How To Set Up And Start A Solo 401
Opening a solo 401 is surprisingly simple, and the fees arent terribly onerous either, especially if your needs are simple. Now, a solo 401 is not as inexpensive to set up as an IRA which is typically free unless self-directed but you still dont have to break the bank to set up your plan either.
Heres how to open a solo 401:
How Do You Qualify For A Solo 401
The IRS rules say that you cannot have a solo 401 if your business has employees other than the owner, their spouse and/or a business partner. The partners in a partnership are generally considered to be self-employed.
In order to be eligible to contribute to a solo 401:
- You must engage in some sort of self-employment activity that generates income for you.
- Your business cannot have employees other than the owner and their spouse.
What Are The Potential Tax Benefits Of A Solo 401
One of the potential benefits of a Solo 401 is the flexibility to choose when you want to deal with your tax obligation. In a Solo 401 plan all contributions you make as the “employer” will be tax-deductible to your business with any earnings growing tax-deferred until withdrawn. But for contributions you make as an “employee” you have more flexibility. Typically, your employee “deferral” contributions reduce your personal taxable income for the year and can grow tax-deferred, with distributions in retirement taxed as ordinary income. Or you can make some or all of your employee deferral contributions as a Roth Solo 401 plan contribution. These Roth Solo 401 employee contributions do not reduce your current taxable income, but your distributions in retirement are usually tax-free. Generally speaking, there are tax penalties for withdrawals from a Solo 401 before 59 1/2 so be sure to know the specifics of your plan.
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The Solo 401 From Rocket Dollar
For individuals with self-employment income, the Solo 401 is the premier retirement account available today. Secure your retirement with unlimited investment options, high contribution limits, and ultimate flexibility.
Notice
in order to make sure we can open all new customers Solo 401s before the important IRS/DOL December 31st deadline. All Solo 401s purchased after this cutoff will not be fulfilled until after . If you are considering a Solo 401, please make your decision in November or early December while there will still be plenty of time for you to sign and approve appropriate documentation and organize year-end contributions with a CPA. Plans established after the deadline but before tax time can have reduced contribution capabilities. This cutoff date is non-negotiable and no exceptions will be granted.
Check out the 2020 Rocket Dollar Solo 401 webinar to learn more about this account and how to use it this year.
What Is A Self
A 401 plan is an employer sponsored retirement savings plan established per provisions of the US tax code. Such plans first came into existence following the enactment of the Employment Retirement Income Security Act of 1974 .
A Solo 401 is a relatively new iteration of this type of plan dating to 2001 and passage of the Economic Growth and Tax Relief Reconciliation Act . This law increased the contributions available to the self-employed version of the 401 and generally streamlined the administration of such plans.
Income from the sponsoring employer may be contributed to the plan on a tax-deferred or Roth basis. Contribution limits are more generous than with IRA based plans, potentially as high as $63,500 per participant.
Since its introduction, the Solo 401 has become the favored option for successful business owners to save for their retirement future, and offers many advantages over options such as SEP IRAs, SIMPLE IRAs and Keough plans. For self-employed investors who qualify, this is our recommended plan of choice.
Income from the sponsoring employer may be contributed to the plan on a tax-deferred or Roth basis. Contribution limits are more generous than with IRA based plans, potentially as high as $63,500 per participant.
This type of qualified retirement plan is also sometimes referred to as an Individual 401, Owner 401 or self-employed 401.
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Can I Invest In Business In My Solo 401
Yes, you can! As long as your solo 401 doesnt engage in any prohibited transactions, it can invest in C corporations, LLCs, and limited partnerships.
Did you notice whats missing from that list? S corporations. Solo 401 plans may not hold S corp shares, but this is not due to the rules governing Solo 401 plans this is due to the S corporation rules, which state that only individuals , certain trusts, and estates.
Contribution Limits For A Solo 401
Self-employed workers may contribute up to $61,000 to a solo 401 in 2022 , or $67,500 if age 50 or older . This is a lot higher than what traditional employees can contribute to a 401 because self-employed workers can make employer contributions as well.
The employee contribution is $20,500 in 2022 , or $27,000 if you’re 50 or older . This is the same amount traditionally employed workers are allowed to contribute to their 401s.
The employer contribution is up to 25% of your net self-employment income, which is defined as all your self-employment earnings minus business expenses, half your self-employment tax, and the money you contributed to your solo 401 for your employee contribution. For example, if you earned $100,000 in net self-employment income, you could make an employer contribution of up to $25,000 to your solo 401.
Your maximum contribution is the lesser of the annual contribution limit , or your employee contribution plus 25% of your net self-employment income. So you cannot contribute more than $61,000 in 2022 , even if your employer contribution would allow for it, and you can’t exceed your maximum employee and employer contributions for the year, even if you haven’t hit the annual limit.
