The 401(k) plan has gained in popularity among small business owners ever since 2001 when some changes to federal tax law made it a better and more flexible choice for their needs compared to some other retirement savings options.
In fact, it now has its own acronym: the SBO 401(k) plan. It's a retirement savings option for small businesses whose only eligible participants in the plan are the business owners (and their spouses, if they are employed by the business too). It can be a smart way for someone who is a sole proprietor or an independent consultant to set aside a decent-sized nest egg for retirement.
- An SBO 401(k) plan—also called a solo 401(k) or self-employed 401(k)—is for businesses whose only eligible participants in the plan are its owners (and spouses).
- These plans are often less complicated and cost less to set up.
- If you have non-owner employees, they must not meet the eligibility requirements you select for the plan.
- There are two components to an SBO 401(k) plan: employee elective-deferral contributions and profit-sharing contributions.
- A solo 401(k)s may also offer loans, doesn't require discrimination testing, and allows for the deduction of plan contributions of up to 25% of eligible compensation.
A 401(k) by Any Other Name
Not content with the federal acronym, various financial institutions have their own names for the SBO 401(k) plan. The independent 401(k) is one of the most generic. Other examples include:
- The Individual(k)
- Solo 401(k) or Solo-k
- Uni-k Plan
- One-participant k
- Self-employed 401(k)
If you are not sure which name your financial service provider uses, ask about the 401(k) plan for the small business owner. The IRS provides a handy primer on such plans.
Is Your Business Eligible?
A common misconception about the SBO 401(k) is that it can be used only by sole proprietors. In fact, the SBO 401(k) plan may be used by any small businesses, including corporations, limited liability companies (LLCs), and partnerships.
The only limitation is that the only eligible plan participants are the business owners and their spouses, provided they are employed by the business.
A person who works for one company (in which they have no ownership) and participates in its 401(k) can also establish an SBO 401(k) for a small business he or she runs on the side, funding it with earnings from that venture.
However, the aggregate annual contributions to both plans cannot collectively exceed the IRS-established maximums.
Simpler Documentation Requirements
For small business owners who meet certain requirements, most financial institutions that offer retirement plan products have developed truncated versions of the regular 401(k) plan for use by business owners who want to adopt the SBO 401(k).
As a result, less complex documentation is needed to establish the plan. A 20-page document for a regular 401(k) plan may be reduced to a three-page document for the SBO 401(k). Fees may also be relatively low.
Make sure to receive the proper documentation from your financial services provider.
Choose Your Eligibility Requirements
As noted above, the SBO 401(k) plan may be adopted only by businesses in which the only employees eligible to participate in the plan are the business owners. For eligibility purposes, a spouse is considered an owner of the business, so if a spouse is employed by the business, you are still eligible to adopt the SBO 401(k).
If your business has non-owner employees who are eligible to participate in the plan, your business may not adopt the SBO 401(k) plan. Therefore, if you have non-owner employees, they must not meet the eligibility requirements you select for the plan, which must remain within the following limitations.
You may exclude nonresident aliens who receive no U.S. income and those who receive benefits under a collective-bargaining agreement.
Years of service
- For 401(k) Employee Elective-Deferral Contributions: You may require an employee to perform one year of service before becoming eligible to make elective deferral contributions.
- For Profit-Sharing Contributions: You may require an employee to perform up to two years of service in order to be eligible to receive profit-sharing contributions. However, most SBO 401(k) plans will limit this requirement to one year.
- For Plan Purposes: An employee is considered to have performed one year of service if he or she works at least 1,000 hours during the year. While you may generally choose to require fewer than 1,000 hours under a regular qualified plan, most SBO 401(k) plans include a hard-coded limit of 1,000 hours.
The Wrong Requirements
Setting the wrong eligibility requirements could result in you being excluded from the plan or non-owner employees being eligible to participate in the plan.
Or, say you elect zero years of service as a requirement to participate in the plan, but you have five seasonal employees who work fewer than 1,000 hours each year. These employees would be eligible to participate in the plan because they meet the age and service requirements.
Consequently, their eligibility would disqualify your business from being suitable to adopt the SBO 401(k) plan. Instead, you could adopt a regular 401(k) plan.
Some SBO 401(k) products, by definition, require further exclusions. Before you decide to establish an SBO 401(k) plan, be sure to check with your financial services provider regarding its provisions.
SBO 401(k) Plan Components
There are two components to the SBO 401(k) plan: employee elective-deferral contributions and profit-sharing contributions.
