Contributing Capital Gains Income to a Solo 401(k) and more | Client Q&A (2024)

FAQs

Contributing Capital Gains Income to a Solo 401(k) and more | Client Q&A? ›

The answer to this one is no, you cannot contribute capital gains to a Solo 401(k). The simple fact is that it is not considered earned income. The only contributions that may be considered for any retirement plan is earned income, which is compensation for performing a service.

Capital gains tax on 401(k)

When you withdraw the money in retirement, any contributions, earnings, and long-term capital gains are taxed as ordinary income. This means that, even though you defer paying tax on capital gains, you won't benefit from the lower long-term capital gains rate.

Contributions to a solo 401(k) are usually made with pre-tax dollars, which reduces your current taxable income. However, the tax treatment is different when you establish a Roth account. For this type of solo 401(k), you would pay taxes upfront on your contributions.

The IRS allows you to funnel up to 100% of earned income into your solo 401(k) on a pre-tax or Roth basis – up to the annual contribution limits for 401(k)s and similar accounts. In 2023, the IRS permits you to save up to $22,500 in a 401(k) and $30,000 if you're age 50 or older.

Note 1: With the passage of SECURE 2.0 Act on December 29, 2022, the employer/profit sharing contribution can now also be applied as a Roth solo 401k contribution or can continue to be made as a pretax contribution.

Retirement accounts such as 401(k) plans, and individual retirement accounts offer tax-deferred investment. You don't pay income or capital gains taxes at all on the assets in the account. You'll just pay income taxes when you withdraw money from the account.

Capital gains taxes are levied on earnings made from the sale of assets like stocks or real estate. Based on the holding term and the taxpayer's income level, the tax is computed using the difference between the asset's sale price and its acquisition price, and it is subject to different rates.

When figuring the contribution, compensation is your “earned income,” which is defined as net earnings from self-employment after deducting both: one-half of your self-employment tax, and. contributions for yourself.

The actual contribution amount, calculated based on the reduced net profit, is reported on Schedule 1, Line 16 of your 1040 tax return.

Solo 401(k) contribution limits

The total solo 401(k) contribution limit is up to $69,000 in 2024. There is a catch-up contribution of an extra $7,500 for those 50 or older.

What is the downside of a Solo 401k? ›

However, there are some downsides you should consider. Like most retirement plans, you'll get hit with taxes and fees if you withdraw the funds before the age of 59½. "One disadvantage is that you must have a triggering event, usually retirement or ending employment, to take a distribution," says deMauriac.

Employer nonelective contributions: As a business owner, you may also make employer contributions to your solo 401(k) plan. Your business can contribute up to 25% of your compensation. Your compensation is considered your net earnings minus one-half of your self-employment tax and your employee elective deferrals.

The big draw of a solo 401(k) is the high contribution limit. For 2024, you can contribute up to $69,000, or $76,500 if you're 50 or older. For 2023, the limits were $66,000, or $73,500 if you're 50 or older.

Contribution limits

The lesser of 100% of compensation or $69,000 for 2024 ($66,000 for 2023; $61,000 for 2022; $58,000 for 2021; $57,000 for 2020, subject to cost-of-living adjustments for later years).

➢ If your self-employed business is taxed as an S-Corporation, C-corporation, LLC taxed as S-corp/C-corp your ability to make Solo 401k contributions is based on the W-2 wages that you receive from your self-employed business eared income not your day-time job W-2 wages.

A Solo 401(k) is specifically designed for self-employed individuals or businesses with no full-time employees other than the owner and their spouse. In contrast, a profit-sharing plan is suitable for companies of any size, including those with many employees.

Earned income includes all of the following types of income: Wages, salaries, tips, and other taxable employee pay.

Capital gains are generally included in taxable income, but in most cases, are taxed at a lower rate. A capital gain is realized when a capital asset is sold or exchanged at a price higher than its basis. Basis is an asset's purchase price, plus commissions and the cost of improvements less depreciation.

Short-term capital gains are taxed at the same rate as your ordinary income. Meanwhile, long-term gains are taxed at either 0%, 15%, or 20%. The rate you pay is based on your taxable income. Just like with ordinary income tax rates, the higher your income, the higher your long-term capital gains tax rate.

In general, net investment income includes, but is not limited to: interest, dividends, capital gains, rental and royalty income, and non-qualified annuities. Net investment income generally does not include wages, unemployment compensation, Social Security Benefits, alimony, and most self-employment income.