What Is A Solo 401 And How Does It Work
A solo 401 is a retirement plan for the self-employed.
If youre a business owner, a solo 401 is a way for you to access the same retirement benefits that youd get as a corporate employee.
In this article, I’ll explain the myriad of solo 401 rules and compare solo 401s to SEP IRAs. I’ll also share with you the solo 401 contribution limits for 2021.
Ways To Structure Your Sole Proprietorship To Include Your Spouse
The IRS makes special provisions when your spouse works in your business. Generally, there are two structures. One is when your spouse is an employee of the business and the other is when both spouses share ownership of the business. Importantly, the employment tax requirements for a spouse/employee can vary from those applying to other employees. These are the three most common business structures involving spouses.
Mom And Brothers Participation Question:
Yes provided they are all owner-employees in the S-corp with not other full-time W-2 common-law employees. The S-corp would sponsor the solo 401k plan and all 5 would participate in the same solo 401k plan. Each participant would separately hold their retirement funds in participant accounts. Lastly, when it comes time to determine if a Form 5500-EZ will need to be filed for the plan, all of the participants balances will need to be added up and if the combined value exceeds $250,000, a Form 5500-ez will need to be filed each year by 07/31.
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What Paperwork You Need To Fill Out To Open Your Account
I was surprised at how much paperwork is required to open a solo 401k account. You’d think it would be simple, with very common forms to fill out. However, it’s completely the opposite. It becomes even more challenging if you add a Roth solo 401k, and you have to do double the paperwork if you’re adding a spouse to your plan.
When opening your solo 401k plan, you will need to create the following documents. You will need to create separate plan documents for both your Traditional and Roth Solo 401ks. They are both considered separate plans for tax purposes.
Plan Documents For Traditional Solo 401k
- 401k Plan Adoption Agreement
- Designation of Successor Plan Administrator
Plan Documents For Roth Solo 401k
- 401k Plan Adoption Agreement
- Designation of Successor Plan Administrator
Required Documents For Individual
- Brokerage Account Application for 401k Account
- Brokerage Account Application for Roth 401k Account
- Designation of Beneficiary Form for Account
- Power of Attorney
Required Documents For Spouse
- Brokerage Account Application for 401k Account
- Brokerage Account Application for Roth 401k Account
- Designation of Beneficiary Form for Account
- Power of Attorney
When you’re done with all these documents, you’ll have two solo 401k plans, and 4 accounts .
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How To Plan Ahead
If youre considering implementing a Solo 401 in your business, be sure to think about what your future plans for your business, and the potential for employees may be.
If hiring employees is a strategy thats on the horizon, it may make more sense to go with an IRA based plan to start with.
If you have a business with a Solo 401 and are considering bringing on employees, reach out to your CPA and plan advisor to understand your options and the relevant timelines in advance. Planning for a transition can make that process a whole lot easier.
This page has been updated to reflect law changes implemented with the SECURE Act of 2019.
Best For Low Fees: Charles Schwab
Charles Schwab
The Individual 401 Plan from Charles Schwab is our top choice for low fees. The account has no opening or maintenance fees as well as no commission trades for stocks or ETFs and over 4,000 no-load, no-transaction-fee mutual funds. Customers can also use its robo-advisor, Schwab Intelligent Portfolios, with no extra fees.
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Accounts are free to open and charge no recurring fees
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Access to trade stocks, ETFs, and thousands of mutual funds for free
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Option for a no-cost robo-advisor
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No solo 401 loans
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High fees for some mutual fund trades and broker-assisted trades
Charles Schwab is our top choice for low fees in a solo 401 plan. Schwabs version charges no recurring fees and no setup fees. It offers commission-free trades for all stocks and ETFs as well as over 4,200 no-transaction-fee funds on the Schwab OneSource funds list. While Schwab offers excellent customer service, be aware that automated phone trades cost $5 and broker-assisted trades cost $25 each. However, many customers could use this account without paying any fees.
