Is an owner-only 401(k) right for you?

How to determine if this unique retirement vehicle makes sense.

The owner-only 401(k) is a retirement vehicle that gained a lot of momentum in 2001 when the IRS made it much more flexible for business owners. It’s a vehicle that has a lot of great advantages – but you must meet certain requirements to deploy it. Here’s a look in more detail.

How much can I contribute?

An owner-only 401(k) allows you to make a contribution both from your salary and from your business. This allows you to maximize your retirement savings, reduce your tax burden and catch up on contributions if you are over 50. For your salary, you can contribute up to 100% of your compensation, provided it doesn’t exceed $20,500 for the year, and you can contribute an additional $6,500 for a total of $27,000.

You, as the business, can contribute up to 25% of your net compensation, or no more than $61,000, plus a $6,500 if over age 50 catchup contribution for a total of $67,500.

Choose your tax advantage

Pick a traditional 401(k) to reduce your income tax in the year your contributions are made, or go with a Roth option in the 401(k) if available, which doesn’t get you an initial tax break but does allow you to withdraw the funds tax-free in retirement. If you think your income will be higher in retirement, the Roth can be a good move. If you think it will be lower, then take the tax break now.

Not just for sole proprietors

Owner-only 401(k)s are for business owners – and not just sole proprietors. You are eligible if you have an S corporation, C corporation, LLC or partnership. The caveat here is that only the actual business owner or their spouse (if they too are employed by the business) are eligible

Other advantages

The owner-only 401(k) offers some administrative advantages over a regular qualified retirement plan. First, unless your balance exceeds $250,000, you do not have to file a 5500 form every year with the IRS. Second, you do not need to perform nondiscrimination testing, which is a compliance regulation from the IRS that usually requires a plan administrator. And, finally, you may be able to take a loan from your owner-only 401(k) of 50% of the account balance (greater than $10,000) or $50,000 – whichever is less. 

Setting it up

Talk to your advisor about setting up an owner-only 401(k). You’ll need an employee identification number, and you’ll sign a plan adoption agreement. Once it’s set up, you can start contributing into vehicles like ETFs, index funds, mutual funds and more – whichever make sense for your long-term financial and retirement goals.

Next steps

• Consider if you meet the requirements for an owner-only 401(k)
• Determine if this might be a good fit to reduce your tax burden for 2022

• Talk to your advisor about how to set it up

Sources: nerdwallet.com; investopedia.com; irs.gov; forbes.com

401(k) plans are long-term retirement savings vehicles. Withdrawal of pretax contributions and/or earnings will be subject to ordinary income tax and, if taken prior to age 59 1/2, may be subject to a 10% federal tax penalty.