The solo 401(k) is a qualified retirement plan specifically designed for a business owner with no full-time employees other than the business owner and his or her spouse. This plan was created by the Economic Growth and Tax Relief Reconciliation Act of 2001 and in general has the same rules and requirements as any other 401(k) plan. For those who qualify, there are big benefits to this plan that may make you re-think a traditional retirement plan and open a solo 401(k).
A solo 401(k) plan is sometimes called a:
- Individual 401(k)
- Self-employed 401(k)
- One-participant 401(k)
- Uni-k
Why is the solo 401(k) so beneficial?
1) The business owner can contribute as both the employee and employer.
Wearing two hats, as both employee and employer, gives the business owner the ability to invest significantly more than investing in traditional retirement plans.
Solo 401(k) contribution limits:
- Elective deferrals (as an employee) up to 100% of compensation up to the annual contribution limit. The limit in 2018 is $18,500 or $24,500 if the participant is over the age of 50. Contributions are made on a pre-tax basis and the earnings will be taxed as regular income when withdrawn in retirement.
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- Employer nonelective contributions (as an employer) up to 25% of your compensation if your business type is a Corporation. If your business type is a Sole Proprietor/Partnership, then you can contribute up to 20% of your compensation. For self-employed individuals, you must calculate the employer contribution based on the company’s net earnings after subtracting half of the self-employment tax and elective deferrals. To calculate this, refer to the IRS website.
In 2018, the total solo 401(k) contribution limit is $55,000 or $61,000 for participants over the age of 50. Keep in mind, if you are a business owner who is also employed by another company and you participate in that company’s 401(k) plan, the limits on elective deferrals are by person, not by plan.
The IRS allows one exception to the no employees rule, the spouse, if he or she earns income from the business. This may result in doubling the amount you can contribute as a family. The spouse can make elective deferrals as an employee and the business owner can then make the plan’s profit-sharing contribution for the spouse up to the contribution limit of the business type.
Note: You can rollover any pre-tax retirement account into your solo 401(k). Some examples of types of retirement accounts you can rollover include a 401(k), 403(b), 457, and an IRA. IRS rules do not permit a Roth IRA to be rolled into a solo 401(k).
Note: Generally, you will be required to file an annual report on Form 5500-SF (link) if the solo 401(k) has $250,000 or more in assets at the end of the year. A plan with fewer assets may be exempt from the annual filing requirement.
2) No nondiscrimination testing required.
A business owner with no common-law employees does not need to perform nondiscrimination testing for the plan, since there are no employees who could have received disparate benefits. This advantage does go away once the employer hires an employee other than his or her spouse.
3) More investment options
The two types of solo 401(k) plans are brokerage based and self-directed. You can choose to open a solo 401(k) through a custodian or a self-directed solo 401(k) plan that is generally offered by self-directed trust companies or facilitators who do not provide investment advice or sell investment products. The self-directed plan will allow you to invest in a variety of investment options without requiring the consent of a custodian.
Some examples of the types of investments that can be made with a self-directed solo 401(k) are:
- Stocks, Bonds, Mutual Funds
- Most currencies
- Real Estate
- Tax Liens/Tax deeds
- Mortgages
- Private loans
- Businesses
- Precious metals
4) Tax and penalty free loan if you choose a self-directed solo 401(k).
A self-directed solo 401(k) plan typically allows plan participants to borrow up to $50,000 or 50% of their account value (whichever is less) for any purpose. The business owner and his or her spouse would each be permitted to borrow up to the maximum amount for any purpose, including financing a business. The loan must be paid back at least quarterly, over a five-year period, and at a minimum Prime interest rate.
The bottom line:
A solo 401(k) is a powerful investment tool that can help self-employed individuals build a sizable nest egg for retirement. Larger contribution limits can allow for more tax deductions, lower tax bills, as well as providing you with greater retirement income. This plan typically allows small-business owners to save significantly more for retirement than they could in traditional retirement plans, enjoy flexible investment options, and avoid the expense and paperwork of setting up a traditional 401 (k).
Carol Chaudet
(Last Updated 8/24/2018)