Schwabs Solo 401 doesnt offer 401 loans. Its active investment platform may not satiate all expert investors, and its active charting and analysis tools lag behind some other brokerage platforms for active traders. However, the pending integration of TD Ameritrade will bring the coveted thinkorswim platform under the Schwab umbrella, which is something active traders at Schwab can look forward to.
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How Do I Open A Solo 401
You can open a solo 401 through most financial institutions and online brokers. You just need your employer identification number to apply. Youd most likely need to sign a plan adoption agreement and fill out an application.
Moving forward, a solo 401 works like most retirement plans. You can build a diversified portfolio with a variety of funds like stocks, bonds and mutual funds. But you must fill out IRS form 5500-SF if your plan has more than $250,000.
About Individual 401 Plans
An Individual 401 Plan allows a self-employed individual , to make highest possible retirement contributions.
Please review the Individual 401 Profit Sharing Plan Basic Plan Document before completing the Adoption Agreement and Employer-Sponsored Retirement Plan Information and Services Agreement.
Keep the original Adoption Agreement and send a copy to T. Rowe Price. Original Adoption Agreements submitted will not be retained. We will only retain an electronic copy.
This form allows you to transfer money from another Individual 401 plan to your T. Rowe Price Individual 401 Plan.
This form allows you to roll over assets from a former employer’s 401 or other eligible retirement plan.
A unique Operator ID will be mailed to you once your application has been processed. It should arrive within 7 to 10 days.
Once you’ve received your Operator ID and temporary password, you can access Plan Sponsor Web, which allows you to administer your plan online.
Once you’ve established your Plan Sponsor Web site, you can begin contributing.
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Ongoing Considerations For Your Solo 401k
One of the great things about a solo 401k is that they are relatively easy to maintain, for the most part. Since you are technically the administrator of your own plan, you are personally required to submit required filings for the plan.
There are two ongoing paperwork requirements that you will need to stay on top of. First, if your plan has over $250,000 in assets on the last day of the plan year, you have to file a form 5500. This can be a bit complicated, but if you can fill out all of that paperwork above, you can likely handle it yourself.
You can submit the IRS Form 5500 for free, electronically here: EFAST2 Filing From The IRS.
If you don’t want to do it yourself, you’ll need your CPA to handle this for you, and they’ll likely charge a fee to do it. However, if you’re using a non-prototype plan, most of the plan providers will help you prepare the Form 5500 each year as part of your annual fee.
The second form you need to keep in mind is a 1099-R, but that form is only required if you take distributions from your 401k plan or if you roll it over, withdraw money of any kind, or change providers. This form is also relatively easy to fill out, but there is no free electronic filing for this form. You either have to pay a service to file it, or mail it in yourself.
What Is A Solo 401 Plan And How Does It Work
A solo 401 plan, also called a one-participant 401 or a solo K, offers self-employed people an efficient way to save for retirement. There are no age or income restrictions, but participants must be business owners with no employees .
The solo K has very high and flexible contribution limits, typically allowing more contributions than SEPs, traditional IRAs and Roth IRAs or SIMPLEs, says Joe Conroy, CFP and founder of Harford Retirement Planners in Bel Air, Maryland.
One key difference between the solo 401 and other self-employed retirement plans is that employees can contribute all of their salary up to the annual maximum contribution. Theyre not limited to 25 percent of their salary, as in some other plans. This feature can allow them to minimize taxes, though this contribution doesnt help them avoid the self-employment tax.
In other respects, the solo 401 operates like any other 401 plan, whether its a traditional 401 or a Roth 401. If you set up your solo 401 to take tax-deductible contributions, it will operate like a traditional 401, allowing you to contribute pre-tax money and get a break on this years taxes. On the other hand, if you opt for a Roth, youll make after-tax contributions, but will benefit from the tax-free withdrawals in retirement.
