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The ‘Solo K’ Retirement Plan

By Michael J. Knight

MAY 2005 - A “Solo K” retirement plan is a flexible and easy way to maximize retirement savings for small, single-owner businesses. This plan adds profit sharing to existing 401(k) plans. Business owners can not only maximize their 401(k) contribution ($13,000 for 2004 if under age 50; $16,000 if over age 50), but can also pay themselves a tax-deductible profit-sharing portion based on net earnings. Solo K plans allow a contribution of up to 20% of modified net profit (net profit minus one-half of the self-employment tax). Under certain circumstances, owners can contribute almost dollar for dollar on their earnings. For example, with a net income of $20,000, a self-employed individual over the age of 50 could have contributed $19,717 for 2004:

Maximum 401(k) deferral:    $16,000

Modified net profit:

Net income                           20,000
Qs SE tax                             (1,413)
Profit sharing:                        $18,587 x 20% 3,717
Total contribution amount      $19,717

The entire contribution of $19,717 can be made when filing the individual tax return. S and C corporations, however, must contribute the 401(k) portion throughout the year, as the salary is paid to the owner (within 15 days).

Additional benefits of Solo K plans include the following:

  • Access to tax-free loans. Loans are not permitted with traditional or Roth IRAs and SEP IRAs.n Minimal administration costs. The Solo K plan is inexpensive to maintain. Annual administration fees range from $30 to $200.
  • Flexible contribution amounts. Each year, funding is up to the owner, who can increase or decrease funding accordingly.
  • Consolidation of existing plans. IRAs, SEP plans, and others can be consolidated into a Solo K plan.

Eligibility

Solo K plans are not for everyone. They are best suited for the following situations:

  • A full-time employee not covered by an employer’s 401(k) plan who earns more than $50,000 of self- employment income.
  • A part-time self-employed individual earning more than $50,000 (common examples include self-employed real estate agents or artists).
  • A family business that employs the owners and their immediate family, such as spouses and children.
  • Sole proprietorships, partnerships, and corporations (including subchapter S and C corporations) that are owner-only businesses or that have only part-time employees (working less than 1,000 hours per year).

How to Apply a Solo K

Implementing Solo K plans can be challenging. Pension actuaries and banks generally do not know much about Solo K plans. Some brokerage firms are aware of the plans, but usually it is not easy to find someone to help.

There are a few rules to follow:

  • The plan must be opened during the calendar year the income is earned. Unlike a traditional IRA, one cannot wait until the April 15 after the year-end to open a Solo K plan.
  • The 401(k) portion of the contribution must be made as an individual’s salary is paid out. For example, if one makes $1,000 per month in earnings, that amount should be placed in the Solo K account.
  • The profit-sharing portion can be contributed during the normal filing of personal income tax returns, including extensions. Sole proprietors, however, may fund both the 401(k) portion and the profit-sharing portion during the filing of their personal return, including extensions.
Michael J. Knight, CPA, practices in Fairfield, Conn. He would like to thank Ryan C. Sheppard, CPA, for his assistance in preparing this article.

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