All the retirement saving options if you’re your own boss.
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Withdrawing Funds From A Self
As with traditional 401 plans, the self-employed 401 is intended to help you save money for retirement, and there are regulations in place to encourage you to do so. For example:
- Withdrawals prior to age 59½ may be subject to a 10% early withdrawal penalty, along with any applicable income taxes1
- You must take required minimum distributions from self-employed 401s beginning at age 722
- Plans can be structured to allow loans or hardship distributions3
- Plans can be structured to accept rollovers from other retirement accounts, including SEP IRAs and traditional 401s, into your self-employed 401
- You can roll your self-employed 401 assets into another 401 or an IRA
Because of its high contribution levels, flexible investment options, and relatively easy administration, the self-employed 401 is an attractive option for small-business owners or sole proprietors who want to be able to save aggressively for the future.
If there is the potential that your business might add employees at a later date, however, know that you will either have to convert your self-employed 401 plan to a traditional 401, or else terminate it. But if you’re confident that you will remain a one-person operation, and you want the high savings options that these plans offer, this type of account may be a good fit.
How To Contribute To A Solo 401k
Solo 401k plans are designed for entrepreneurs, contract workers and the self-employed who have no employees other than a spouse, and there can be big benefits to using this type of plan. Participants can self-direct their money and investments, there are generous contribution limits, and there are minimal tax filing requirements. It offers all of the benefits of a traditional plan as well as some additional benefits. The generous contribution opportunities are what will be discussed herein.
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Who Can Get Started
If you generate some form of self-employment income, you can establish a Solo 401k plan. Even if that self-employment income is a side gig in conjunction with a regular 9-to-5, you qualify. Establishing a Solo 401k is a great way to maximize your retirement savings if you were late in getting started. It will also benefit investors who are uncomfortable making traditional investments.
The Results Can Be Pretty Incredible
Of course, many self-employed people don’t have the ability to contribute the maximum amount allowed to a solo 401. However, even modest contributions add up over time.
For example, let’s say that you’re self-employed and that you’ll have $80,000 in net self-employment income for 2021. You decide to set aside a total of 10% of your net self-employment income in a solo 401. Not only could this reduce your taxable income by $8,000 for the year, but if you repeat the process every year, you could end up with a retirement nest egg of more than $928,000 after 30 years — and that assumes just 2% annual income increases and a historically conservative 7% annual rate of return.
Imagine if you decided to invest even more. With a solo 401, you can dramatically reduce your taxable income while building up a million-dollar nest egg.
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Best For Real Estate: Rocket Dollar
Rocket Dollar
Rocket Dollar allows you to invest in anything you can pay for with a checkbook. That means you can invest in real estate and other non-traditional assets while enjoying the tax advantages of a solo 401 account.
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Checkbook control allows you to invest in real estate and other alternatives
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Support for 401 loans and Roth contributions
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Option for upgraded account that includes free wire transfers, checks, tax form filing, and other features
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Basic accounts require $15 monthly fee and $360 setup fee
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Premium accounts require a $30 monthly fee and $600 setup fee
If you dont want the limitations of traditional financial markets, you may want to consider Rocket Dollar. Instead of stocks, ETFs, mutual funds, and bonds, Rocket Dollar accounts give you the control to buy any asset with your solo 401 that the IRS allows. That can include rental properties, fix-and-flip real estate, or land that you think will appreciate in value. You can invest outside of real estate as well, such as private investments in a startup or precious metals, however, Rocket Dollar’s flexibility makes it the solo 401 that’s best for real estate.
Contribute To Your Solo 401
Once you set up the Solo 401 account, you can fund the account using a check, wire transfer, or rollovers from old 401s. If the plan allows, you can decide to make monthly installments or one lump sum payment. You can make employee contributions and profit sharing contributions to the Solo 401 up to a contribution limit of $58,000 in 2021.
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Contribution Limits In A One
The business owner wears two hats in a 401 plan: employee and employer. Contributions can be made to the plan in both capacities. The owner can contribute both:
- Elective deferrals up to 100% of compensation up to the annual contribution limit:
- $20,500 in 2022 , or $27,000 in 2022 if age 50 or over plus
If youve exceeded the limit for elective deferrals in your 401 plan, find out how to correct this mistake.
Total contributions to a participants account, not counting catch-up contributions for those age 50 and over, cannot exceed $61,000 for 2022 .
Example: Ben, age 51, earned $50,000 in W-2 wages from his S Corporation in 2020. He deferred $19,500 in regular elective deferrals plus $6,500 in catch-up contributions to the 401 plan. His business contributed 25% of his compensation to the plan, $12,500. Total contributions to the plan for 2020 were $38,500. This is the maximum that can be contributed to the plan for Ben for 2019.
A business owner who is also employed by a second company and participating in its 401 plan should bear in mind that his limits on elective deferrals are by person, not by plan. He must consider the limit for all elective deferrals he makes during a year.