If you think tax rates will be higher in the future, like I do, then a Roth can be a very valuable account to reduce your future tax burden in retirement, Conroy says.
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The 6 Best Solo 401 Companies Of 2022
- Best for Account Features: E*TRADE
- Best for Mutual Funds: Vanguard
- Best for Real Estate: Rocket Dollar
Fidelitys self-employed 401 plan is our pick for best overall due to a combination of very low fees, a wide range of investment choices, and the companys emphasis on retirement savings.
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No regular account fees and no commissions for stock or ETF trades
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10,000+ no-transaction-fee mutual funds including four Fidelity funds with no fund expenses
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Retirement resources including calculators, apps, and education resources to help you improve your retirement savings and investment strategy
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Some active traders may want more powerful active trading tools
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No electronic deposit for contributions
Fidelity self-employed 401 accounts are a great choice for fee-conscious investors, earning our top overall pick. The Fidelity solo 401 charges no opening or closing costs and no annual maintenance fees. Customers can invest in stocks, ETFs, and over 3,400 mutual funds with no trading commissions. That means many small business owners could use this account without ever paying any fees to Fidelity. If you need help to place orders, however, the $32.95 broker-assisted trade fee may be an impediment.
Read our full Fidelity review.
S To Set Up A Solo 401
There are specific steps that must be taken to properly open a solo 401 plan, according to the Internal Revenue Service .
First, you have to adopt a plan in writing, making a written declaration of the type of plan you intend to fund. The choices are the same as are given to an employee opening a 401 plan: you can choose a traditional 401 or a Roth 401. Each has distinct tax benefits.
A solo 401 must be set up by December 31st in the tax year for which you are making contributions.
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Rules For Figuring Out Your Solo 401k Contribution
Figuring out how much you can contribute to your solo 401k as the employee is easy. Its the lesser 100% of your contribution or up to $19,500.
Employer contributions can be a little more difficult to figure out. Heres the rule on employer contributions: you can make profit-sharing contributions of up to 25% of your net income from self-employment.
Your net earnings are your net business profit less half of your self-employment tax and employer plan contributions you make for yourself and your spouse. You can find your net income on your tax forms. Its on your tax Schedule C or C-EZ if you are a sole proprietor, and its your w-2 wage if youre an S-Corp.
Open Solo 401 Account
Once youâve obtained the required documents, you can set up the Solo 401 account. You should open the retirement before the tax filing date, and it should be created based on the rules provided in the plan documents. For example, if you want to contribute during the year, you can open the account any time before December 31.
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Where Can I Open A Solo 401k Account
If you are self-employed, find out where you can open a Solo 401 and the process involved when opening a self-directed retirement account.
One of the perks of being self-employed is the ability to self-direct your retirement savings. Self-employed individuals can open a Solo 401 account to access the same level of service as a company-sponsored 401 plan. A Solo 401 allows the owner-employee of the business to contribute up to $19,500 in 2021, and still make profit-sharing contributions up to $58,000 in 2021, or $64,500 if you are above 50.
You can open a Solo 401 account with different types of providers such as brokerages, banks, and self-directed custodians. You should compare the different Solo 401 providers to determine the company with the best Solo 401 account that meets your retirement needs. You should also compare the fees charged by each provider and the investment options available in each plan.
What If My Spouse Owns His/her Own Business
If your spouse owns part of the business, he or she can set up a separate Solo 401k. In most cases, this is not necessary but there can be reasons to make this selection. Your spouse might need different plan documents to ensure IRS compliance, future amendments, restatements, and updates to his or her plan, or have other unique requirements. Your spouse or you might also have legal reasons why a separate Solo 401k plan is preferred.
A time when a spouse might consider a separate Solo 401k plan is if they have their own sole proprietorship . They have a separate employer identification number and operate the business independent from your business. There can be intermingled business relationships but the businesses are separate entities.
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