) with the department of labor.  The standard for 5500 can be cumbersome, but the short form is considerably less so.  There are no annual 5500 filing requirements if the total balance in your solo 401(k) is less than $250,000.

 

Examples:

The contribution limits to solo 401(k)s can be tricky, so here are a few examples:

 

Sole Proprietorship or Single Member LLC

Imagine that Stephanie, 35 years old, is a sole proprietor and has $125,000 in self employment income on Schedule C of her tax return.  Stephanie may make $19,000 in employee deferrals.  She may also make a profit sharing contribution of 25% of her adjusted earned income: $92,935.  Adjusted earned income is calculated as: (Self-employment compensation – deductible portion of self-employment tax) / (1 + contribution percentage).

($125,000 – $8,831) / (1 + 25%) = $92,935.  25% of this amount works out to $23,233.  Stephanie’s total contribution between elective deferrals and profit sharing contributions would be $42,233.

 

S-Corp or C-Corp

Let’s say Kyle, who is 58 years old, earned $75,000 in W-2 wages from his S-corp.  He deferred $19,000 in regular deferrals and $6,000 in catch up contributions.

His business could contribute up to $18,750 in profit sharing contributions ($75,000 * 25%), totaling $43,750 in annual contributions.  Note that Kyle’s profit sharing limit is based on $75,000 in W-2 compensation.

If Kyle’s W-2 income were $275,000, he could still make the $19,000 employee deferral and $6,000 catch up contribution, but his profit sharing contribution would be limited to $37,000 based on the aggregate limit.  This total contribution would be $19,000 + $6,000 + $37,000 = $62,000.

 

Partnership or Multi Member LLC

Now let’s say that Kyle converts his business from an S-corp to a multi member LLC, and earns $65,000.  He has several business partners but no employees.

He may still defer $18,000 as an employee and $6,000 as a catch up contribution.  But since he no longer has W-2 wages, he bases his profit sharing contribution on the K-1 income attributable to self-employment earnings.  His total contribution limit would be $19,000 + $6,000 + $16,250 ($65,000 * 25%) = $41,250.

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30 Comments

  1. In your SCorp example above, when you write, “Note that Kyle’s profit sharing limit is based on $75,000 in W-2 compensation” are you referring to the dollar figure that shows up in Box1 (Wages) or Box3 (Social security wages) or Box5 (Medicare wages and tips) of Form W-2? In other words, if say the SCorp is reimbursing Kyle $500/mo for health insurance premiums he paid out of pocket (the IRS allows, “premiums paid on behalf of a greater than 2% SCorp shareholder-employee are deductible by the SCorp and reportable as wages on the shareholder-employee’s Form W-2, subject to income tax withholding.”) then his W-2 Box1 = $75k but his Box3 and Box5 = $69k. In this situation, is your statement that, “His business could contribute up to $18,750 in profit sharing contributions ($75,000 * 25%)” still correct or is the calculation now $17,250 in profit sharing contributions ($69,000 * 25%)?

    • Hi Daniel – thanks for the question.

      My understanding is that the limit is 25% of compensation that’s subject to self-employment tax. This is the amount from which the social security tax of 12.4% is calculated (and the amount in Box 3 of a W-2).

      In your example I believe the correct calculation would then be $69,000 * 25% = $17,250. This assumes that the $500/mo reimbursement is not subject to social security wages though, which is something you might want to check with a CPA.

  2. Kyle can contribute the $18K, plus $6K catch-up amount regardless to what the other partners choose to do(?), but is his ability to increase his contribution for the profit sharing portion subject to restriction based on the other partners’ participation in that regard?
    John

    • Hi John,

      Thanks for the question. If I’m understanding you correctly, I don’t believe the actions of other partners will affect Kyle’s maximum contribution. His contribution would be based on his net earned income, from schedule K-1. At least that’s my understanding – I’m not a CPA though.

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  4. I understand that the individual contributions to a Solo 401k must be made by Dec 31, but can the additional profit sharing contribution be made after Dec 31?

  5. “Employer Contributions
    As an employer, you can make profit sharing contributions to your plan. Profit sharing contributions are limited to 25% of your compensation from an S-corp, C-corp, partnership, or multi member LLC.”

    Can you tell me where the IRS says that a multi-member LLC contributions are 25%? Since each member of the multi-member LLC is essentially the same (tax-wise) as a single member LLC, I don’t understand why the multi-member LLC folks are allowed to contribute more (25% vs an effective 20%). It doesn’t make sense and I can’t find the IRS rule that states this.

    If this is true where does the Members Self Employed deduction accounted for and why doesn’t the multi-member end up over contributing.

    Thanks

  6. correction of the previous comment….
    What I meant to say is
    If this is true where does the multi-members Self Employed tax deduction get accounted for and why doesn’t the multi-member end up over contributing?

