Profit sharing plans are often mentioned alongside 401k accounts, which can make the two sound interchangeable. In reality, they serve different purposes. A profit sharing plan centers on employer contributions, while a 401k (including a Solo 401k for self-employed individuals) has its own structure and rules. Both are recognized retirement plans under the tax code, but they don’t work in the same way.
Maximize Your Retirement Savings With a Solo 401k
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Understanding the distinction matters because the plan you choose could affect how much you can contribute, how those contributions are treated for tax purposes, and who is eligible to participate. Many business owners and self-employed professionals explore both options; the key is knowing how each plan is set up before you decide.
Is a 401k or Solo 401k Considered a Profit Sharing Plan?
A traditional 401k and a Solo 401k are not pure profit sharing plans, but they share some features. They are typically structured as profit sharing plans with an added 401k component. This design makes them more flexible than a standalone profit sharing plan.
Here’s how they compare:
✅ Pure profit sharing plan – Only the employer makes contributions, based on a formula in the plan document.
✅ 401k plan – Employees can defer a portion of their wages into the plan, and employers may add matching or nonelective contributions.
✅ Solo 401k plan – A business owner wears both hats: contributing as the “employee” through elective deferrals and as the “employer” through profit sharing contributions.
📝 Note: The employer portion in a Solo 401k is often called the profit sharing contribution, but the plan itself is still classified as a 401k.
401k Contribution Limits in 2025
The IRS sets annual limits on how much can go into a 401k. These limits apply to elective deferrals, catch-up contributions, and combined totals.
✅ Employee elective deferrals – Up to $23,500
✅ Catch-up contributions – An additional $7,500 for individuals age 50 and older
✅ Special catch-up for ages 60–63 – Up to $11,250, which could bring total employee deferrals to $34,750
✅ Employer + employee combined (annual additions) – Limited to the lesser of 100% of compensation or $70,000. Catch-up contributions may be made on top of this $70,000 cap.
📝 Note: Some employers permit after-tax employee contributions beyond the standard limits. These after-tax contributions can potentially be rolled into a Roth account through what’s known as a Mega Backdoor Roth strategy. However, not all 401k plans allow this feature.
Solo 401k Contribution Limits in 2025
A Solo 401k is designed for self-employed individuals and business owners with no employees other than a spouse. One advantage is that the owner plays both roles — employee and employer — when contributing.
✅ As the employee – Up to $23,500 in elective deferrals, plus a $7,500 catch-up for age 50+ or $11,250 for ages 60–63
✅ As the employer – Profit sharing contributions up to 25% of compensation (the definition of compensation depends on business structure, such as net income for sole proprietors or W-2 wages for S Corps)
✅ Combined Solo 401k contribution limit – Up to $70,000 in 2025, plus any eligible catch-up contributions
Contribution calculations vary based on how “compensation” is defined for your business type. For example, sole proprietors typically use net income from Schedule C, while S Corp owners use W-2 wages.
Profit Sharing Plan Contribution Limits
Profit sharing plans have their own set of rules that determine how much an employer may contribute on behalf of eligible employees. These contributions are made at the employer’s discretion and do not need to be tied to actual business profits.
✅ Employer deduction limit – Contributions are generally capped at 25% of eligible compensation.
✅ Annual additions limit – In 2025, the total contribution for each participant is limited to the lesser of 100% of compensation or $70,000.
✅ Catch-up contributions – Not available for employer profit sharing contributions. Catch-ups only apply to employee elective deferrals in a 401k.
✅ Plan type classification – Profit sharing plans, traditional 401k plans, and Solo 401k plans are all considered defined contribution plans. They are subject to the annual additions limit under IRC Section 415(c).
📝 Note: A 401k may include a profit sharing feature, which allows the employer to add nonelective contributions on top of employee deferrals.
Eligibility Rules for Profit Sharing Plans
Employers must apply the plan fairly across eligible employees. According to IRS guidelines, an eligible employee is someone who:
✅ Is at least age 21
✅ Has completed one year of service (typically at least 1,000 hours worked)
✅ Is not covered by a collective bargaining agreement (e.g., union contract)
✅ Is not a nonresident alien with no U.S.-source income
Vesting and Distributions
Employers may establish a vesting schedule for profit sharing contributions, subject to IRS limits. Vesting determines how long an employee must stay with the company to gain full rights to employer contributions.
Withdrawals follow the same rules as other retirement accounts:
✅ Distributions before age 59½ – Any taxable portion is generally subject to a 10% additional tax, unless an IRS exception applies.
✅ Distributions after age 59½ – Taxed as ordinary income, with no early withdrawal penalty.
📝 Comparison note: Profit sharing contributions work differently from Solo 401k contributions. A Solo 401k allows business owners to contribute both as the “employee” (through elective deferrals) and as the “employer” (through profit sharing). This dual role often makes a Solo 401k more flexible for self-employed individuals than a standard profit sharing plan.
In Summary
Profit sharing plans, 401k plans, and Solo 401k plans all fall under the umbrella of defined contribution retirement accounts, but each has distinct rules for contributions, eligibility, and plan design. Employers have flexibility in deciding how much to contribute under a profit sharing plan, while 401k and Solo 401k plans allow elective deferrals in addition to employer contributions. Contribution limits also differ, with Solo 401k plans giving business owners a unique opportunity to contribute in both roles.
For those exploring their options, the right choice often depends on business structure, the number of employees, and retirement savings goals. Reviewing the IRS guidelines and comparing plan features can help determine what may work best for a particular situation.
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