Secure Act 2.0 Keeps Door Open for Higher Limits in Solo 401(k)s

Interested business owners should act quickly and be advised about the value of these retirement savings accounts.

Both the Setting Every Community Up for Retirement Enhancement (Secure) Act and the Secure 2.0 Act made valuable changes to make saving for retirement easier and more attractive for taxpayers. Secure Act 2.0 also contained some provisions designed to “fix” issues created by the original Secure Act.

One of those issues was a new rule that allowed business owners to establish solo 401(k)s retroactively — but only permitted employer contributions after the end of the calendar year. This limitation made it difficult for small-business owners who were attracted to the structure, yet would not be certain about their earnings for the plan year until early in the next year.

Secure Act 2.0 fixed this “glitch” to allow retroactive employee deferrals. Interested business owners shouldn’t wait to act and should be advised about the value of these retirement savings accounts today.

Solo 401(k)s: The Basics

A solo 401(k) is a 401(k) plan that covers only the business owner and their spouse. In most ways, the solo 401(k) operates in the same manner as a traditional 401(k) — meaning that contributions are made on a pre-tax basis and subject to ordinary income taxes when withdrawn during retirement.

One key advantage of a solo 401(k) plan is that the employer-participant is not required to perform nondiscrimination testing because there are no employees to consider, whether non-highly compensated or otherwise. Filing requirements are also minimal — if the plan’s assets are at least $250,000 at year-end, the plan is required to file an annual report on Form 5500-EZ.

Solo 401(k)s also allow the owner to make larger contributions each year. For 2022, the owner-employee can contribute up to $20,500 (with a $6,500 catch-up contribution, for a total limit of $27,000 if the participant is 50 or older) in pre-tax dollars per year as an employee. The contribution limit increases to $22,500 with a $7,500 catch-up contribution limit for 2023.

However, the business owner is also permitted to contribute to the solo 401(k) plan as employer (for a total employer-employee contribution limit of $61,000 in 2022 (or $67,500 for those ages 50 and older). The limit increases to $66,000 in 2023 with a $7,500 catch-up contribution limit.

Employer contributions are also generally limited to 25% of compensation (20% if the business is not incorporated), up to the overall maximum of $61,000 (or $67,500, considering catch-up contributions) in 2022 and $66,000 (with a $7,500 catch-up) in 2023.

However, it is important to remember that sponsors of solo 401(k)s are not permitted to have any employees. Thus, business owners who happen to hire employees at some point during the business’s operation will no longer qualify for the solo 401(k) structure — meaning that they’ll be subject to the traditional nondiscrimination requirements that apply generally to 401(k) plans unless they satisfy certain safe harbor criteria.

Secure Act 2.0 Changes

The original Secure Act extended the deadline to allow qualified retirement plans to be adopted as late as the sponsoring employer’s tax filing deadline, including extensions. However, business owners could only make elective deferrals to the plan on a prospective basis (meaning that contributions for any given tax year still had to be made before year-end). Thus, business owners were limited to making only employer contributions to the plan and were not entitled to the full benefit of the employer-employee combined contribution.

The Secure 2.0 Act modified this rule to allow sole proprietors and owners of single-member LLCs to make elective deferrals up until their tax filing deadline, not including extensions, for the prior year (i.e., April 14, 2024, for plans adopted in 2023).

This new rule is effective for plan years beginning after Dec. 29, 2022.

Conclusion

The solo 401(k) can provide a valuable, streamlined retirement savings method for small-business clients without employees — and it’s important for those clients to understand the added value for first-year contributions created under the Secure 2.0 Act.

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