There are so many physical therapists and occupational therapists finding ways to increase their income by being solopreneurs.
Some of us generate our primary income by being self-employed and running our own business, while others are employees who create additional income streams by working a self-employed physical therapy side hustle or occupational therapy side hustle.
If you fall into either of these categories, you should consider opening an independent 401(k) to save and invest for retirement.
This article will give you the ins-and-outs on
- What an independent 401(k) is
- Who qualifies to have an independent 401(k)
- How much you can contribute to an independent 401(k)
- When you can open and contribute to an independent 401(k)
- Where you can open an independent 401(k)
- And so much more. . .
Let’s get started.
What Is An Independent 401(k)?
Like the more familiar employee 401(k) you may have had access to if you have ever worked as an employee, the individual 401(k) is a 401(k) retirement savings account for the self-employed.
While it is most commonly called an individual 401(k), sometimes written as an i401(k), it can also be referred to as a solo 401(k), Solo-K, Uni-K, or One-Participant k.
For simplicity, I’ll continue to call it an individual 401(k) here.
What Criteria Do And Do Not Make You Eligible For An Individual 401(k)?
1. Employment Status
As I mentioned above, the individual 401(k) is for the self-employed. So being self-employed is the first qualification you must meet in order to be eligible to open an individual 401(k).
Your self-employed job does not need to be your main source of income, though.
Let’s say you work as a staff physical therapist employee at one job but you also work as an independent contractor physical therapist. Then you can open an independent 401(k) account using the income you generate from your independent contractor work, which is self-employment.
2. Having Employees
To be eligible for an independent 401(k) account, you may not have any full-time employees defined as working more than 1,000 hours per year or any long-term employees defined as working 500 hours per year in 3 consecutive years.
The exception to this rule, though, is for a spouse. Your spouse can be a full-time employee for your business if he or she earns income from your business.
3. Entity Status
You do not need to form an entity such as an LLC or corporation to be eligible for an independent 401(k).
But the type of entity you are does affect the amount you can contribute to an individual 401(k) plan – more on this later.
Your age will not restrict you from being eligible for an independent 401(k).
Your income will not restrict you from being eligible for an independent 401(k), as long as you are generating income from self-employment.
How Much Can I Contribute To An Individual 401(k)?
For year 2022, the IRS allows you to contribute up to $61,000 to an individual 401(k) plan.
But you can’t just deposit $61,000 into an individual 401(k) account.
Since you are self-employed, think of yourself as both the employer and the employee.
That’s why you must make two different types of contributions to an individual 401(k):
- An Employee Contribution
- An Employer Contribution
Let’s dig into these a bit more.
1. The Employee Contribution
The employee contribution is also called the Elective Deferral.
This is the amount of money you deposit into your independent 401(k) as the employEE of your business.
In year 2022, the IRS allows you to contribute the lesser of up to $20,500 or 100% of your compensation to your individual 401(k).
If you are more than 50 years old, you can contribute more, but we’ll discuss that a little bit later.
Pro Tip: Since your employee contribution amount is not limited by how much income you make, you do not need to wait until the end of the year to figure out how much income you made and then only contribute a certain percentage of that income. Instead, if you like, you can make your employee contribution as a lump sum at the beginning of the year.
2. The Employer Contribution
The employer contribution is also called the Profit-Sharing Contribution.
This is the amount of money you deposit into your independent 401(k) as the employER of your business.
The IRS has different maximum values for the employer contribution depending on the entity of your business.
If your business operates as a sole proprietor or partnership, then the most you can contribute is 20% of your net income.
If your business is a corporation, though, then the most you can contribute is 25% of the employee W-2 gross income.
In both of the above cases, for year 2022, your overall total individual 401(k) contribution amount cannot exceed $61,000. So if you decide to contribute the maximum employee contribution for year 2022 of $20,500 then the most you can contribute to that same individual 401(k) plan through an employer contribution is $40,500.
As the IRS demonstrates, calculating this can get a little hairy, so I recommend you get assistance from your tax professional.
