Understanding Solo 401k Qualifications and Benefits

A solo 401k is a retirement plan designed for self-employed individuals and small business owners, allowing them to save for retirement while reducing their tax liability. This plan is also known as an individual 401k or a one-participant 401k.

To qualify for a solo 401k, you must be a self-employed individual or have a small business with no full-time employees. You can also qualify if you have a spouse who works for your business, but you must be the primary income earner.

The solo 401k plan allows you to contribute up to 20% of your net self-employment income, or $57,000 in 2023, whichever is less, to your retirement account. This can be a significant tax savings, as you can deduct your contributions from your taxable income.

A solo 401(k) is an individual 401(k) designed for a business owner with no employees.

You can't contribute to a solo 401(k) if you have full-time employees, but you can use the plan to cover both you and your spouse.

As the employer, you're in charge of setting up and managing the plan, and you can contribute to it just like you would to a regular 401(k).

With a solo 401(k), you can save for retirement with tax advantages, particularly if you don't access the money until after reaching age 59½.

You can use the plan to cover both you and your spouse, making it a great option for self-employed couples.

To qualify for a solo 401(k), you must claim some self-employed income, but you don't need to work full-time in a self-employed capacity. A common example is an individual who works for an employer but also does part-time consulting on the side.

To be eligible, your business must not employ any full-time employees who are eligible to participate in the plan, except for business partners and their spouses. A full-time employee is generally defined as one who works at least 1,000 hours per year for their employer.

You can even have a solo 401(k) if you also work for another employer besides yourself, but keep in mind that your annual contribution limit is for all your 401(k) accounts combined, not individually.

A Solo 401(k) is a type of retirement plan that's often misunderstood.

It's not a "special" type of plan by design, but rather a regular 401(k) plan that's available to self-employed individuals and small business owners.

To qualify for a Solo 401(k), you must claim some self-employed income, even if it's just part-time.

This can include consulting income, for example, if you work for an employer but also do some consulting on the side.

A Solo 401(k) Plan can be adopted by any self-employed business, including a sole proprietorship, limited liability company, partnership, C-Corporation, S-Corporation, etc.

The business adopting the plan must not employ any full-time employees that are eligible to participate in the plan, other than the business partners and their spouses.

Full-time employees are generally defined as those who work at least 1,000 hours per year for their employer.

To qualify for a solo 401(k), you must claim some self-employed income, but you don't need to work full-time in a self-employed capacity.

You can have a solo 401(k) even if you work for another employer, but keep in mind that your annual contribution limit is for all your 401(k) accounts combined, not individually.

A solo 401(k) can be adopted by any self-employed business, including a sole proprietorship, limited liability company, partnership, C-Corporation, S-Corporation, etc.

The business adopting the solo 401(k) plan must not employ any full-time employees that are eligible to participate in the plan, other than the business partners and their spouses.

A full-time employee is generally defined as one who works at least 1,000 hours per year for their employer.

Certain employees may be excluded from plan eligibility, such as those under age 21, non-resident aliens, and union members for which retirement benefits were the subject of a collective bargaining agreement.

Here are some business entities that can adopt a solo 401(k) plan:

You can also have a solo 401(k) if you have a partnership or an LLC taxed as a partnership, but the deadline for depositing salary deferrals into the solo 401(k) and funding the profit-sharing contribution is the partnership tax filing date of March 15 (or September 15 if an extension was filed).

There are two basic types of Solo 401(k) plans: brokerage-based and self-directed. The type of plan is determined by the plan documents, which control the operations of the plan.

A brokerage-based plan typically limits investment options to market-based assets like stocks and mutual funds. On the other hand, a self-directed plan offers more investment options, including real estate, private business, and alternative assets.

Self-directed plans also often include a loan feature, allowing participants to borrow up to the lesser of $50,000 or 50% of their account value. This loan can be used for any purpose.

A self-directed Solo 401(k) Plan also contains a built-in Roth sub-account, which can be contributed to without income restrictions. This is a key benefit for those who want to take advantage of Roth contributions.

Here's a comparison of the two plan types:

Ultimately, the choice between a brokerage-based and self-directed Solo 401(k) plan depends on your individual investment goals and preferences.

One key difference between a Solo 401(k) and a SEP IRA is the ease of contributing the maximum amount. In a Solo 401(k), you can contribute up to $18,500 in 2018 through the Salary Deferral component, which isn't available with a SEP IRA.

A Solo 401(k) also offers a $6,000 catch-up contribution for plan participants over the age of 50, a feature not found in SEP IRAs.

If you're eligible, a Solo 401(k) Plan can offer Roth contributions, even if you're not eligible to contribute to a Roth IRA due to income limitations.

You can open a Solo 401(k) Plan at most local banks and financial institutions, without needing a special custodian, making transactions faster and more economical.

Here are some key differences between a Solo 401(k) and a SEP IRA:

A Solo 401(k) also allows for after-tax contributions, which can be converted to Roth solo 401k designated funds, a feature not available in SEP IRAs.

Account rollovers are a convenient way to transfer funds from one retirement account to another. Not all Solo 401(k) plans accept incoming rollovers, so it's essential to check the plan document first.

You can roll over money from a traditional IRA, SEP, Qualified Plans, or Keoghs, including profit sharing, money purchase pension, and defined benefit plans, into a Solo 401(k) plan. A SIMPLE IRA is eligible for rollover after a two-year holding period.

