What You Need to Know About an Individual 401k

April 14, 2015


Individual 401K

What is an Individual 401k?

An individual 401k, also called a one-participant 401k plan or a Solo 401k, is a retirement plan for the self-employed. It is for business owners who have no employees other than the owner’s spouse. An individual 401k comes in two versions, traditional or Roth, just as other 401k plans do. If you choose the traditional version, you input money on a pretax basis and pay taxes upon withdrawal. In the Roth version, you input money on an after-tax basis and it is then not taxed upon withdrawal. You can divide your contributions between a traditional and a Roth 401k. Which you should choose depends upon your current and projected tax rates.

401k Contribution Limits

Individual 401k plans have similar rules and requirements as other 401k plans except greater contributions are allowed at identical income levels, recognizing that the small business owner is both the employer and the employee. This allows the business owner to maximize retirement contributions and tax deductions. Contributions are allowed of 100% of earned income up to the contribution limit. The 2014 Individual 401k contribution limit is $52,000 and $57,500 if age 50 or older. Only the salary deferral portion is eligible for a Roth contribution. The 2014 Roth 401k salary deferral limit is $17,500 and $23,000 if age 50 or older. Salary deferral and profit sharing contributions are 100% tax deductible although contributions to a Roth 401k made with the salary deferral portion are not tax deductible.

Borrowing Can Be Permitted
Another distinction of the Individual 401k is that some plans allow you to borrow against its value. Loans up to 50% of the total value of the 401k, with a $50,000 maximum, are permitted. The loans are received tax-free and no taxes are due if loan payments are made on time. If you withdraw money from your individual 401k before you’re 59 ½, you will owe a 10% penalty unless you qualify for a hardship withdrawal. You also owe income tax on the withdrawal.

Contributions Are Not Mandatory
Contributions are not mandatory and can be increased, decreased, or skipped entirely. This provides additional flexibility for small business owners as higher contributions could be made in good years so that you can obtain higher tax deductions in those years. Conversely, you can make low contributions in years that you don’t need the deduction or money is tight.

Contact Us
Several types of individual 401k plans are available. At Clay Northam Wealth Management we work with you to determine what type of retirement plan is best for you. If you are self-employed, an individual 401k may meet your needs. Feel free to contact us to discuss your retirement planning options.