    It seems like the 1040 adjustments for self-employment tax would end up with a different amount for 401k “employer” portion of the deductions.

    If what you say in your blog entry is true then a multi-member LLC member is allowed to contribute/deduct more than a single member LLC member would, given an equal net income.

    From examples above….
    Single member Stephanie makes $125,000 and her employer contribution is $25,000 .
    If multi-member Kyle makes $125,000 he would have an employer contribution of $31,250

    Is that correct?

    Thanks

  7. One last entry from the IRS website that would seem to make my point, The first sentence being the most inmportant…

    “Topic Number 554 – Self-Employment Tax
    You’re self-employed for this purpose if you’re a sole proprietor (including an independent contractor), a partner in a partnership (including a member of a multi-member limited liability company (LLC) that has elected to be treated as a partnership for federal tax purposes), or are otherwise in business for yourself. The term sole proprietor also includes the member of a single member LLC that’s disregarded for federal income tax purposes and a member of a qualified joint venture. You usually must pay self-employment tax if you had net earnings from self-employment of $400 or more. Generally, the amount subject to self-employment tax is 92.35% of your net earnings from self-employment. You calculate net earnings by subtracting ordinary and necessary trade or business expenses from the gross income you derived from your trade or business. You can be liable for paying self-employment tax even if you currently receive social security benefits. The law sets a maximum amount of net earnings subject to the social security tax. This amount changes annually. All of your net earnings are subject to the Medicare tax.”

    • Hi Brian,

      I think you’re right on the money here – there’s no difference between member of a multi-member LLC and a single member LLC. I’ll make the appropriate changes to the post.
      Thanks for bringing this to my attention!

  8. I have a single member s-corp & contribute annually to a solo 401(k) each year. Unlike previous years, my W2 wages in the s-corp for 2017 is only $20,000. I am 58 year old. How much in employer contributions is allowed and how much in employee contributions is allowed? Thanks!

    • Hi Megan,

      Hypothetically, you could defer all $20,000 as an employee deferral ($18,000 + $2,000 in catch up contributions). You could also make profit sharing contributions of 25% of your W-2 wages: $20,000 * 25% = $5,000. Make sure you consider my disclaimer though, that this is not intended to be personalized advice, and I am not an accountant or an attorney.

  9. “S-Corp or C-Corp
    Let’s say Kyle, who is 58 years old, earned $75,000 in W-2 wages from his S-corp. He deferred $18,000 in regular deferrals and $6,000 in catch up contributions.

    His business could contribute up to $18,750 in profit sharing contributions ($75,000 * 25%), totaling $42,750 in annual contributions. Note that Kyle’s profit sharing limit is based on $75,000 in W-2 compensation.

    If Kyle’s W-2 income were $275,000, he could still make the $18,000 employee deferral and $6,000 catch up contribution, but his profit sharing contribution would be limited to $35,000 based on the aggregate limit. This total contribution would be $18,000 + $6,000 + $35,000 = $59,000.”

    Question: Let’s say Kyle has a WIFE that works for/earns income from the same small business, but is not the owner, but qualifies to contribute to the solo 401k… does she have to earn a certain amount to max her contribution or does she get to max it out simply because Kyle was eligible to as the company made a certain amount?

    Could you give me the same example, as illustrated above, to demonstrate how Kyle’s wife could max her contribution to the limit? From my understanding, the couple can contribute up to $118,000. Just having a hard time finding out how much the spouse has to earn for the couple to reach the $118,000 (or $106,000 if under 50).

    Thanks a million in advance!

    • Thanks for the question Blake. First off, I like the idea of adding your spouse to the company in order to make 401(k) contributions on her behalf. Be careful though. By adding her as a participant to your plan, the 401(k) is no longer “solo”. You’ll have to either perform some compliance testing each year (to ensure the plan doesn’t discriminate against certain classes of employees) or comply by the safe harbor provisions. Here’s the IRS page that describes the safe harbor plans: https://www.irs.gov/retirement-plans/plan-sponsor/401k-plan-overview.

      So let’s assume you amend your plan to add your spouse as a participant. They can put in $18,500 (as of 2018) as an employee. You can then add profit sharing contributions if you with. The maximum amount you can contribute will typically be 25% of her annual comp, but also depends on how the plan is set up.

      Multi participant 401(k) plans are very different than solo-k’s. They’re a great opportunity to put away more tax deferred cash as a household, but you’d probably want some help from a service provider to ensure it’s set up correctly. Also, make sure your spouse is doing bona fide work in the business & earning their comp. This is an area the IRS scrutinizes. Give me a call if you’d like to discuss further.

  10. The IRS breaks it down to Solo Proprietorship/Single Member LLC vs SCorp/CCorp/multimember LLC when determining profit sharing limits. What if you’re a single member LLC with the S Corp tax election. In that case what prevails? It does appear to be safer to go with the Single member LLC limit, however it would be beneficial to know which method to apply. Do you have any insight on this issue?

