The interim Name, Image and Likeness (NIL) Policy has opened many doors for college athletes – including the door that requires annual income tax filings for NIL deals. To deduct some of their expenses against this new form of income, many college athletes have set up LLC’s making their income reportable on Schedule C on their tax return. As self-employed individuals, they are also searching for ways to begin saving for their future retirement. Traditionally, the self-employed have turned to Simplified Employee Pension (SEP) plans, but there may be a better option for athletes: a solo 401(k).
What is a Solo 401(k) Plan?
A solo 401(k) or individual 401(k) is a retirement savings plan for self-employed business owners with no full-time employees qualifying for the plan. By using a solo 401(k) for retirement savings, business owners may contribute to the plan from both the stance of an employee as well as the business. Eligibility requirements for the plan must adhere to the IRS guidelines and be filed in the plan’s legal documents by December 31 of the year in which the first contribution is to be made from the employee’s stance.
How Much Can College Athletes Contribute to a Solo 401(k)?
A self-employed individual, or an athlete in this case, may make contributions up to the lesser of $20,500 or 100% of compensation for 2022. On top of the employee contributions to the plan, the individual may make a business contribution of 25% of total compensation to the employee from the business. “Total compensation” from the business can be calculated as the business’ net profit less 50% of self-employment tax. The two forms of contributions are subject to an overall limit of $61,000 for the 2022 tax year. There are generally early access penalties for withdrawals before the age of 59 ½ years of age and it’s important to consult the specifics of the plan before considering early access.
How Can Athletes Maximize Contributions to a Solo 401(k)?
Solo 401(k) plans allow for the spouse of a business owner to also contribute to the plan, subject to the same limitations as the owner. This would effectively double the amount of available retirement plan contributions allowed in one individual 401(k) plan.
What are the Tax Implications of a Solo 401(k) Plan?
Unlike SEP plans, contributions made by the employee have the option to contribute to a Roth solo 401(k) or a traditional solo 401(k). When contributions are made to a Roth solo 401(k), the contribution does not reduce the individual’s current taxable income. But during retirement, the distributions are generally tax-free. A contribution to a traditional solo 401(k) plan will reduce the taxpayer’s current year taxable income but is subject to tax upon distribution; therefore, deferring the tax into the future. Any contributions made from the business to the plan is also a deduction against the business’ income but can’t be contributed to a Roth plan. Again, effectively deferring the tax until the time of distribution.
SEP or Solo 401(k) for College Athletes?
An SEP plan doesn’t allow the individual to make the $20,500 employee contribution that the 401(k) plan does. If the business has a low-income year, the contributions for that year are limited by the net profit of the business. The solo 401(k) allows the business owner to make contributions even in reduced income years via the employee contribution. In addition to the limited contributions, the solo 401(k) does allow plan loans, unlike the SEP plan.
Not sure if the solo 401(k) plan is right for you? Anders Sports, Arts and Entertainment advisors are well versed in benefits and limitations of the various retirement plan options for collegiate athletes. We can assist in advising for year-end tax planning and overall guidance. Contact an Anders advisor below to discuss your specific tax situation.
