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How to Fund Your Business Using 401(k) in 2022
Employee voluntary deferral contributions and profit-sharing contributions are both part of the solo 401(k) plan.
Employee voluntary deferral contributions and profit-sharing contributions are both part of the solo 401(k) plan.
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Employee Contribution Limits: You may defer up to 100% of your pay, but not more than the yearly maximum for the year. The cap for both 2021 and 2022 is $19,500 ($20,500 for 2022), additional $6,500 for persons over 50.
Employer Contribution Limits: Your employer may contribute up to 25% of your earnings (20% if you’re a sole proprietor or a Schedule C taxpayer)
Employee Contribution Limits: You may defer up to 100% of your pay, but not more than the yearly maximum for the year. The cap for both 2021 and 2022 is $19,500 ($20,500 for 2022), additional $6,500 for persons over 50.
Employer Contribution Limits: Your employer may contribute up to 25% of your earnings (20% if you’re a sole proprietor or a Schedule C taxpayer)
How does My Business Create Liquidity? - Deferring A Percentage Of Your Salary Can Free Up Much Needed Funding!
You may contribute up to 100% of your salary as an employee elective deferral, but not more than the year’s elective deferral cap. Contributions to profit-sharing are restricted to 25% of your total pay (or 20 percent of your modified net profit if your business is a sole proprietorship or partnership).
The employee voluntary deferral contribution plus the profit-sharing contribution of up to $58,000 for 2021 and $61,000 for 2022 makes up the total solo 401(k) contribution.
If your company is a corporation, the profit-sharing payment is calculated using your W-2 salary. For example, if you earn $70,000 in W-2 pay, your profit-sharing contribution might be up to $17,500 ($70,000 x 25%). When combined with a $19,000 salary-deferral contribution, the total comes to $36,500.
It gets a little more complicated if your company is a sole proprietorship or partnership. Your profit-sharing payment in this situation is based on your adjusted net profit and is limited to 20%. In IRS Publication 560, the IRS gives a step-by-step procedure for calculating your adjusted net profit.
Borrowing Against My 401(k). Give Your Business Some Breathing Space With A Loan From Your 401(k) Plan.
If your business needs some liquidity, short term cash flow, or extra money to pay those outstanding invoices, the interest rate on 401(k) loans tends to be relatively low, perhaps one or two points above the prime rate which is less than many consumers would pay for a personal loan.
Also, unlike a traditional loan, the interest doesn’t go to the bank or another commercial lender, it goes to you. Since the “interest” is returned to your account, some argue, the cost of borrowing from your 401(k) fund is essentially a payment back to yourself for the use of the money.
Key Factors To Take Into Consideration
Consider that you’ll have to return the loan using after-tax cash, and that you could lose investment profits while the money is out of your account.
If you lose your job, you’ll have to pay back the loan sooner—by the deadline for filing your next tax return.
If you fail on the loan, the amount you owe becomes a withdrawal, and you will face tax and potentially penalties.
Such a loan may seem appealing. Most 401(k) plans enable you to borrow up to 50% of the money in your account, up to $50,000, and for up to five years. The loan is tax-free since the monies are not withdrawn, simply borrowed. The loan is then progressively repaid, including both principle and interest.
You should however think carefully before you dip into your future nest egg. If you don’t play your sums right you could end up getting burnt in the long run and end up paying back more than the whole investment will yield. My advice is to borrow 25% of your plan only if it is absolutely necessary and even then when you have above 80% of your contributions paid up.
That it is not to say that you shouldn’t tap into the 401(k) pot, as this can be a genuine lifeline and even opportunity for your business in hard times. Use the funds wisely and always pay the returns on time, better still if you have an extra windfall from using the plan to make a loan against, pay the loan back early and keep on building that retirement fund.
