3762 / What is a solo 401(k) plan?
Editor’s Note: The original SECURE Act extended the deadline to allow qualified retirement plans to be adopted as late as the sponsoring employer’s tax filing deadline, including extensions. However, employers could only make elective deferrals to the plan on a prospective basis (meaning that contributions for any given tax year still had to be made before year-end). The SECURE Act 2.0 modified this rule to allow sole proprietors and owners of single member LLCs to make elective deferrals to their solo 401(k) plans up until their tax filing deadline, including extensions, even for the first year the plan is in place. This new rule is effective for plan years beginning after December 29, 2022.
A solo 401(k) plan refers to any 401(k) plan that covers only the business owner or the business owner and his or her spouse. These plans are subject to the same rules and requirements as any other 401(k) plan. Nondiscrimination testing is not required since the business does not have any common law employees who could have received disparate benefits. Solo 401(k) plans are a product of qualified plan reforms implemented by EGTRRA 2001, which substantially improved the tax favored treatment for employers sponsoring 401(k) plans. These changes were designed to encourage greater savings for retirement and to provide more incentive to businesses funding 401(k) plans.
The first of these changes increased the deduction limit for profit sharing and stock bonus plans (which includes 401(k) plans) to 25 percent of compensation.1 Before 2002, profit sharing and stock bonus plans were subject to a deduction limit of 15 percent of compensation.
Planning Point: For self-employed individuals, compensation is defined as net earnings less a deduction of 50 percent of self-employment tax and employee contributions. The IRS publishes a separate deduction and rate worksheet for self-employed individuals in Publication 560.
Second, the definition of compensation for purposes of the 25 percent limit includes elective deferrals to a qualified plan, Section 403(b) plan, Section 457 plan, SEP, SIMPLE, or
Section 125 FSA plan.2 This means that the payroll on which the 25 percent is based became higher than it was in earlier years, resulting in a higher deduction limit for employer contributions to the plan.
Planning Point: If a self-employed individual also participates as an employee in another 401(k) plan, the limits on elective contributions are per individual, not per plan, so the aggregate contributions into all the plans cannot exceed the limit.
After the EGTRRA 2001 amendments, elective deferrals no longer reduce the amount of employer contributions for purposes of calculating the 25 percent deduction limit.3 This means that a higher amount could be attributable to matching contributions, nonelective contributions or other amounts paid by the employer. The elective deferral limits increased as well: the limit is $23,500 for 2025 (projected), up from $23,000 for 2024, $22,500 for 2023, $22,000 in 2022 and $19,500 for 2020-2021 ( Q 3760), and, for individuals age 50 or older, catch-up contributions are permitted ($7,500 for 2023-2024 and $6,500 in 2020-2022 ( Q 3761)).4
Planning Point: These changes to the calculation of the employer deduction for all profit sharing plans, including 401(k) plans, led to a proliferation of solo 401(k) plans. Although the advantages to a sole proprietor or one person corporation can be significant, it is important to note that the plan is subject to the same minimum participation, coverage, nondiscrimination, and other requirements that apply to any other qualified defined contribution plan, in the event one or more employees are later added to the sponsoring employer.
Third, total contributions to an employee’s account (excluding catch-up contributions) cannot exceed $70,000 in 2025 (projected), $69,000 in 2024, $66,000 in 2023, $61,000 in 2022, $58,000 in 2021 and $57,000 in 2020.5