As 2020 comes to an end, it is critical that Solo 401(k) owners understand when and how to make their 2020 contributions. There are three important deadlines you must know if you have a Solo 401(k) or if you plan to set one up still in 2020. A Solo 401(k) is a retirement plan for small business owners or self-employed persons who have no other full-time employees other than partners or a spouse. It can be fully self-directed into real estate, LLCs, or other alternative investments, and allows the owner/participants to contribute up to $57,000 per year (far more and faster than any IRA). For 2020 contributions, the employee maximum is $19,500, and the employer’s maximum is $37,500 for a total of $57,000. As I outlined in my prior article on Entrepreneur, the limits for 2021 increase to $58,000.
New Solo 401(k) Set-Up Deadline is 12/31/20
First, in order to make 2020 contributions, the Solo 401(k) must be adopted by your business by December 31st, 2020. If you haven’t already adopted a Solo 401(k) plan, you should start now so that documents can be completed and filed in time. If the 401(k) is established on January 1st, 2021 or later, you cannot make 2020 contributions.
2020 Contributions Can Be Made in 2021
Both employee and employer contributions can be made up until the company’s tax return deadline including extensions. If you have a sole proprietorship (e.g. single-member LLC or schedule C income) or C-Corporation, then the company tax return deadline is April 15th, 2021. If you have an S-Corporation or partnership LLC, the deadline for 2020 contributions is March 15th, 2021. Both deadlines (March 15th and April 15th) to make 2020 contributions may be extended another six months by filing an extension. This a huge benefit for those that want to make 2020 contributions but who won’t have funds until later in the year to do so.
W-2’s Force You to Plan Now
While employee and employer contributions may be extended until the company tax return deadline, you will typically need to file a W-2 for your wages (e.g. an S-Corporation) by January 31st, 2021. The W-2 will include your wage income and any deduction for employee retirement plan contributions will be reduced on the W-2 in box 12. As a result, you should make your employee contributions (up to $19,500 for 2020) by January 31st, 2021 or you should at least determine the amount you plan to contribute so that you can file an accurate W-2 by January 31st, 2021. If you don’t have all or a portion of the funds you plan to contribute available by the time your W-2 is due, you can set the amount you plan to contribute to the 401(k) as an employee contribution, and will then need to make said contribution by the tax return deadline (including extensions).
Now let’s bring this all together and look at an example outlining how this may work. Sally is 44 years old and has an S-Corporation for her online business. She is the sole owner and only employee and had a new Solo 401(k) established in 2020. She has $120,000 in net income for the year and will have taken $50,000 of that in wage income that will go on her W-2 for the year. That will leave $70,000 of profit that is taxable to her and that will come through to her personally via a K-1 from the business. Sally has not yet made any 2020 401(k) contributions but plans to do so in order to reduce her taxable income for the year and to build a nest egg for retirement. If she decided to max-out her 2020 Solo 401(k) contributions, it would look like this:
- Employee Contributions – The 2020 maximum employee contribution is $19,500. This is dollar for dollar on wages so she can contribute $19,500 as long as she made $19,500. Since Sally has $50,000 in wages from her S-Corp, she can easily make a $19,500 employee contribution. Let’s say that Sally doesn’t have the $19,500 to contribute, but will have it available by the tax return deadline (including extensions). What Sally will need to do is let her accountant or payroll company know what she plans to contribute as an employee contribution so that they can properly report the contributions on her payroll and W-2 reporting. By making a $19,500 employee contribution, Sally has reduced her taxable income on her W-2 from $50,000 to $30,500. This assumes she made a traditional contribution. A Roth employee contributions would not reduce the taxable income on the W-2. At even a 30% tax bracket for federal taxes and a 5% tax bracket for state taxes that comes to a tax savings of $6,825.
- Employer Contributions – The 2020 maximum employer contribution is 25% of wage compensation not to exceed $57,000 in total. Since Sally has taken a W-2 wage of $50,000, the company may make an employer contribution of $12,500 (25% of $50,000). This contribution is an expense to the company and is included as an employee benefit expense on the S-Corporation’s tax return (form 1120S). In the stated example, Sally would’ve had $70,000 in net profit/income from the company before making the Solo 401(k) contribution. After making the employer matching contribution of $12,500 in this example, Sally would then only receive a K-1 and net income/profit from the S-Corporation of $57,500. Again, if she were in a 30% federal and a 5% state tax bracket, that would create a tax savings of $4,375. This employer contribution would need to be made by March 15th, 2021 (the company return deadline) or by September 15th, 2021 if the company were to file an extension.
In the end, Sally would have contributed and saved $32,000 for retirement ($19,500 employee contribution, $12,500 employer contribution). And she would have saved approximately $11,200 in federal and state taxes. That’s a win-win.
Keep in mind, you need to start making plans now, and begin coordinating with your accountant or payroll company as your yearly wage information on your W-2 (self-employment income for sole props) is critical in determining what you can contribute to your Solo 401(k). Also, make certain you have the plan set-up in 2020 if you plan to make 2020 contributions. While IRAs can be established until April 15th, 2021 for 2020 contributions, a Solo K must be established by December 31st, 2020 if you want to make 2020 contributions. Don’t get the two confused, and make sure you’ve got a plan for your specific business.
Note: If you’ve got a single-member LLC taxed as a sole proprietorship, or just an old-fashioned sole prop, or even or an LLC taxed as a partnership (where you don’t have a W-2), then please refer to our prior article here on how to calculate your Solo K contributions as they differ slightly from the s-corp example above.
We can help in establishing your solo(k) at KKOS Lawyers using our IRS pre-approved solo(k) plan documents where you can self-direct the solo(k) and have checkbook control right out of the plan. We handle statements and reporting as well as IRS required plan document updates for your solo 401(k) at Directed Trust Company.