The Power of the Solo 401(K) Plan
The question I had often wondered about is why a sole business owner, with no employees except for him or herself, would want to set up a 401(k) plan when they could simply set up a profit sharing plan. Why all the brokers were touting the wonderful things about setting up a 401(k) plan for the business owner with no employees? Then one day I decided to crunch the numbers, and low and behold it made perfect sense.
- The maximum elective deferral limit for 2015 is $18,000.
- The maximum that any participant in a defined contribution plan (profit sharing/401(k) plan) can generally receive is the lesser of 100% of compensation or $53,000 in 2015 (the “Section 415 Limit”).
- Starting in the year in which an individual reaches age 50 and subsequent years, a 401(k) plan may allow the individual to make a “Catch-Up Contribution.” The Catch-Up Contribution for 2015 is $6,000. The Catch-Up Contribution does not count against the deduction limit, the maximum elective deferral limit, or the Section 415 Limit.
EXAMPLE 1: The sole shareholder of the corporation has annual compensation of $100,000. With a profit sharing plan, the maximum contribution would be the lesser of 25% of eligible compensation (the deduction limit) or the Section 415 Limit of $53,000. Therefore, the maximum contribution is $25,000.
EXAMPLE 2: Using the same facts as in Example 1 but by adding a 401(k) feature, the maximum benefit that the owner can receive is now increased from $25,000 to $43,000 by making an elective deferral of $18,000. The 401(k) deferral is not subject to the 25% deduction limitation.
EXAMPLE 3: The sole shareholder of the corporation now makes $150,000 per year. The maximum allowable contribution to a profit sharing plan is $37,500 (25% deduction limit). By adding the 401(k) feature, the maximum contribution is now increased to $53,000. The Section 415 Limit now comes into play.
EXAMPLE 4: Now assume the same facts as in Example 3 except that our business owner is age 55. This has no impact if it is only a profit sharing plan. However, the maximum contribution with the catch up contribution of $6,000 now is increased to $59,000.