By Ian Berger, JD
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A solo 401(k) plan is a great retirement savings vehicle for self-employed business owners with no employees (other than their spouse). But if you’re considering a new solo 401(k), be aware that there’s a December 31, 2022 deadline to open up the plan if you want to make 2022 elective deferrals.
The IRS considers a business owner with a solo 401(k) to wear two hats – one as an employee and one as an employer. As an employee, you can make elective deferrals up to $20,500 for 2022, or $27,000 if age 50 or older. (Those limits will jump to $22,500/$30,000 for 2023.) As an employer, you can also make additional contributions up to 20% of adjusted net earnings. However, there’s also an overall limit on combined elective deferrals and employer contributions. For 2022, that maximum is $61,000, or $67,500 if you defer the additional $6,500. (For 2023, those limits increase to $66,000/$73,500.) For many business owners, a solo 401(k) allows for much higher contributions than a SEP or SIMPLE IRA.
Solo 401(k) plans are also exempt from ERISA, which means that plan administration is much simpler than with a company 401(k). One negative, however, is that solo plans don’t benefit from ERISA creditor protection.
The rules for starting up new solo plans became muddled after the SECURE Act became law. Before 2020, if a company wanted to have a new plan in place for a particular tax year (say 2019), it had to formally establish the plan by the last day of that tax year (December 31, 2019). Now, businesses have extra time – until the due date for the corporate tax return, including extensions. So, for example, a business can open up a new plan for 2022 as late as September 15 or October 15, 2023, depending on the type of business.
So, what’s the problem? Well, this extended deadline is available only for employer contributions – not for elective deferrals. If you’re a sole proprietor and want to make elective deferrals for a tax year, the IRS says you must make a deferral election by the last day of that year. But you can’t make an election unless your plan has already been put into place. Translating all of this into plain English: If you want to make solo plan deferrals for 2022, you must adopt a new solo plan and make a deferral election by December 31, 2022.
What if you miss that deadline? Under the SECURE Act, you’d still have until next September or October to get a new solo plan in place. But you’d only be able to make employer contributions – not elective deferrals – for 2022.