- Employee Contribution Limits: You may make a salary-deferral contribution of up to 100% of your compensation but no more than the annual limit for the year. For 2019, the maximum is $19,000, plus $6,000 if the person is age 50 or over. For 2020, the limit is $19,500, plus $6,500 for people age 50 or over.
- Employer Contribution Limits: The business may contribute up to 25% of your compensation (20% in the case of a sole proprietor or a Schedule C taxpayer) but no more than $56,000 for 2019 and $57,000 for 2020. An employee age 50 or above can still contribute an additional $6,000 in 2019 and $6,500 in 2020.
SBO Contributions vs. Other Plans
In comparison to other popular retirement plans, the SBO 401(k) plan has high contribution limits as outlined above, which is the key component that attracts owners of small businesses.
Some other retirement plans also limit the contributions by employers or set lower limits on salary-deferred contributions.
The following is a summary of contribution comparisons for the employer plans generally used by small businesses.
|Account||Elective Deferral||Maximum Employer Contribution||Catch-Up Contribution|
|SBO 401(k)||$19,000 for 2019;
$19,500 for 2020
|25% of compensation or 20% in the case of a sole proprietor or a Schedule C taxpayer||$6,000 for 2019;
$6,500 for 2020
|SEP IRA||Not Allowed||25% of compensation or 20% of modified net profit for unincorporated business owners||Not Allowed|
|Profit-Sharing or Money-Purchase Pension Plan||Not Allowed||25% of compensation or 20% of modified net profit for unincorporated business owners||Not Allowed|
|SIMPLE IRA||$13,000 for 2019, $13,500 for 2020||3% of compensation/income||$3,000|
As mentioned earlier, you may make employee elective-deferral contributions of up to 100% of your compensation but no more than the elective-deferral limit for the year.
Profit-sharing contributions are limited to 25% of your compensation (or 20% of your modified net profit if your business is a sole proprietorship or partnership).
The total SBO 401(k) contribution is the employee selective-deferral contribution plus the profit-sharing contribution of up to $56,000 for 2019 and $57,000 for 2020.
If your business is a corporation, the profit-sharing contribution is based on W-2 wages you receive. If you receive $70,000 in W-2 wages, for instance, your profit-sharing contribution could be up to $17,500 ($70,000 x 25%). When added to a salary-deferral contribution of $19,000, the total would be $36,500.
If your business is a sole proprietorship or partnership, the calculation gets a little more involved. In this case, your profit-sharing contribution is based on your modified net profit and is limited to 20%.
The IRS provides a step-by-step formula for determining your modified net profit in IRS Publication 560.
In response to the COVID-19 pandemic, the IRS extended numerous 2020 deadlines for filing and paying taxes. Check with your tax accountant to take advantage of any applicable extensions.
Other Benefits of the SBO 401(k)
There are a number of other benefits that come with the SBO 401(k).
As with other qualified plans, you may be able to borrow from the SBO 401(k) up to either 50% of the balance or $50,000, whichever is less. Check the plan document to determine if any other limitations apply.
5500 filing may not be required
Because the plan covers only the business owner, you may not be required to file Form 5500 series return unless your balance exceeds $250,000.
No discrimination testing
Generally, certain nondiscrimination testing must be performed for 401(k) plans. These tests ensure that the business owners and higher-paid employees do not receive an inequitably high amount of contribution when compared to lower-paid employees. These tests can be very complex and may require the services of an experienced plan administrator, which can be costly.
Because the SBO 401(k) plan covers only the business owner, there is no one against whom you can discriminate, so these tests are not required.
Similar to other employer plans, the SBO 401(k) allows you to deduct plan contributions of up to 25% of eligible compensation. For plan purposes, compensation is limited to $280,000 for 2019 ($285,000 in 2020). Earnings of more than that amount are disregarded for plan purposes.
If you own more than one business, you must check with your tax professional to determine whether you are eligible to adopt the SBO 401(k). Ownership in another business that covers employees other than the business owner could result in your being ineligible for this type of plan.
Internal Revenue Service. "One-Participant 401(k) Plans." Accessed May 19, 2020.
Internal Revenue Service. "Retirement Plans for Self-Employed People." Accessed May 20, 2020.
Internal Revenue Service. "Taxpayer Relief for Certain Tax-Related Deadlines Due To Coronavirus Pandemic." Accessed May 19, 2020.
Merrill. "Can I Borrow from my Solo 401k Account?" Accessed May 20, 2020.
Internal Revenue Service. "One-Participant 401(k) Plans." Accessed May 19, 2020.
Internal Revenue Service. "Retirement Topics -- 401(k) and Profit-Sharing Plan Contribution Limits." Accessed May 20, 2020.