    • The deciding factor is how you file. If you make the S Corp election, the s corp limits will apply. There are a lot of variables when deciding whether to file as an s corp or a single member LLC. Usually the best thing is to run a side by side projection so you can weigh the pros and cons of either strategy.

  11. How is the employer contribution to a solo 401(k) plan made? from the checking account of the business? or from the sole employee’s personal checking account?

  12. I have a multi member llc, 2 members taxed as partnership 401 k contributions for 2017 maxed at $60,000. With the over 50 cath up for both partners. 1 partner allocated $24000. to a Roth, the other partner allocated 100% to traditional 401k. How is this reported on schedule k -1, and schedule K of form 1065.

    • Good question. I assume that they’d fall in line 13d on form 1065, schedule k. The balance would be reflected on line 14a. I’d check that with a tax professional though.

  13. Sole prop and wife are 1040 Sch C business owners and both are over 60. Can both contribute to the Solo 401k plan as “employees” @ $24K each? AND if they have net income of $100K – an additional $20K?
    Thanks for your response.

      • Grant, I believe you are incorrect. It is my understanding the IRS allows for non-owner spouses to participate in a Solo 401k established for their spouse’s business, and still remain a solo 401k. This I’ve gathered from multiple resources, including the IRS website. As for Paul’s question, I’m not sure but it seems both spouses could contribute the $24K amount and then an additioinal contribution for the profits with each capped at their SS wage amount. However, if the non-owner spouse received a salary of only $24K (all of which is contributed to the 401K) then that spouse would be capped at $6K of the profits. The owner spouse could contribute their $24K plus about 20% of $74K. I believe the salary paid to the non-owner spouse would be a business expense (along with the employer match amount to SS and medicare) and thus the profit would be close to $74K for the owner spouse. I think the non-owner spouse would have their profit sharing limit capped at their W2 wages, ($24K x 25% = $6K), and the owner spouse at ($74K x 20%=$15,800). Several factors would apply when considering how much to pay the non-owner spouse, including whether the owner spouse has already maxed out on SS from another job ($128,400 in 2018). If the owner spouse maxed out SS at their other job, they may want to not pay their spouse more than the $24K as salary as such will incure SS and medicare tax, whereas the maxed out spouse would receive the amounts not subject to those taxes. If I’m correct, this couple could contribute $69,800 in total to the 401k accounts with the deferral of income taxes on that amount. However, they would still incur SS and medicare taxes on some of those funds.

  14. “S-Corp or C-Corp
    Let’s say Kyle, who is 58 years old, earned $75,000 in W-2 wages from his S-corp. He deferred $18,000 in regular deferrals and $6,000 in catch up contributions.

    His business could contribute up to $18,750 in profit sharing contributions ($75,000 * 25%), totaling $42,750 in annual contributions. Note that Kyle’s profit sharing limit is based on $75,000 in W-2 compensation.

    If Kyle’s W-2 income were $275,000, he could still make the $18,000 employee deferral and $6,000 catch up contribution, but his profit sharing contribution would be limited to $35,000 based on the aggregate limit. This total contribution would be $18,000 + $6,000 + $35,000 = $59,000.”

    In the second example, could Kyle contribute the full $59,000 as a profit sharing contribution and $0 as employee deferral? If so, wouldn’t this be advantageous because FICA is payable on employee deferral but is not payable on the profit sharing contribution?

    Thanks for your response.

  15. Wait… so if it’s based on SS wages…the max amount to pay SS on is $128k … so that would mean you could never contribute more than max of $50k; 18k elective and 25%of 128k.
    Obviously I am understanding this wrong ..but how so?
    If corp contribution is based on SS wages…. ss taxable wages max is 128.4k.

    • Not sure, but isn’t only the wage portion of your S Corp profit subject to SS? Unlike a sole propietorship, an S Corp is allowed to identify some of the profit as “wages” thus subject to SS tax, and some of the money as a return on investment, and thus not subject to SS tax.

  16. If as a spouse employee (over 50) I receive $24,500 as W2 wages, and put that all into the 401K, is my profit sharing limit then 20% or 25% of that $24,500 amount, regardless of the ultimate profit of my spouse’s sole propietorship?

  17. If my sole proprietorship net income is $20,000, but I’m over 60, can I contribute more than the net income (less 1/2 self employment tax) by using the catch-up feature? Does the catch-up not depend on net income at all?
    NI=$20K
    SE Tax~2K
    EE contribution limit= 18K
    Catch up=6.5K
    Do I understand this correctly?
    Thx.

  18. I’m getting really confused between the employer and the employee deduction limitations… I am simply one person who will be earning contractor income (self-employed). If my earned income in this respect is $19,000, can I contribute the entire $19k (as the 2019 limit indicates)? This whole employee vs. employer piece is really confusing, considering I am both I guess?

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