How much can I shelter from taxation under a SOLO 401(k) plan?

Discover the different types of contributions available in Solo 401(k) plans. From employer contributions to employee deferrals, learn how you can maximize your retirement savings. Find out about profit-sharing contributions, catch-up contributions, and after-tax contributions. Start planning for your future today!

Author

John Paul Ruis QKA CISP

May 23, 2023

Understanding Solo 401(k) Contributions: Employer and Employee Contributions Explained



Solo 401(k) plans have several types of contributions that can be made.   Since the owner is also an employee, there are initially two types of contributions available.

Employer contribution – the most common employer contribution is called a profit-sharing contribution.   The employer can contribute on behalf of each employee based on a percentage between 0-25% of each eligible employee’s income.  The percentage must be the same for all owners, however, if there are multiple owners.  For example if an owner earned $100,000 of W-2 wages from the business for the year, the business can make a $25,000 contribution towards the employee’s 401(k) account and the business can use it as a tax deduction.  This contribution of course must be tracked separately since the rules around this type of contribution are different from other types of contributions.  That is where a proper recordkeeping platform is essential.  Let’s move on to the employee’s contribution.

Employee contribution -  As an employee, the employee can defer a portion of their income (W-2 $100,000) up to the deferral limit for the year which is $22,500 (2023).  This means that instead of being taxed on $100,000, if the employee deferred the maximum amount their taxable income is reduced to $77,500.  The deferral amount can also either be pre-tax as previously illustrated or done on a post-tax basis called a designated Roth.  The limit stays the same for both combined however, the benefit of the Roth although it doesn’t reduce the taxable income, the earnings grow to eventually be tax-free!!!!

Maximizing Tax Benefits: Exploring Different Contribution Types in Solo 401(k) Plans


With the different characteristics of the two types of deferrals, it is emphasized to keep the two contributions tracked in different buckets.  Both grow tax deferred but one (Roth) is eventually tax free!!!

If an individual will attain age 50 before the end of the tax year, the individual can make an additional contribution called a catch-up contribution of $7,500 (2023).  This contribution can either be pre-tax or Designated Roth.

The limit for both the profit sharing and regular deferrals is called the annual additions limit and this limit is $66,000 (2023).  This excluded the catch-up which means for someone who is aged 50 their maximum for the year is $73,500 (2023).

 

In some cases based on the income of the individual, they may not get to the $66,000 limit. In this scenario, they can choose to make an additional contribution called an after-tax contribution.  This contribution is different from a Roth since the tax-deferred growth of earnings will be taxable upon distribution. 

Platforms like the Quest Trust, IRA Resources Trust and SEPIRAk platforms are some platforms that can accommodate the tracking of the different types of contributions.   Their platforms also provide the most features for Solo 401(k) plans.