You live together, travel together, and made a family together. You do everything together. And, if conditions are right, you can use your Solo 401(k) to start saving for your retirement together.
Solo 401(k) plans operate like a regular 401(k) where a spouse is treated as an owner and works for your business. The spouse however must receive income from the business to contribute to the Solo 401(k) retirement plan. But there are rules and requirements. Let's explore...
Two is better than one —especially if you’re talking about people contributing to a retirement plan. Solo 401(k)s are designed to be used by the self-employed, partnerships, and corporations who only employ owners and their working spouses. In other words, the plan is only for a business owner with no employees.
Contributions follow the same limits as any 401(k) plan. However, since the plan does not have regular employees these plan are not subject to nondiscrimination test 401(k) plans are typically subject to. These tests are cumbersome and may limit the amount of contributions owners may make to the plan.
You might be wondering if it’s possible for your spouse to contribute to your Solo 401(k) plan. By virtue of marriage, the spouse is also considered an owner automatically. If the spouse has earned income from the business, the spouse can contribute to the same plan. And remember, as long as the plan has no employee who is not an owner, the couple can contribute the maximum amount of contributions allowable under law.
Solo 401(k) Contribution Limits
In a Solo 401(k) the married couple can both make contributions to the plan as employees and also receive contributions to their plan from the company.
Like any retirement plan, there are pros and cons to consider. One of the benefits of a Solo 401(k) plan is when choosing to make a contribution called a deferral (from your paycheck as an employee) you can choose to contribute on a pre-tax basis or as a Roth contribution, after-tax basis.
If you choose a defer into the plan on a pre-tax basis the upside to this is that it will reduce your taxable income for the year. However, when you are ready to retire, the distributions will be taxed as normal income.
Should you choose a Roth 401(k), the contributions are made using after-tax dollars. While this won’t help you reduce your taxable income for the year, when you’re ready to retire, and you satisfy certain criteria, you earnings will be distributed tax-free. It all depends on what works best for your current situation.
It's important to mention that unlike in a Roth IRA, income limits do not apply for contributions to a Roth 401(k). The married couple can contribute regardless of their income level.
In 2022, the 401(k) contribution limit is $20,500 for deferrals with an additional profit sharing contribution of 25% of compensation. The combined limit of the deferral plus profit sharing is $61,000. If you are aged 50 and older along with the $20,500 you can make an additional $6,500 called a catch-up contribution.
This amount is not limited by the $61,000 and can go over that amount. In a nutshell if your income is enough to support the total contribution you maximum for 2022 can be up to $67,500 if you are at least the age of 50.
In 2023 the deferral maximum was increased to $22,500 with a combined limit with the profit sharing amount increased to $66,000. Remember you can make an additional $7,500 if you are at least age 50. This mean that the limit may be up to $73,500 depending on your income for the year.
Profit sharing and Deferral contributions to a Solo 401(k) are discretionary — you don’t have to contribute to the plan. This allows for a little flexibility in your spending should the economy take a turn for the worse.
As you can see, Solo 401(k) contributions are much higher than Roth IRA and Traditional IRA contributions. You can also contribute to your IRAs in addition to contributing to your Solo 401 (k) which is an added plus.
Deciding what type of 401(k) is right for you can be difficult. How much you save on income taxes depends on your adjusted gross income. This is different for everyone. Consider consulting a financial professional before making your final decision for your small business.
Solo 401(k)s allow their owners to choose their own investments without needing the consent of an account custodian. The Owner is considered the Trustee or Custodian of the plan assets.
The plan document and adoption agreement specifies what types of assets are allowed in the plan. While most would agree that greater freedom to make choices is better, it also means that you have more responsibility. Solo 401(k)s offer many diverse investment opportunities, but make sure to do your due diligence before making an investment.
As mentioned earlier, gains are tax-deferred. If you purchase a property using your Solo 401(k) and sell it, making a $100,000 profit, the tax on the gains would be deferred from taxation. If you had purchased the property outside of a retirement plan, the gains would be subject to both state and federal taxes. Investing under a retirement plan gives you the advantage of not having to pay tax on the gains, allowing the opportunity to build more wealth under a retirement plan.
Since Solo 401(k) plans can have a checking account tied to it, investing in real estate is as simple as cutting a check from your 401(k).
Just like with real estate, the interest payments you receive from making private loans will be tax-deferred. If you ended up choosing a Roth 401(k), the contributions would be tax-free because the taxes have already been paid on them. If you have satisfied certain criteria your earnings will also be distributed tax-free.
It's important to have the right tools to track loan payments as well as income from these. The income from the loan payment needs to be allocated correctly.
With a self-directed Solo 401(k) you can open trading accounts at any brokerage or online. There are an endless array of investment opportunities to choose from when investing in the market. And because you control your Solo 401(k), you have the freedom to pick the companies you have the most confidence in for your retirement investment strategy.
How Can IRAR Help?
IRAR has been helping people to diversify their retirement savings for over 25 years. If you are interested in learning more about Solo 401(k)s and how they can help you plan for the future, for a free consultation.