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Entrepreneur’s Max Out Retirement Contribution (up to $55k/year) READ TIME: 3 Minutes

 I set up my financial planning practice in Glen Ellyn back in 1996, one of my first concerns was how I would save for retirement as an entrepreneur.   At the time, the best plan for me was a SEP IRA which allowed me to set aside 25% of my “net” income.  Several years ago a new rule was created that allowed me to set up an Individual 401k while allowing me to make a 25% of “net” profit sharing contribution to plan each year.

How it works:

Individual 401(k)s. These are the most flexible option and let you make the largest contributions, or “deferrals.”

Also called “solo” or “one-participant” 401(k)s, they are available to free-lancers, independent contractors (great for realtors) and sole proprietors, as well as business owners with no employees other than a spouse.

You also can set up an individual 401(k) if you have a regular job but also have self-employment income on the side.

Since you are both the employer and the employee, you can contribute to the plan in two ways. As an employee, you can contribute up to 100% of your compensation, up to a limit of $17,000 in 2012, plus a catch-up contribution of $5,500 if you are at least 50 years old, for a total of $22,500.

As the employer, you can contribute up to 20% of your self-employment earnings—or 25% if your business is incorporated.

In 2012, total contributions from both employer and employee can’t exceed $50,000, or $55,500 if you are 50 or older.

For the purposes of determining the amount you can contribute, “compensation” is defined as your gross income minus business expenses, minus one-half of your self-employment taxes—that is, Social Security and Medicare taxes, which in 2012 total 13.3% of the first $110,000 of income. (Social Security taxes are capped at that level this year.)

So, for example, if you are over 50 and have net self-employment income of $50,000, you could contribute a maximum of $22,500 as an employee, plus the maximum employer contribution of $9,294, for a total of $31,794.

You can generally deduct your contributions from your net business income, which is the amount you report on Schedule C. If your business is incorporated, you can deduct the salary deferral from W-2 earnings and the employer contribution as a business expense.

The limits on elective deferrals are calculated by person, not by plan. So, if you have contributed $10,000 to another employer’s 401(k), you can defer only $7,000 in your individual 401(k).

One of the best things about the Solo 401k, is that there are not any set up fees or annual IRA filings to deal with.  I have had one for seven years and have set them up for several self employed clients that have loved the plan.

If you have questions about this, contact me.  Forward this to any self employed person you know.

2 thoughts on “Entrepreneur’s Max Out Retirement Contribution (up to $55k/year) READ TIME: 3 Minutes”

  1. Mel says:

    “If your business is incorporated, you can deduct the salary deferral from W-2 earnings and the employer contribution as a business expense.”

    Do you know if you are allowed to deduct the employer contribution as a business expense for a single person LLC, taxes as a pass through entity?

    1. Brad Rosley says:

      I’m not a CPAa, but I would guess the answer would be “yes”.

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