What is the Owner Only 401k?
Furthermore, why would you want one?
You may have heard of this term.
They all point to the same kind of plan--- what I refer to as the Owner Only 401k (or officially by the IRS One-Participant 401(k) Plans).
There’s a lot of choices for retirement plans for small business owners…
- A SEP IRA
- A SIMPLE IRA
- A 401k with Match
- A 401k with Match and/or Profit sharing
- A Defined Benefit Plan
- A Cash Balance Plan
Each of these can appropriate and could be considered for the right circumstances. We’ll publish more blog posts on each of these in the future.
Who Can Use (and Who Cannot Use) An Owner Only 401k
This is for you if you are a business owner (and/or their spouse) who doesn’t have ANY other W-2 wage employees.
This is also for you IF you have profits or W-2 wages that you pay yourself. The official IRS term is “earned income”. Basically, that you made money!
This doesn’t have to be a huge amount of money, but it could be. Could be $1k or $2k or $50k or $100k or $500k.
It doesn’t have to be a full time business. It could be a side hustle or part time business- as long as you are getting paid via 1099 – whether that flows to you personally as a sole proprietor or through your own S-Corp that you own.
This is NOT for you if you have any W-2 employees outside of you and your spouse (if applicable). However, don’t fret. There’s plenty of other options out there for you like we listed above. More to come on those other plans in the future.
This is also NOT for you if you haven’t made any money from your business or if you don’t have any 1099-MISC income. You can’t contribute to this plan if you are making W-2 wages at an employer that doesn’t provide any 1099-MISC side hustle.
How Much Can You Put into an Owner Only 401k?
The business owner wears two hats in a 401(k) plan: employee and employer. Contributions can be made to the plan in both capacities. The owner can contribute both:
- Elective deferrals up to 100% of compensation (“earned income” in the case of a self-employed individual) up to the annual contribution limit:
- $19,000 in 2019, or $25,000 in 2019 if age 50 or over ($18,500 in 2018, or $24,500 in 2018 if age 50 or over); plus
- Employer nonelective contributions up to:
- 25% of compensation as defined by the plan, or
- for self-employed individuals, see discussion below
If you’ve exceeded the limit for elective deferrals in your 401(k) plan, find out how to correct this mistake.
Total contributions to a participant’s account, not counting catch-up contributions for those age 50 and over, cannot exceed $56,000 (for 2019; $55,000 for 2018).
Example: Ben, age 51, earned $50,000 in W-2 wages from his S Corporation in 2018. He deferred $18,500 in regular elective deferrals plus $6,000 in catch-up contributions to the 401(k) plan. His business contributed 25% of his compensation to the plan, $12,500. Total contributions to the plan for 2018 were $37,000. This is the maximum that can be contributed to the plan for Ben for 2018.
A business owner who is also employed by a second company and participating in its 401(k) plan should bear in mind that his limits on elective deferrals are by person, not by plan. He must consider the limit for all elective deferrals he makes during a year
What the IRS is saying here is that you could contribute the elective deferral of up to $19,000 in 2019 MAX--- doesn’t matter whether you have 1 plan or 2 plans. The most you can put in a 401k is $19k of the elective deferrals.
HOWEVER- you still have the employer nonelective contributions. You can still put in a maximum of 25% of compensation up to $56,000.
The employer nonelective contributions are pretty much exactly like the SEP-IRA.
Unique Features of the Owner Only 401k
Besides the previously mentioned deferral limits and contributions, there are a few other features that you should consider.
- If a husband has a consulting business, consider having your spouse work for you and pay them a wage of some sort or add them into the ownership of the company. This way you can dramatically increase the tax deductible contributions that you can make.
- You can ‘loan’ yourself some money. As opposed to a SIMPLE IRA or SEP IRA or traditional IRA, with a 401k, you could elect to take a 401k loan. When you do that, you are taking money out of your account ---- up to 50% of the account balance or $50,000 whichever is less --- and you amortize the loan over a certain period of time and a certain interest rate. Rather than paying back the bank with interest, you just loaned yourself money and you are paying your own account back with interest. This is TAX FREE as long as you are keeping up with the payments.
If you are in a pinch for cash, this could be a wonderful way to borrow to expand your business or cover your bills AS LONG AS you pay back the loan. If you default on the loan, now it becomes taxable.
- Unlike ‘normal’ 401ks, the administration costs can be super, super low as long as your plan is below a certain amount of assets. I believe that’s $250,000 currently. Once you are over that amount, you need to file the form 5500. (That would be a disadvantage of the plan)
- You can rollover old IRAs/ SEP IRAs/401ks etc into this plan. If that amount is under $250k like we just discussed, you avoid the administration costs and then you can look at some other aspects you couldn’t do before without paying taxes --- like the ‘Regular’ Back Door Roth IRA that we outline in this blog post.
- You could also potentially take advantage of the “SUPER” back door Roth IRA up to the $56,000 of contributions that we outline in this blog post.
Final Thoughts on the Owner Only 401k
The owner only 401k is a really powerful vehicle. It is a really simple way to get money socked away for retirement.
If you are self-employed and don’t have any employees, you should consider it as a tool in your arsenal.
What do you think---- would you consider an Owner Only 401k?
E-mail me at firstname.lastname@example.org and let me know.
Material discussed is meant to provide general information and it is not to be construed as specific investment, tax, or legal advice. Individual needs vary & require consideration of your unique objectives & financial situation. Please consult with your accountant or tax advisor for specific guidance.