Pro Tip: Unlike your employee contribution, your employer contribution amount is based on how much income you made that year. Therefore, you’ll probably want to wait until the beginning of the next year to make your employer contribution.
Here’s a table to summarize:
Can I Contribute More To My Individual 401(k) If I Am Over 50 Years Old?
Yes, you can, by making what are called “catch-up contributions.”
These catch-up contributions can only be made if you are over 50 years in age and they are considered part of the employee contribution.
In 2022, the maximum amount that these catch-up contributions can be is $6,500, as noted in the table above.
How Much Can I Contribute To My Individual 401(k) If I Also Have A 401(k) From My Employer?
Some of us work as an employee at one job but also generate income from a second, self-employed physical therapy side hustle (link my PT list of side hustles article) or occupational therapy side hustle (link my OT list of side hustles).
If you have a 401(k) through your employee job and then also open an individual 401(k) for your independent contractor job, you can find yourself having and contributing to more than one 401(k).
Here’s what you should know.
Employee Contributions To Multiple 401(k) Plans
Making an employee contribution to multiple 401(k) plans is okay, but when those contributions are added up they cannot surpass the yearly employee contribution maximum of $20,500 for year 2022.
For example, let’s say you are an occupational therapist under the age of 50 and you have a traditional 401(k) through your employee job and an individual 401(k) through your side hustle. You decide to contribute $10,500 to your employee 401(k) and $10,000 to your individual 401(k). This is fine because the total of these two contributions does not surpass this year’s employee contribution annual maximum of $20,500.
Another note regarding the employee contribution to multiple 401(k) plans is that if you are over 50 years in age you are still limited to no more than $6,000 total catch-up contributions across all of your 401(k) plans.
Employer Contributions To Multiple 401(k) Plans
The IRS does not limit employer contributions in the same way as it does employee contributions.
Although the employer contribution cannot be large enough to surpass the total contribution limit for a 401(k), which is $61,000 in year 2022, this is not an aggregate limit across all of your 401(k) plans.
For example, let’s say you are a physical therapist under the age of 50 and you have a 401(k) through your employee job and an individual 401(k) through your side hustle. Your employer does not offer a match so you decide to contribute all of the maximum $20,500 to your individual 401(k) plan. You can then contribute the maximum allowed $40,500 to your individual 401(k). Your employer can also still contribute up to $40,500 towards your employee 401(k) plan.
That’s a potential total retirement contribution of $101,500!
What If My Spouse Works For My Business?
As we previously covered, your spouse is the only person who can work full-time for your business while still allowing you to be eligible to have an individual 401(k).
But guess what?
Since your spouse is working for your business, as long as they are collecting their own income from your business, they can also have their own individual 401(k).
The ability to have an individual 401(k) for your spouse essentially doubles the amount of money you can save for retirement as a family.
How cool is that?!
When Can I Make Contributions To My Individual 401(k)?
You can make the employee contribution to your individual 401(k) anytime throughout the year.
However, when deciding how much your employer contribution should be, it can be a wise decision to wait until you know the income you generated that tax year. This can help you avoid potentially overcontributing, which is why the IRS allows you up until the day you pay your taxes (April 15th or, if you file an extension October 15th) to make your employer contribution.
Do I Need To Make A Contribution To My Individual 401(k) Every Year?
Where Can I Open An Individual 401(k)?
You can choose a provider to open an individual 401(k) plan for you.
Here are some examples of providers in no specific order:
- Charles Schwab
- TD Ameritrade
Some providers offer certain features for an individual 401(k) plan, while others do not, so you will want to do your research before choosing a provider.
How Do I Make Contributions To My Individual 401(k)?
It depends on the provider you choose as each provider will have their own steps for you to follow.
How Do Taxes Work With My Contributions?
A nice aspect about an individual 401(k) is you have two tax options:
1.) The Traditional 401(k) Pre-Tax Option
You can set your individual 401(k) up so that your employee contributions are made on a pre-tax basis, similar to a traditional 401(k) from an employee job.
