Is A Solo 401 Right For Me
If you bring in any self-employment income, a solo 401 could be a good option for you. The plan comes with a broad range of investment options and high contribution limits. And if your spouse is involved, you can maximize your contributions and save money quickly.
According to Lee, a solo 401 works well for married couples and small professional services firms. However, she reiterates that it won’t work if you have even one employee.
Td Ameritrade Solo 401k
TD Ameritrade is another low cost brokerage that offers a prototype free solo 401k plan. Their plan is the hardest to dissect, but here is what we could gather. However, after discussing their plan with them, here is what we found.
The TD Ameritrade solo 401k plan does allow both traditional and Roth contributions. They also allow loans from their solo 401k plan. We couldnt get a clear answer on what types of rollover options they allow into and out of their solo 401k plan.
Looking at their plan document, they only allow rollovers from 401, 401, 403, 403, 408, and 457 accounts.
They also offer a lot of investment choices within their 401k plan. For example, they offer Vanguard ETFs commission free.
There are no setup fees or annual account fees with TD Ameritrades plan. All regular trades within the 401k are subject to their standard commission which is $0 per stock, ETF, and option trade. However, even beyond the Vanguard ETFs, they offer other ETFs commission free as well.
Learn more about in our TD Ameritrade Review.
Should You Do A Roth Solo 401k
One of the options that’s become important is allowing for a Roth solo 401k. Surprisingly, many brokerage firms currently don’t allow a Roth solo 401k, but it can be a valuable option.
When it comes to your solo 401k, it’s important to remember that you have two aspects of contributions to your plan:
Where a Roth option comes in handy is if you’re looking for tax diversification. With Roth contributions, you are using post-tax money. So, you will pay more in taxes today, but you will pay less in the future. However, if you’re putting in large profit sharing contributions into your solo 401k, then it might make sense to make Roth contributions.
The reason? It will give you tax diversification in retirement. You can choose whether you use taxable or tax free money in the future – and options are always great.
The important thing to remember here is options. You just want the options to be able to invest how you choose.
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Prototype Plan Vs Custom Plan
Once you understand what options you want for your solo 401k plan, its time to discuss plan documents.
See, your solo 401k really has two parts:
When it comes to the solo 401k plan documents, you can either use a prototype plan, or create your own custom plan.
A prototype plan is typically offered by the brokerage firms that offer free solo 401k plans. They are called prototype plans because they are very generic plans that were created by a lawyer, and anyone can use them. However, because these are generic plans, they might not offer all of the options youre looking for in a solo 401k.
For example, Fidelitys solo 401k plan doesnt offer a Roth solo 401k option. Vanguards solo 401k plan doesnt offer loans from your 401k. As such, you need to carefully consider the options available in a prototype solo 401k. E*Trade offers the most robust prototype solo 401k plan.
On the other hand, you can create a custom solo 401k plan. This is where you pay a company to draft you plan documents that are custom to your needs. The reason you create this is because you want to invest in alternative assets like real estate.
Other options include:
Keep Your Solo 401k Investments Passive
What is a passive investment? Passive investing methods seek to avoid the fees and limited performance that may occur with frequent trading. Passive investings goal is to build wealth gradually. Also known as a buy-and-hold strategy, passive investing means buying a security to own it long-term.
Here are some of the most popular passive investments that can be a part of your Solo 401k:
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What’s So Great About 401 Accounts
A 401 is a popular type of employer-sponsored retirement plan that’s available to all employees 21 or older who have completed at least one year of service with the employer, usually defined as 1,000 work hours in a plan year. Some employers enable new employees to join right away, even if they haven’t met this criterion yet.
In 2021 you’re allowed to contribute up to $19,500 to a 401 or up to $26,000 if you’re 50 or older. In 2020, those amounts rise to $20,500 and $27,000. These limits are much higher than what you find with IRAs, and they enable you to set aside a fairly large sum annually.
Most 401s are tax deferred, so your contributions reduce your taxable income each year. You must pay taxes on your distributions in retirement, but you may be in a lower tax bracket by then, in which case you would save money. Some employers also offer Roth 401s. You pay taxes on contributions to these accounts now, but you’ll get tax-free withdrawals in retirement.
Some employers also match a portion of their employees’ 401 contributions, which can make the task of saving for retirement a little easier. Each company has its own rules about matching, so consult with your HR department to learn how yours works.
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.
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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.
How To Open A Traditional And Roth Solo 401k
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Employer Profit Sharing Contribution:
The employer profit sharing contribution is a percentage, much like a SEP IRA. Its 20% of your self-employment income or W-2. If youre a C corporation, S corporation or partnership, its 20%.
When you combine your employee and employer contribution, you can reach a maximum contribution of $56,000 if youre under 50 and $62,000 if youre over 50.