What If I Have Multiple Businesses
To do this, general opinion is that you can set up a holding company for the separate companies and make the holding company the adopting company for the Solo 401k. A holding company is usually a company that doesnt do any business with anyone, it just owns other companies. The trick to making this work is of course to have the other companies which would be called, Subsidiary companies the companies that go out there and do business and are owned by the holding company. Those need to be passed through entities meaning that they dont pay taxation at their own level, they just pass through the earning up to the parent company. So LLCs are pass through entities, and if you use LLCs, then one other benefit youll get is that youll have the subsidiary company structured as an LLC and it only has one owner or one member which would be the parent company. It would be a single member LLC. If you have a single member LLC, it doesnt even have to file a tax return in the first place. Single member LLCs the IRS instructs to be disregarded for tax purposes. For further clarification, please consult your CPA or tax advisor.
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How A Solo 401 Works
Solo 401s are available only to self-employed workers with no employees, with an exception for business owners who employ their spouses. To open one of these accounts, you must have an employer identification number , which you can get from the U.S. Internal Revenue Service .
You’re allowed to make two types of contribution to your solo 401: an employee contribution and an employer contribution. Your employee contribution limit is the same as the 401 contribution limit for any traditionally employed worker — $19,500 in 2021, or $26,000 if you’re 50 or older. These rates increase in 2022 to $20,500, or $27,000 if you’re 50 or older.
If you’d like to contribute more than this, you can make additional contributions as an employer, but this calculation is a little more complicated. You may contribute up to 25% of your net self-employment income for the year. That is all the money you’ve earned from your business minus any business expenses, half of your self-employment taxes, and the money you contributed to your solo 401 as an employee contribution.
Only the first $290,000 in net self-employment income counts for the year, and the total amount you may contribute to your solo 401 as employee and employer in 2021 is $58,000, or $64,500 if you’re 50 or older. In 2022, those increase to $61,000, or $67,500 if you’re 50 or older.
Roth Solo 401k For Tax
Roth accounts are especially attractive to high-income earners. A Roth Solo 401k plan allows after-tax contributions regardless of income level. The key benefit is tax-free earnings. No matter how much the earnings grow and compound over the years, when it comes time to withdraw these funds for your retirement, every cent is tax-free.
There are many strategies with a Solo 401k but the best-proven strategy with a retirement plan is targeting long-term gains over short-term growth.
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Best For Account Features: E*trade
E*TRADE
E*TRADE gives you more flexibility with its solo 401 offering. E*TRADE supports both traditional individual 401 plans and Roth 401 plans. You are also able to take out a loan on your 401 balance at E*TRADE, all of which makes E*TRADE best in our review for account features.
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Choose between traditional or Roth 401 contributions
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Support for 401 loans
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No recurring account fees, and commission-free stock and ETF trades
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Now run by Morgan Stanley, meaning changes are likely
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High fee for broker-assisted trades and some mutual fund trades
E*TRADE has a long history of supporting online investors, with its first online trade placed in 1983. It is now a subsidiary of Morgan Stanley after an acquisition that closed in October 2020. At E*TRADE, you can choose between traditional and Roth individual 401 plans, which allows you to choose between pre-tax and post-tax contributions. You can also take a 401 loan from an individual 401 account at E*TRADE.
There are no listed fees to open or keep a solo 401 account at E*TRADE. Stock and ETF trades are commission free. The brokerage also supports over 7,000 mutual funds on its no-load, no-transaction-fee list. E*TRADE supports options, futures, and fixed-income bonds and CDs, as well.
Read our full E*TRADE review.
Third Party Solo 401k Providers
If you need something a little more robust that the free prototype plans these five brokerage firms offer, then you need to find a third party service that will create the plan documentation for you.
Some of the common reasons why you’d consider using a third-party service to create your solo 401k documentation:
- You want a choice in brokerage
- You want to invest in alternative assets such as real estate, startups, cryptocurrency, promissory notes, tax liens, precious metals, and more.
- You want checkbook control over your 401k
- None of the prototype providers matches exactly what you’re looking for with options
We’re not going to go in-depth on these providers because this section effectively becomes al-la-carte with what you can get and pay for. I just wanted to list some of the most popular third party plan providers that you can reference in your search for the best plan.
Remember, just because you go with a third party provider also doesn’t mean you can’t invest at your favorite firm. For example, you can create a third party solo 401k and then have that 401k held at Fidelity. This gives you access to all of Fidelity’s investment choices, but your options are created by the plan, and NOT Fidelity.
Also, you can use these plans to execute a Mega Backdoor Roth IRA. In fact, several of these companies specifically advertise that they offer it.
This isn’t an exhaustive list. There are also local firms in most areas that can create 401k plan documentation as well.
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