By Ian Berger, JD
Are you considering opening up a new solo 401(k) and looking to maximize your 2021 contribution? If so, you may need to act quickly. There is a December 31, 2021 deadline for establishing a new plan if you want to make 2021 elective deferrals.
In a solo 401(k), the business owner is considered to wear two hats — an employee and an employer. This allows the owner to make elective deferrals as an employee and employer contributions as an employer. That can result in higher contributions than allowed with a SEP or SIMPLE IRA.
You can make elective deferrals up to $19,500 for 2021, or $26,000 if age 50 or older. (Those limits will increase to $20,500/$27.000 for 2022.) You can also make employer contributions up to 20% of adjusted net earnings, or 25% of compensation if your business is incorporated. There’s also an overall limit on combined elective deferrals and employer contributions. For 2021, that limit is $58,000, or $64,500 if you are 50 or older and defer the additional $6,500. (For 2022, those limits go up to $61,000/$67,500.)
There is confusion over the deadline for opening up a new solo plan. That’s because of a provision in the SECURE Act giving businesses extra time to set up new retirement plans. Before the SECURE Act, businesses had to establish a new plan by the last day of their tax year. Now, they have until the due date for the corporate tax return, including extensions. Depending on the type of business, that will be as late as the following September 15 or October 15.
However, this extended deadline is available only for employer contributions – not for elective deferrals. If you’re a sole proprietor or partner and want to make elective deferrals for a tax year (e.g., calendar year 2021), the IRS says you must make a deferral election by the last day of that year (e.g., 12/31). But you can’t make a deferral election unless a plan has been put into place. This means that if you want to make deferrals for 2021, you must adopt a new solo plan and make a deferral election by 12/31/21.
If you miss the 12/31/21 deadline, you can still adopt a new 2021 plan in 2022 – by the 2021 corporate tax return deadline with extensions. However, that would limit your 2021 contributions to employer contributions only. Since you wouldn’t be able to make 2021 salary deferrals, the maximum 2021 contribution for a new solo plan adopted in 2022 (even for those age 50 or older) would be $58,000.
The timing rules for solo 401(k) elective deferrals are even stricter if your business is incorporated. In that case, you must make a deferral election before the compensation you are deferring would have been paid to you. So, it is getting very late in the year for an incorporated business owner looking to open a new solo plan for 2021 to make significant 2021 deferrals.