A 401k is a great retirement savings tool for business owners and employees alike, but what if you’re self-employed? Or what if you own a small business with no employees? In that case, you may be able to set up a solo 401k. In this article, we’ll discuss the benefits of a solo 401k for your LLC and how to set one up.
What is a Solo 401k?
A solo 401k is a retirement savings plan that’s available for business owners who have no full-time employees (other than themselves or their spouses). If you’re self-employed or if you own a small business LLC with no employees, you may be able to set up a solo 401k.
Like other types of 401ks, a this type allows you to save for retirement in a tax-advantaged way. Contributions to your solo 401k are made with pretax dollars, which reduces your current taxable income. And, if your solo 401k plan allows it, you can make after-tax contributions to your account. Earnings on your solo 401k grow tax-deferred until withdrawal, at which point they’re taxed as ordinary income.
Benefits of a Solo 401k for Your LLC
There are several benefits of setting up a solo 401k for your LLC, including the following:
1. You Can Make Higher Contributions Than With Other Retirement Plans
If you have an IRA, contributions limits are $6,000 ($7,000 if you are over 50).
For a SEP IRA, for 2022 you are limited to $61,000 contribution limits.
But with a solo 401k, the contribution limits are much higher. In 2022, you can contribute 100% of your salary up to $20,500. Your company can contribute 25% of your salary as well.
For example, if your net taxable income is $300,000, you can contribute $20,500 personally. Your company can contribute another $75,000, or $95,500 total.
2. You Can Get a Tax Break on Your LLC Income
First, your company can make the maximum contribution limit to your retirement account as a business tax deduction reducing the net taxable income of the company itself. If you’re self-employed and have an LLC, chances are good that you pay self-employment taxes on your LLC income. These taxes are currently imposed at a rate of 15.3%, made up of 12.4% for Social Security and 2.9% for Medicare. When you make contributions to your solo 401k, however, those contributions reduce your taxable income. That means less money paid in taxes.
3. You May Be Able to Borrow From Retirement Account
As the owner of an LLC, there may be times when you need to borrow money for business expenses but don’t qualify for a traditional bank loan. If that’s the case, some solo 401k plans allow loans from the account. These are typically at low interest rates and with repayment terms of five years or less. Of course, taking out a loan from your retirement account should be considered a last resort. Missed payments could trigger tax penalties and jeopardize the future of your retirement savings. However, it’s nice to know that this option is available if needed.
Guidelines and Rules for Setting Up a Solo 401K
If you’re thinking about setting up a solo401K for your LLC, there are some guidelines and rules that you’ll need to follow. For starters, your LLC must have no full-time employees other than yourself or your spouse (if applicable). Also note that there’s no requirement that your LLC actually earn any income—the IRS simply requires that it have the potential to earn income before you can set up a solo 401K.
Another important thing to keep in mind is that all contributions must be made by the end of the year. You can’t carry them over into the next year like you can with other types of retirement accounts such as an IRA or SEP IRA. Expenditures from the account can be used for any purpose without penalty once you reach age 59 1/2. Prior to that age, withdrawals are subject to both federal and state taxes as well as an early withdrawal penalty. Also, keep in mind that once you establish a solo 401K ,you must continue contributions until reaching age 70 1/2 —at which point required minimum distributions begin.
Investments You Can Make With Your Retirement Account
Just as with other types of retirement accounts, the investment options available within a solo 401K will depend on the custodian chosen to hold the money in the account. However, most custodians offer a wide variety of investment options including stocks, bonds, mutual funds, ETFs, and more. You also have the option of investing in real estate, residential or commercial property, or even raw land —all without paying early withdrawal penalties or taxation.
The Bottom Line
Setting up a solo 401K for your LLC comes with many advantages —including high contribution limits, lower taxes owed on LLC income, and more control over how the money is invested. Of course there are a few guidelines and rules to follow —but once you understand how they work setting up a solo 401K enjoying all the associated benefits shouldn’t take long at all.