A Solo 401(k) plan can also be rolled over to another traditional 401(k) plan or into a traditional IRA and rollover IRA. Designated Roth accounts in a Solo 401(k) plan can be rolled over to another 401(k) plan with designated Roth accounts or to a Roth IRA.

You can contribute up to 100% of your compensation to a solo 401(k) as an employee, with a maximum limit of $23,000 in 2024, plus an additional $7,500 if you're 50 or older.

The deadline for employee solo 401(k) annual contributions is generally December 31 for the year, but sole proprietors and single-member LLCs have until Tax Day (usually April 15) of the following year to make contributions.

As the employer, you can contribute up to 25% of your employee's compensation to a maximum of $69,000 in 2024 to your employee's accounts, subject to certain limitations. Contributions you make as an employer may be deductible as a business expense and generally must be made by Tax Day (usually April 15) of the following year.

Here's a summary of the contribution limits for solo 401(k) plans:

Note that the combined total of employee and employer contributions to your account cannot exceed $69,000 in 2024 plus the $7,500 catch-up contribution if you're 50 or older.

As an employer and employee of yourself, you need to understand the contribution limits for a solo 401(k) plan.

The employee contribution limit is up to 100% of your compensation, with a maximum of $23,000 in 2024. If you're 50 or older, you can contribute an additional $7,500.

As the employer, you can contribute up to 25% of your employee's compensation, with a maximum of $69,000 in 2024.

The combined total of employee and employer contributions cannot exceed $69,000 in 2024, plus the $7,500 catch-up contribution if you're 50 or older.

Here's a breakdown of the contribution limits:

Profit sharing contributions as an employer are limited to 25% of your compensation for S-Corporations, C-Corporations, Partnerships, and Multi-member LLCs. However, for sole proprietorships and single-member LLCs, the limit is about 20% of earned income, as calculated in Publication 560.

Keep in mind that these limits impact contributions to other 401(k) plans, and there's no limit to the number of plans you can make profit sharing contributions to, as long as they're unrelated businesses and you stay under the $57,000 limit.

Traditional solo 401(k)s offer tax-deferred growth, which means you won't pay taxes on investment earnings until withdrawal.

The value of tax-deferred growth depends on your current tax bracket versus what it will be in retirement.

Some people may prefer the predictability of paying taxes now and avoiding them in retirement with a Roth solo 401(k).

The decision between traditional and Roth solo 401(k)s ultimately depends on your individual circumstances and expected tax situation.

Designated Roth accounts are a great option for Solo 401(k) plans, allowing you to make after-tax contributions and take tax-free distributions of contributions and qualified earnings.

The income limitations for contributing to a Roth IRA do not apply to making designated Roth contributions to a Solo 401(k) plan. This makes it possible for high-income self-employed individuals to make Roth contributions.

The designated Roth account is forbidden from taking employer contributions, which must be made to the pre-tax Solo 401(k) account.

Here are some key features of designated Roth accounts in a Solo 401(k) plan:

The five-year holding period for a designated Roth account does not carry over to a Roth IRA rollover, so it's essential to understand how rollovers work.

Some Solo 401(k) plans allow loans, but not all of them do. If your plan document has a loan provision, you can take a loan from the plan.

Loans are limited to 50% of the total 401(k) value, with a maximum of $50,000. The loan repayment term is typically 5 years, but it can be extended to 10-15 years if the loan is used for a primary residence.

The interest rate charged on the loan is usually the Prime Rate or Prime plus 1% or 2%. This interest rate varies depending on the Solo 401(k) provider.

If you fail to repay the loan according to the terms, you'll face taxes and early withdrawal penalties. The IRS considers the unpaid loan as an early distribution from the retirement account.

You can choose between a traditional and Roth solo 401(k) plan, both of which offer tax advantages. The traditional option reduces your income in the year you make contributions, but distributions in retirement will be taxed as ordinary income.

A Roth solo 401(k) offers no initial tax break, but allows you to take distributions in retirement tax-free. This is a better option if you expect your income to be higher in retirement and/or you expect tax brackets to be higher in the future.

If you think your income will go down in retirement, or you expect tax brackets to remain the same or lower, opt for the tax break today with a traditional 401(k). The IRS has strict rules about when you can tap the money you put into either type of account.

With a solo 401(k), you get to choose which kind of plan might be more advantageous for you, as you're your own employer. You can't access the money until after reaching age 59½, or you'll pay taxes and penalties on any distributions.

To implement a solo 401(k) plan, you must establish it by December 31st of the tax year you'd like to contribute for.

You can open a solo 401(k) at most online brokers, though you'll need an employer identification number. The broker will provide a plan adoption agreement for you to complete, as well as an account application.

If you want to make a contribution for this year, you must establish the plan by Dec. 31 and make your employee contribution by the end of the calendar year.

You can typically make employer profit-sharing contributions until your tax-filing deadline for the tax year. This deadline includes extensions, which could push your deadline out another six months to September 15th or October 15th.

Here's a summary of the contribution deadlines:

Elective deferrals may be deposited any time before your tax filing deadline, which is usually April 15th for sole props, single member LLCs, and C-Corps, and March 15th for multi-member LLCs, partnerships, and S-Corps.

Although your contributions may be deposited any time before your tax filing deadline, they need to be reported on your W-2 (in the case of an S-Corp or C-Corp) by January 31st.

Once opened, solo 401(k)s are pretty simple to maintain. Plans with assets over $250,000 must file form 5500 SF with the department of labor.