Solo Effort

SHORTLY AFTER I retired in March 2017, I was asked to consult on some projects. I knew it was going to be a more complex tax year than I���d faced before. I had earned income from my previous employer, pension income and self-employment income from my consulting.

On top of all that, my wife started a new fulltime job the Monday after I retired. We switched to her benefits, but her company didn���t have a high-deductible health plan with an HSA, or health savings account. That meant that, three months into the year, we lost two valuable tax-deductible savings options: my 401(k) and HSA.

Losing those options concerned me. Was there any way to cut our tax bill? I knew there were retirement plans for small businesses, but I wasn���t very familiar with them. I didn���t think we���d meet the income limits to fund an IRA. A SEP IRA���a variation on an IRA intended for small business owners���seemed like a good idea, but I knew little about the accounts. I then discovered a plan that seemed tailor-made for us: a solo 401(k).

A solo 401(k) is like a traditional 401(k) plan, but covers a sole business owner with no employees. One exception: The business owner���s spouse can also participate. The contribution limits for a solo 401(k) are the same as any other 401(k). But with a solo 401(k), the business owner wears two hats: He or she can contribute both as the employee and the employer. Contribution limits for 2019 are:

Employee elective deferrals of up to 100% of earned income, though these contributions are capped at $19,000, or $25,000 if age 50 or older.
Employer contributions of up to 25% of compensation.
Total contributions to a participant���s account cannot exceed $56,000, or $62,000 if age 50 or older.

The definitions of earned income and compensation are important and a little tricky. For employee contributions, you can deduct 100% of ���net earnings from self-employment less one-half of your self-employment tax.���

When figuring your contributions as an employer, compensation is your earned income, which is defined as net earnings from self-employment, but with two deductions: one-half of your self-employment tax, plus any solo 401(k) contributions you make as an employee.

You can direct your employee contributions to either a tax-deductible or Roth account. Meanwhile, your contributions as an employer go into a tax-deductible account. If you���re also employed by a second company and participate in its 401(k) plan, contributions to that other plan limit your ability to fund a solo 401(k).

A 401(k) plan is typically required to file an annual report on Form 5500-SF. A solo 401(k) plan, however, is exempt from the annual filing requirement if it has $250,000 or less in assets at the end of the year.

There���s plenty of information online about solo 401(k)s, including from the IRS, financial firms and other sites. I investigated some of the larger firms before choosing Vanguard Group. It was surprisingly easy and inexpensive to set up the plan. It was linked to my other accounts, so I could see my entire holdings with one logon. And because we were established customers, Vanguard waived the annual account fee. With my solo 401(k), I can invest in all of Vanguard���s mutual funds.

The account must be opened by Dec. 31 if you want to contribute for the current tax year, but you have until the April 15 tax-filing deadline to make contributions. This turned out to be helpful. In my first year, most of my consulting income came in the fourth quarter. I used the 401(k) contribution to tailor our tax bill. Using TurboTax, I computed a number of tax returns with different contribution amounts until I achieved a final tax owed that we were comfortable with. I was happy to have this ���dial��� to turn, as I fine-tuned our tax bill.

The following year���2018���my income varied even more. I had less self-employment income from my business, but picked up some more as a part-time employee for a small business. Again, a significant portion of my income came in the fourth quarter. This variability made tax planning a bit more complicated. In 2018, we were able to defer virtually all of the self-employment income to limit the tax owed. Note that income from working full- or part-time for another business doesn���t count when computing the maximum allowable solo 401(k) contribution. Instead, you need to be working as a contractor, with income reported to you on Form 1099.

Richard Connor is�� a semi-retired aerospace engineer with a keen interest in finance. Rick enjoys a wide variety of other interests, including chasing grandkids, space, sports, travel, winemaking and reading. His previous articles include What Number,��Taking Your Lumps��and��Quiet Heroism. Follow Rick on Twitter��@RConnor609.

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