Is your business a solo show? Learn about owner-only 401(k) plans

How to determine if this retirement vehicle makes sense for you.

The owner-only 401(k) is a retirement vehicle that gained a lot of momentum in 2001 when the IRS made it much more flexible for business owners. An owner-only 401(k) is a retirement savings account designed for those running a business as the only employee, allowing contributions not just from your salary but also your business. It’s a vehicle that offers many advantages – but you must meet certain requirements to deploy it. Below is more insight into how owner-only 401(k) plans work.

How much can I contribute?

An owner-only 401(k) allows you to make a contribution both from your salary and from your business. This allows you to maximize your retirement savings, reduce your tax burden and catch up on contributions if you are over 50.

You can designate up to 25% of your total compensation to a profit-sharing plan, plus up to $23,000 to a 401(k) plan if you earn at least that amount annually. This brings your total contribution level up to a maximum of $69,000, or 100% of your total compensation, whichever is less.

If you are 50 or older, you can make an additional “catch-up” contribution of up to $7,500.

Choose your tax advantage

Pick a traditional 401(k) to reduce your income tax in the year your contributions are made or go with a Roth option in the 401(k) if available, which doesn’t get you an initial tax break but does allow you to withdraw the funds tax-free in retirement. If you think your income will be higher in retirement, the Roth can be a good move. If you think it will be lower, taking the tax break now may be right for you.

Spousal benefits

While this type of plan is specifically for businesses with no employees, you and your spouse can participate if you both are employed by and receive compensation from the business.

Other advantages

The owner-only 401(k) offers some administrative advantages over a regular qualified retirement plan. Unless your balance exceeds $250,000, you do not have to file a 5500 form every year with the IRS. You also do not need to perform nondiscrimination testing, which is a compliance regulation from the IRS that usually requires a plan administrator. And you may be able to take a loan from your owner-only 401(k) of 50% of the account balance (greater than $10,000) or $50,000 – whichever is less.

An owner-only 401(k) also allows for consolidation of multiple accounts. Most retirement plan assets, including funds from profit sharing and money-purchase plans, and both traditional and SEP IRAs, can be transferred into your owner-only 401(k).

Setting it up

Talk to your advisor about setting up an owner-only 401(k). You’ll need an employee identification number, and you’ll sign a plan adoption agreement. Once it’s set up, you can start investing in vehicles like ETFs, index funds, mutual funds and more – whichever make sense for your long-term financial and retirement goals.

401(k) plans are long-term retirement savings vehicles. Withdrawal of pre-tax contributions and/or earnings will be subject to ordinary income tax and, if taken prior to age 59 1/2, may be subject to a 10% federal tax penalty.