All employer contributions must always be made on a pre-tax basis.
The term “pre-tax” means that the contributions you make will not be taxed. However, when you take qualified distributions, meaning when you eventually withdraw the money from your individual 401(k), then that amount will be taxed.
This traditional 401(k) option can be better if you expect your income to be lower in retirement.
2.) The Roth 401(k) After-Tax Option
If having your qualified distributions taxed doesn’t sound too appealing, then consider the Roth 401(k) option.
The benefit of the Roth option is that, since your contributions are taxed before they are invested, your 401(k) plan has both the opportunity to grow tax-free and you can eventually take qualified distributions tax free.
Although all employer contributions must be made on a pre-tax basis, you do have the option to make your employee contributions on a Roth after-tax basis.
It’s important to note that a “Roth individual 401(k)” is not actually a different plan from a standard individual 401(k) – it’s still the same individual 401(k) plan but with an after-tax contribution option activated.
This Roth 401(k) option can be better if you expect your income to be higher in retirement.
When Should I Open An Individual 401(k)?
There are certain deadlines you need to meet in regards to opening your 401(k) plan and making your employee and employer contributions.
Opening Your Account
If you don’t have an individual 401(k) account yet and you want to make a contribution for this year, you must establish the individual 401(k) plan by December 31st of this year.
I recommend that you don’t cut it too close, because you will need to give your chosen provider a few weeks to open the individual 401(k) for you.
Figure out which provider you should open your account with by finding out how 5 of the most well-known individual 401(k) providers stack up again each other.
Making Your Employee Contribution
If you want to make a contribution for this year, you will also need to make your employee contribution by December 31st of this year.
Making Your Employer Contribution
The IRS understands that you will want to know your net income before making your employer contribution. That’s why you have until your tax-filing deadline for the tax year (April 15 or, if you file an extension, October 15) to do so.
What Do I Need To Open A Individual 401(k)?
To open an individual 401(k) plan, you will need an Employee Identification Number.
You can obtain this from the IRS for free online.
Do I Need To File Any Paperwork On An Ongoing Basis?
If your individual 401(k) has a balance of at least $250,000 at the end of any given year, then you must fileForm 5500-EZ.
If your balance is less than $250,000 then nothing needs to be filed with the IRS.
When Can I Access The Money In An Individual 401(k)?
The IRS has rules for when you are allowed to access the money in your individual 401(k).
1. Minimum Required Distribution
You must start taking the minimum required distribution once you are 72 years old.
2. Early Distribution
Of note, if you are taking early distributions from a traditional individual 401(k), then both your contributions and earnings are taxed. This means that the amount of money you previously contributed to your individual 401(k) as well as the money you made from investing your contribution will both endure the penalty.
However, if you have a Roth individual 401(k), then you already paid taxes on your contributions. Therefore, only your earnings will face the up to 10% penalty if you took distributions too early.
You can’t take distributions of only your contributions and not your earnings, though, as the two cannot be separated from each other. So when you take distributions, both will be included.
Can I Do A Backdoor Roth IRA?
An individual 401(k) is not limited by the pro rata calculation so you can do a backdoor Roth IRA conversion.
What About A Self-Directed 401(k)?
A self-directed 401(k) is a type of 401(k) that gives you access to less common investment options such as
- Real Estate
- Developing Land
- Precious Metals
You will still need a provider for your individual 401(k) and you will still be limited to the contribution rules previously discussed.
If these investments are of interest to you, then consider a self-directed individual 401(k).
Final Thoughts. . .
Overall, the individual 401(k) can be a great option for retirement saving and investing for physical therapists and occupational therapists who create income from their own business, whether that be a side hustle or a main stream of income.
You can get access to generous contribution limits and tax options – just make sure you follow all of the rules previously covered.
Are you a solopreneur physical therapist or occupational therapist? Do you have an individual 401(k)? Or do you have a different retirement plan? Let me know in the comments section below!