Tuesday, June 11, 2024

How To Open A Solo 401k

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How A Solo 401 Works

Steps to Open a Solo 401k

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.

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.

If you find yourself in need of cash later on, you can take a loan from your solo 401 just as you can from a traditional 401. Typically, you’re limited to the lesser of 50% of your balance or $50,000, but the government has doubled these limits in 2020 to help those affected by the pandemic.

Three Reasons You Need To Open A Solo 401 Now

High five to the smart business owner who uses a Solo 401 to lower the taxes on their S-Corp.


Nobody likes paying more taxes than they need too. Small business owners are lucky to have many opportunities to keep more of their hard-earned money through expert tax planning. One of the biggest ways to slash your tax bill if you own an S-Corp is to open a Solo 401. For those who maximize contributions, the tax savings can be in the tens of thousands of dollars per year.

As I write this in late October, many of you business owners just finished your 2018 taxes. My phone has been ringing off the hook will business owner referrals from CPAs and Tax attorneys. These business owners are dismayed at how much they ended up owing in taxes for 2018. They realized they needed to be proactive for 2019, and are looking for guidance on how to pay less in taxes this year

Tax planning for small business owners has changed under the Trump Tax plan. What you may have worked a few years ago, may not be optimal today.

Similarly, your business revenue, and hopefully profit, has grown of the past few years as well. Bigger profits further necessitate more active tax planning for your business. Bottom, the more you make, the more taxes your business will face.

1) Huge Tax Deduction

Related: How to Choose the Best Retirement Plan for your Small Business.

2) Deadline to Open a 401 in Looming

3) Great Way to Save for Your Future

Here are the Contribution Limits for a Solo 401 in 2019


See What Vanguard Assets Qualify

Eligibility is first calculated using qualifying assets for an individual client. We then combine the qualifying assets of clients sharing a residential address to determine final eligibility*.Assets that qualify

  • Any assets under management of Vanguard Personal Advisor Services.
  • Vanguard mutual funds and Vanguard ETFs held by a client in certain personal accounts qualify. Personal account types include: individual non-retirement, education savings accounts, IRAs, Joint, Trust, Custodian, Guardian, UTMA, UGMA, Estate, Sole Proprietorship, and Single-Participant SEP IRA plans.

Also Check: How Do You Take Money Out Of 401k

How Much Can I Contribute To A Solo 401

As a business owner or freelancer, you can act as two different entities the employee AND the employer. Meaning you can contribute to your Solo 401 in two ways.

The IRS caps your total contributions at $58,000 for 2020 and 2021. Your elective deferral limit is $19,500. If you are over 50, an additional $6,500 catch-up contribution is permissible.

The most your employer’s nonelective contribution can be is 25% of your compensation from the business, or until you reach $58,000 total, whichever is less.

The IRS has a useful example to illustrate how this works:

âBen, 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.â

In other words, you can contribute $58,000 into your Solo 401 without paying taxes first. This will be able to grow tax-free until itâs time to withdraw during retirement.

Keep in mind that if your business is a side-business, these limits are tied to the person, not the account. If you participate in a 401 with another company, these limits apply to contributions you make to that account as well.

Limiting Our Tax Liability

How to Set Up a Solo 401(k) in 6 Steps

Most people dont realize that they only pay for half of their FICA taxes from their own paycheck. Their employer pays the other half of the Social Security and Medicare taxes. When youre self-employed, that means paying an additional 7.65% in taxes to cover the total self-employment tax of 15.3%. Thats in addition to the income tax you pay.

As our self-employment taxes grew, we started looking for ways to reduce our tax liability. The first we did was reconfigure our business to operate as a LLC taxed as an S-Corporation. The short story is that we were now required to pay ourselves a monthly salary. While wed effectively pay self-employment tax on our salaries, the rest of our company profits are available to be taken as distributions. That money is still subject to income tax rules, but not self-employment tax.

Electing S-Corp taxation status was great, but we knew there were more ways to save. We talked to a few of our friends and discovered that we could save even more in taxes by changing how we saved for retirement. By switching from a SEP IRA to a Solo 401, we had the ability to save gobs of money for retirement while reducing our tax burden even further. That sounded great to us, and we jumped on the opportunity.

Recommended Reading: How To Recover 401k From Old Job

What Are The Contribution Limits In A Solo 401

As the employer, you can contribute up to 25% of compensation up to the annual dollar maximum of $58,000 for 2021. The IRS defines compensation as earned income, which is net earnings from self-employment after deducting one-half of your self-employment tax and contributions for yourself . You can use IRS help tools like this when deciding how much you are able to contribute.

The great thing about a solo 401 is that once the employer maxes out the contributions, you as the employee can then also max out your own contributions from your paycheck. For 2021, the maximum allowable contribution for someone under 50 is $19,500 and $26,000 for those over age 50. As long as the combined amount of employee and employer contributions do not exceed the $58,000 annual dollar limit, you can max out both contributions.

Lets use an example for illustration. Lets say with the 25% compensation maximum, you have calculated that the business can add $36,000 into your solo 401. You can now add an additional $19,500 out of your paycheck from the business, making the total amount you are able to contribute that year $55,500. This is under the $58,000 dollar limit. This is also way more than most employees get into a 401 plan in a year. Employees are usually limited to their own $19,500 maximum, plus whatever the company matches, which is not usually as high as $36,000. This is a huge benefit of a solo 401!

What To Look For In A Solo 401k

Going through the process of shopping around for a solo 401k provider, I’ve learned a lot about what to look for. There are a lot of options and nuances that you should look for when shopping for a 401k. Many of the “free” providers offer simple generic plans, and if those don’t work for you, you can have a third party provider create a custom 401k plan for your business, which you can then take to a brokerage.

