Most people think a solo 401(k) is just a place for self-employed people to stuff a bunch of cash to save for retirement. We see much more dimensionality to it! In this article, we’ll cover what the solo 401(k) deadlines are, and other basic information. But more importantly, we’ll discuss how to use these vehicles strategically in order to optimize your retirement savings.
Before we get into the blog, we are financial planners in Morristown, New Jersey. Although nothing in this article may be interpreted as tax or legal advice (ask your CPA or legal advisor for such guidance), we’ve written other blogs on financial planning and retirement that may be useful to you:
Is the life insurance provided by my employer enough?
Our easy, clear take on the question of if Social Security increases with inflation
End of year financial planning
What to do When Your Social Security Benefits Are Reduced
I’m invested in a 2030 target date fund – help!
And now let’s get into it!
Who is a solo 401(k) good for?
Let’s start with the basics.
A solo 401(k) is a business retirement account that can only be used for self-employed people with no employees. It allows the owner to contribute a total of $66,000 in 2023.
This is a good option for a business owner who wants to save a sizeable (but not extraordinary) amount for retirement.
A few basics about this type of retirement vehicle:
- Remember that as the owner of a business with no employees, you are both the employer and employee.
- As employee, your contribution can be the lesser of 100% of compensation or $22,500 in 2023.
- As employer, you can contribute 25% of your compensation or your net earnings as a self-employed person. This is your net earnings minus one half of self-employment tax and all plan contributions. The maximum is determined by a formula. A business owner would need business profit over $200,000 to contribute the maximum amount. This limit increases by the rate of inflation each year.
Solo 401(k)s allow a $6,500 catch-up contribution for people over 50, and contributions can be made on a post-tax basis.
What are the solo 401(k) deadlines?
It’s important to follow the rules regarding deadlines for contribution to a solo 401(k) in two major aspects: account opening and funding.
Account opening – you must have opened the account by December 31st of the previous year in order to be able to contribute in that calendar year. So, for example, the deadline for solo 401(k) account opening would have been December 31, 2022 if you want to make a contribution for 2022. Note: you don’t have to fund it – you only have to have opened it by that time.
There are certain exceptions to this rule under the SECURE Act 2.0. You may have up until the tax filing deadline to open and fund the account.
Funding your solo 401(k) – you have up until the tax filing deadline to make your annual contribution. If you file an extension, you have up until October 15th (if you select for the six-month extension). This may vary by business entity type.
It’s important to be able to meet these deadlines for your solo 401(k) to maintain its status. Additionally, you’ll be required to follow the IRS rules for qualified retirement plans as per the IRS Publication 560.
Retirement savings strategy for business owners
While a solo 401(k) is a valuable tool for self-employed people, it’s not the be-all-end-all. We think it’s a good place to start. However, as time goes on and businesses grow, we see many business owners shortchanging themselves of the opportunity to save more on a tax-deferred basis by not being open to the other options that exist.
The usual progression we see is:
- You start with a solo 401(k) when it is just you, or you and your spouse, in the business.
- As you take on employees, you establish a safe harbor 401(k).
- As your take home pay grows and you gain the ability to save more, you establish a defined benefit plan.
Whoa – we just rained down a lot of technical terms out there!
Let’s take a moment and define some wording.
Safe Harbor 401(k)
Most people are already familiar – but in case you aren’t, a 401(k) is a profit-sharing plan. Your employees can contribute on a pre-tax basis, usually on a periodic basis and as a percentage of your salary.
To improve their workers’ ability to save for retirement, many employers contribute to the employee’s account. This is called “matching.” The limit for 401(k) contributions in 2023 is $22,500 which applies to all deferrals (contributions made by the employee) as well as matching contributions.
Setting up the 401(k) as a Safe Harbor plan can reduce administrative complexity. This is a 401(k) plan with matching that is structured so it allows you to bypass the 401(k) nondiscrimination tests, which can be administratively burdensome.
Defined Benefit Plan
This type of retirement vehicle is typically thought of as suitable for large corporations. However, for small to medium sized business owners who have the capacity to sock away tens or even hundreds of thousands of dollars, a defined benefit plan is a great option.
In our blog about financial tips for business owners, we discuss a hypothetical example. Be sure to check it out; as you can see, this can get a bit complex.
As businesses grow, their savings needs change. It’s important to get the right advice about which retirement savings vehicle is right for you at each stage of growth, because there are legal and tax implications to the different set ups mentioned above. Moreover, the administrative complexity – deadlines for a solo 401(k) contribution (or whichever type of plan you choose), managing plan documents, filing IRS forms – tends to increase as you adopt more sophisticated savings vehicles. Consult with a tax and/or financial advisor if you need help figuring it out.
Are you clear on those solo 401(k) deadlines yet?
Between the deadlines for a solo 401(k), which retirement plan to pick for your business, etc., all of these technicalities can be a lot for someone to take in.
We are financial advisors in Morristown, NJ serving the local community and beyond. If you have questions about your retirement, how much life insurance you need, retiring in New Jersey, moving there, affording to live there, or (like us) are just plain old Bruce Springsteen fans, reach out and send us a message.
Sources
IRS. (17 March, 2023). Publication 560: Retirement Plans for Small Business. https://www.irs.gov/pub/irs-pdf/p560.pdf