Insights

Secure 2.0: Retroactive First Year Deferrals for Sole Proprietors

01.19.24

The SECURE 2.0 legislation added a unique benefit for sole proprietors to take advantage of for the 2023 tax year. Specifically, a new 401(k) plan can be adopted in 2024 and contributions can be counted as 401(k) deferrals for the 2023 year.

Why is this so great?

Prior to the SECURE Act in 2019, the only option for establishing a retirement arrangement after year-end was a SEP-IRA. This type of plan allows company contributions only (e.g., no employee contributions), and the limit is 25% of compensation. A SEP-IRA can be established for the prior tax year no later than the tax filing due date for such year.

Effective for 2020, the SECURE Act created the ability to establish a 401(k) or defined benefit plan retroactively, just like a SEP-IRA. This greatly increased the options available, whether establishing an initial arrangement or adding a plan onto an existing one.

However, a problem with retroactive plans is that, even if they normally allow for employee contributions (like a 401(k) plan), the timing doesn’t allow for such contributions in the first year. The law requires that employee contributions be made from a payroll occurring during the plan year. Therefore, if you set up a plan after the end of the year, you just can’t make it work! This is why, prior to 2024, retroactive plans were limited to company contributions in the first year.

Advantages for sole proprietors in 2024:

Sole proprietors are anyone who receives business income reportable on a Schedule C attached to their individual tax return and is not organized as a different type of entity (like a corporation). Some examples of sole proprietors are:

  • Independent contractors (i.e., contract physicians and ride-booking drivers)
  • Performing artists
  • Freelance writers
  • Photographers
  • Graphic designers
  • Gig workers

As mentioned, SECURE 2.0 provides that sole proprietors may adopt a 401(k) plan in 2024 retroactive for the 2023 year and make 401(k) deferrals for 2023. It also extends this ability to Limited Liability Companies (“LLCs”) that are taxed as sole proprietorships.

Requirements to take advantage of retroactive 401(k) deferrals:

  • The company must be a sole proprietorship, or an LLC taxed as a sole proprietorship.
  • The company cannot have any employees other than the owner.
  • The 401(k) plan must be adopted by the tax filing deadline for 2023, including any extensions.

Company contributions (SEP-IRA and Profit Sharing) are limited to 25% of compensation. “Compensation” for a sole proprietor means “Earned Income”, which is the Schedule C income, less the deductible portion of the self-employment tax and company retirement plan contributions. Employee 401(k) deferrals are not included in this 25% limit.

Let’s look at the maximum 401(k) plan contributions for a 50-year-old sole proprietor adopting a retroactive plan in 2022 vs. 2023.

Adoption YearPlan YearSchedule C Income, less SE Tax401(k) DeferralsCompany ContributionsTotal Contribution
20232022$100,000$0$20,000*$20,000
20242023$100,000$30,000$20,000*$50,000

*The maximum contribution is ( $100,000 – $20,000 ) x 25% = $20,000.

The ability to make retroactive 401(k) deferrals more than doubles the total tax-deductible contribution for the year!

How can you take advantage of these changes?

Before making SEP-IRA contributions for 2023, be aware of the advantages of adopting a retroactive 401(k) plan. Investment companies frequently call a one-person 401(k) a “Solo 401(k)”. This is the same thing! Don’t miss out on additional tax deductions for 2023.

Please contact Jason Hamilton, Director of Retirement, if you have questions or would like to learn more at jason.Hamilton@mai.capital.


MAI Retirement is a division of MAI Capital Management, LLC (“MAI”). 

MAI is an investment adviser registered with the Securities and Exchange Commission.

MAI does not provide legal or tax advice to retirement plans.  Please consult your legal or tax advisor before making any legal or tax decisions. 

We look forward to learning about your financial goals.

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