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SBO 401(k): Definition, How It Works, and Contribution Strategies

Last updated 03/23/2024 by

Alessandra Nicole

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Fact checked by

SBO 401(k), also referred to as an independent 401(k), serves as a tax-deferred retirement savings option tailored for small business owners (SBOs) and their spouses. This article delves into the features, contribution limits, considerations, and nuances associated with this government-registered plan, providing comprehensive insights for individuals in the finance industry.

Understanding an SBO 401(k)

An SBO 401(k) represents a retirement savings avenue primarily targeted at self-employed small business owners. This tax-deferred plan operates similarly to standard 401(k) arrangements, affording participants the choice between self-directed or professionally managed investments. Contributions to an SBO 401(k) are deductible, with an annual limit set at $22,500 for 2023 (rising to $23,000 in 2024). Individuals aged 50 and above have the option to make catch-up contributions of up to $7,500 annually.

Features of SBO 401(k)

The SBO 401(k) shares resemblances with SEP IRAs but boasts potential cost advantages in terms of setup and maintenance. Additionally, the plan often allows for loans against the accrued funds. However, it’s crucial to note that eligibility is restricted to businesses devoid of external employees.

SBO 401(k) versions

Two variations of the SBO 401(k) exist: traditional and Roth versions. In the traditional variant, contributions are made on a tax-deferred basis, subject to taxation upon withdrawal. Conversely, the Roth version entails after-tax contributions, enabling tax-free growth without taxation upon withdrawal. Utilizing financial calculators can aid in determining the optimal option, with participants having the flexibility to divide contributions between both plans.

Contribution routes

Participants can channel contributions to their SBO 401(k) via two routes: as an employee and as an employer. In the former, individuals can defer up to $22,500 of their salary in 2023 ($30,000 for those aged 50 and above), with these limits increasing to $23,000 and $30,500 respectively in 2024. Employers, on the other hand, can contribute up to 25% of their compensation to the plan. The combined maximum yearly contribution stands at $66,000 for 2023 and $69,000 for 2024, with an additional catch-up contribution available for individuals aged 50 and over.

Opening and setting up a SBO 401(k)

Initiating a SBO 401(k) can be facilitated through an online platform provided by a broker. This process entails furnishing the employer identification number (EID), completing account details, executing a plan adoption agreement, and selecting suitable investment avenues.

Multiple 401(k) plans

While maintaining multiple 401(k) plans is permissible, participants must adhere to IRS-defined contribution limits. For instance, individuals may opt for a 401(k) plan with their employer while concurrently holding a one-participant 401(k) plan for their business. However, total contributions across all plans must not surpass the prescribed IRS limits.
Here is a list of the benefits and drawbacks to consider.
  • Opportunity for tax-deferred retirement savings
  • Potential cost advantages compared to SEP IRAs
  • Flexibility in contribution routes and investment choices
  • Eligibility limited to businesses without external employees
  • Potential taxation upon withdrawal for traditional SBO 401(k) contributions
  • Complexity in plan administration and compliance

Frequently asked questions

What are the tax implications of an SBO 401(k)?

Contributions to a traditional SBO 401(k) are tax-deductible, thereby reducing the individual’s taxable income for the year. However, taxes are applicable upon withdrawal during retirement. Conversely, contributions to a Roth SBO 401(k) are made with after-tax dollars, resulting in tax-free withdrawals during retirement.

Are loans permitted against SBO 401(k) funds?

Yes, many SBO 401(k) plans allow participants to borrow against the funds accumulated in the account. These loans typically need to be repaid within a specified period, failing which they may be treated as distributions, subject to taxes and penalties.

What happens if my business hires additional employees?

If a business covered by an SBO 401(k) plan hires external employees who meet the eligibility criteria, such as age and service requirements, the plan may need to be modified or terminated. Consulting with a qualified financial advisor or tax professional is advisable in such scenarios to ensure compliance with regulatory requirements.

Key takeaways

  • SBO 401(k) is tailored for small business owners and their spouses, offering tax-deferred retirement savings.
  • Contribution limits for 2023 are $22,500, increasing to $23,000 in 2024, with additional catch-up contributions for those aged 50 and over.
  • Participants can choose between traditional and Roth versions, with varying tax implications.
  • Opening and setting up a SBO 401(k) can be easily done online with the required employer identification number (EID).
  • While having multiple 401(k) plans is permissible, total contributions must comply with IRS-defined limits.

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