Solomon & Hoover CPAs, PLLC Blog

Jason left his job — and a company-sponsored 401(k) plan — four years ago to start his own consulting business. Since then he’s been too busy and too cash-strapped to save for retirement. But now his business is thriving, and he wants to know what options are available to a 45-year-old self-employed individual.

Although a Simplified Employee Pension (SEP) plan or a traditional profit-sharing plan is a possible option, Jason’s financial advisor suggests a solo 401(k). Among its many benefits: Jason can contribute larger annual amounts — and make up for lost time.

Best of both

This relatively new retirement savings option combines features of a standard 401(k) with those of a profit-sharing plan. You fund it two ways:

1. With salary deferrals — in 2012, as much as 100% of the first $17,000 ($22,500 if you are 50 or older) of your compensation, and

2. With “employer” profit-sharing contributions. If you’re a sole proprietor, this can be as much as 20% of your self-employment income, subject to certain adjustment, or 25% of your W-2 compensation.

The maximum contribution limit — combining both the salary deferral and the profit-sharing contribution — in 2012 is $50,000 ($55,500 if you’re 50 or older).

Plan in action

Assuming that Jason’s net self-employment income is $100,000 in 2012, he can contribute $35,587 to his solo 401(k). By contrast, his SEP contribution limit would be $18,587. However, the figures would be slightly different if Jason paid himself a $100,000 salary from his corporation. In that case, his maximum SEP contribution would be $25,000, but he could contribute as much as $42,000 to his solo 401(k) plan.

Because both SEP and solo 401(k) plans have a 2012 maximum contribution of $50,000, the solo 401(k) contribution limit advantage decreases and eventually disappears for younger participants. Those 50 and older, however, are eligible for catch-up contributions under only the solo 401(k), allowing a maximum contribution of $55,500.

Additional features

Solo 401(k)s boast other benefits. Participants have the flexibility to contribute smaller amounts — or nothing at all — in lean years and can borrow as much as 50% of their account balance. Also, these accounts can hold nontraditional investments such as real estate.

To determine whether you’re eligible for participation (some small business owners with employees also may be), talk with your financial advisor.