Being self employed means that the taxes will be more complicated, but if you do the proper research then you could make it work for you. There are many different types of self employment; one usually would be an independent contractor or an owner of a small business. For the small business owner, they must be responsible for all of the tax information for the whole company. Even so, their taxes and their 401k are rather straight forward. The independent contractor will have a bit more trouble usually because their taxes are not automatically deducted and neither is their solo 401k.
They are responsible for proactively paying the IRS their taxes. For either of these cases, their solo 401k plan can serve as a retirement fund for themselves, or they can even apply for a loan to use a portion of it for other purposes. The law for solo 401k plans changed in 2002. The plans were becoming more popular because of the benefits they give, so the agency made accommodations so that the owners of the plans could put away more resources in a fiscal year. Before the law was changed, the employees deferral was subtracted from the employer’s contribution, but since the law has changed, that is no longer the case.
Under the prior law, the total amount of contributions both the employer and the employee could not exceed 25% of the employees yearly income. After the change to the law was made, only the contribution from the employer is limited to 25% and the employee can supplement in addition to that. Now the contribution limit is $49,000. The yearly contributions to the solo 401k have two parts to them that are important to understand; the salary deferral contribution and the profit sharing contribution. These two were mentioned briefly above, but we will go into detail with each. The salary deferral contribution is based on whether the employee is within a corporation or a sole proprietorship.
Within a corporation, the salary deferral contribution is limited by the W-2 in the amount of $16,500. For a business that is taxed as a sole proprietorship, it is based on what is called net adjusted business profits. This is figured by subtracting half of the business expenses and half of the self employment tax. With the profit sharing contribution though, corporations can contribute up to 25% as we explained above, but the sole proprietor contribution can be 20% of the net adjusted business profits. The addition between these two items will give us the maximum amount that a solo 401k can cave up within one year.
Another advantage of these plans is that other retirement plans can be added to the solo 401k. Many corporations have been devising their own retirement plans because of the amount of criticism that the ordinary 401k was receiving. Because of the age differences, we are just now seeing the effect of the first types of 401ks are having because those people are now retiring. Some of them are realizing that the amount saved up will not be enough to support a retirement. The response of this criticism has been that many of these retirees have not had the recommended time at their employment for the 401k to amount to the necessary savings for retirement.
It was intended to start savings when the employee is 21 years old. If we run our own calculation with their calculator, we will have some interesting results. If I started saving at the age of 40 and I earned $80,000 a year, and I contributed half of that annually I would have $3 million by the time I am 65. But if I begin saving when I was 21, and I contributed just ten percent every year, I would have over ten million for my retirement.