Whoa, that sounds confusing, and it can be. So let’s look at the major options that you need to consider when selecting a solo 401k provider.

  • Does the 401k provider offer both Roth and Traditional contributions?
  • Does the 401k provider offer after-tax contributions to do a mega backdoor Roth IRA.
  • Does the 401k provider offer loans from the plan?
  • What types of investment options are allowed in the plan?
  • Does the provider allow rollovers into the plan and rollovers out of the plan?
  • The costs to maintain the plan
  • The costs to invest within the plan

Based on your wants and needs, there are a lot of things to compare when shopping for a solo 401k provider. Let’s compare some of the main firms that offer solo 401ks. We’re going to start with the 5 major firms that provide Prototype Plans. These are the “free” plans that the companies advertise.

Also Check: Why Cant I Take Money Out Of My 401k

Where To Open A Solo 401

For us, a Solo 401 seemed like a no-brainer. So, we looked at several different online investment brokers to see what our options were. In the end, we came back to where we started. We decide to open our Solo 401 with Vanguard. And in case you were wondering, were not paid by Vanguard in any way to say that. #notaffiliatelinks

We already had several different investments with Vanguard and had been very happy with them. We love their low fees and have never had any issues with any of our investments. Plus, we are pretty boring when it comes to our investments. We prefer to stick our money mostly in index funds and let the market work its beautiful compounding magic!

The onboarding process at Vanguard is pretty easy. Youll receive about 115 pages of documents, but the only thing you really need are the forms. Personally, I chose to have them mailed to me, but you can also download them online.

Youll be required to open your new Individual 401 using the Authorization Form and the Individual 401 Plan Adoption Agreement. After that youll the Individual 401 New Account Form to open accounts for you and your spouse. You may also wish to complete the Salary Reduction Agreement for each employee to keep your files legit. Simply complete the forms and mail them to Vanguard .

What Does The Solo 401 Allow Me To Invest In

Solo 401k Webinar – Complete “How to” Guide – Open a Self-directed Solo 401k Account at Gemini

You have a wide range of flexibility when it comes to investment strategy with a solo 401. You may choose to invest in traditional stocks, bonds, or mutual funds. However, you might also choose other options like real estate, gold coins, tax liens, promissory notes, silver, or private equity. Your financial professional or tax advisor can help you if you have any questions.

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 .

Flexibility To Choose Between Traditional & Roth

With an employer-sponsored plan, you are almost always stuck with a traditional plan. Many employers do not offer Roth plans because they are difficult to manage and maintain. A traditional 401 might not be the best option for you, and with a solo plan, you can choose which type of account you open. You might end up saving yourself thousands of dollars in tax benefits by having the flexibility to choose which type of account you open.

What Are The Drawbacks Of A Solo 401

While there are many advantages to a solo 401, there are also drawbacks. The biggest drawback of this plan is that if your business hires an employee, you must include that employee in the 401 plan, and adhere to all IRS testing requirements. This can become cumbersome and more costly for the business but isnt necessarily bad. It is just something to be aware of. You cannot hire an employee and simply exclude them from the 401 and keep it to yourself as the owner.

Another drawback, which is not much of one at all, is that once the plan assets are over $250,000, the plan owner must fill out an IRS form 5500-EZ each year. Again, not much of a hassle, just a little extra paperwork.

The Basics Of A Solo 401


A solo 401 plan is an individual retirement account designed for business owners. Heres what you need to know:

Who qualifies

To be eligible for a solo 401, you must be self-employed with no employees except your spouse.

Eligibility requirements

There are no income or age requirements to qualify. Freelancers, independent contractors and small businesses with no qualifying employees generally qualify for a solo 401.

The only caveat is that your business should be legit, ongoing and regularly attempt to turn a profit. For example, if your business consistently operates at a loss every year, and you cant show the intention to generate earned income, the IRS may classify your business as a hobby, which can impact your solo 401.

What is a qualifying employee?

The IRS defines a qualifying employee in the following ways:

  • A full-time employee working more than 1,000 hours per year
  • A part-time employee working at least 500 hours per year for three consecutive years

Contribution limits

With a solo 401, you are both the employee and employer.

  • Elective deferrals. As an employee, you can invest up to $19,500 per year, with an additional $6,500 in catch-up contributions if youre 50 or over.
  • Employer non-elective contributions. As the employer, you can contribute up to 25% of your earned income.

Tax advantages

Solo 401s can help you save for retirement and come with distinct tax benefits:

Deadline to open one

Tax status

If You’re An Employer

If you already offer a 401 plan to your employees and would like to add a designated Roth 401 option to it, your plan’s service provider or custodian should be able to help. The IRS also has information for employers on its website, irs.gov. That includes Publication 4222, 401 Plans for Small Business, and Publication 4530, Designated Roth Accounts Under 401, 403 or Governmental 457 Plans.

How To Set Up A Solo 401

Heres a quick rundown on the steps to open a solo 401:

  • Select a provider. Compare plan administrators to find a provider that fits your needs, including fees, investment options and customer experience.
  • Create your plan documents. Fill out all the employer application paperwork, including elections on your investment choices.
  • Review employee disclosures. Learn how the plan works, as well as employees rights and responsibilities.
  • Provider opens your solo 401. The account should be formed by your businesss tax filing deadline.
  • Fund your solo 401. Make contributions to your account in monthly installments or as a lump sum.
  • What information do I need?

    When completing a solo 401 application, youll need the following details handy:

    • Employer taxpayer ID number
    • Name and address of the plan administrator
    • Social Security number

    While many brokers offer $0 commissions, youre still responsible for fund expenses.

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