Open An Account With Your Provider
Once you have chosen a provider and have obtained all required documents and disclosures, you can open your solo 401 account. This account should be opened before your tax-filing deadline and following guidelines in your plan documents.
While youre allowed to set up a Solo 401 account after the year ends and make prior-year contributions similar to IRA funding, its best to set up a new account in the year that itll be effective and make your first contributions in the same year.
IRS-mandated funding deadlines:
- Employee contributionsRoth, catch-up, or regularmust be made within the business tax year
- Employer contributions can be made by the tax deadline for the previous year
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Talk To Hr About Enrolling In Your 401
If you’re interested in opening a 401, talk with your employer to learn about how your company’s plan works. Some employers automatically enroll employees and withhold a default amount of their paychecks, which you can change yourself at any time. You can also opt to stop contributing to the plan if you’re not interested in doing so right now.
Other companies require participants to declare their desire to participate in the 401. You’ll have to fill out paperwork saying that you’d like to contribute to the plan and how much money you’d like to set aside initially. You can always change this later.
You’ll also need to choose your beneficiary — the person you’d like to inherit your 401 if you die — when you sign up. Usually you choose a primary beneficiary and a secondary, or contingent, beneficiary who will inherit the 401 if the primary beneficiary is deceased or doesn’t want the money.
Who Qualifies For A Solo 401k Plan
There are two main eligibility requirements: one is that you must be self-employed, and the second is that you must earn self-employment income.
You can typically fit the first requirement if youre a freelancer, sole-proprietor, business owner without any employees , or independent contractor. The second requirement, self-employment income, can be verified through tax records.
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How To Start A 401
Setting up a 401 plan can be as simple or as complicated as you like. Most people outsource at least some portion of the process. In particular, they use a template legal document to establish the 401 plan, which is substantially less expensive than hiring attorneys to draft original documents. Unless your retirement plan is especially complicated or youre trying to get fancy , youll probably use preconfigured programs from 401 vendors. These programs are often called volume submitter or prototype plans, and theyre an excellent choice for most companies and nonprofits. Here are the crucial pieces of any 401 plan. While this list seems extensive, in some cases, a single company provides several of these services.
The plan document is a legal document that details the rules of your 401 plan. It defines specific terms, and provides a roadmap for any questions that come up when administering the plan. The plan document is a long legal document that most people never see. Instead, employees receive a shorter version of the document, known as the Summary Plan Description , when they enroll in the plan. For reference, heres a sample of a plan document.
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Did You Know?
Solo 401k plans with checkbook control are IRS approved, and they can be used to invest in more areas than traditional plans. Investments can be made in cryptocurrency, tax liens, mortgages, and the real estate market, as well as many other opportunities. The sky is the limit. Contact us today to get started.
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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.
Solo 401k Rules For Multi
A multi owner LLC or partnership is a very common business structure. If you have one, you may be wondering, can I still have a Solo 401k even though my business has multiple owners who are not me or my spouse? The answer is yes! As usual, you just need to stay within the rules. With a multi-member LLC we can simply exclude the other partners from your Solo 401k plan by role title. We just need the other partners role titles, such as president or secretary. These should be listed in your LLC operating agreement
When we exclude the other role titles from your plan, this keeps your Solo 401k truly solo and separate from your other partners. Just the same, each partner can have their very own Solo 401k plan with the other partners excluded. Each plan can include the partners spouse whos plan it is.
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Find A Solo 401 Provider
The most critical step in the setup process is finding the right solo 401 provider. The best solo 401 providers should provide a simple, straightforward, affordable plan. You should choose a provider that can also support your business as it grows and its needs change.
When choosing a solo 401 provider, you should consider these three factors:
- Costs: Choose a provider with manageable and competitive fees. Be sure to compare the fees of multiple providers to find the most affordable plan that matches your business needs.
- Level of management: Some providers will offer hands-on management for a monthly or annual fee, assisting you with regulatory and compliance filings. However, not all providers actively administer solo 401 plans. Consider the level of management needed from your provider before choosing.
- Investment flexibility: Choose a provider that gives you access to the investment options you want in alignment with your financial needs.
If you already have an investment account or IRA plan, ask your current provider if they offer solo 401 plans. Otherwise, choose a provider that offers factors that align with your personal needs.
If I Offer A 401 To My Employees Are There Compliance Regulations I Must Follow Or Can The Retirement Plan Provider Help With These
Certain employers who offer 401 and other retirement plans must abide by the Employee Retirement Income Security Act of 1974, as amended, which helps ensure that plans are operated correctly and participants rights are protected. In addition, a 401 plan must pass non-discrimination tests to prevent the plan from disproportionately favoring highly compensated employees over others. The plan fiduciary is usually responsible for helping comply with these measures.
This information is intended to be used as a starting point in analyzing employer-sponsored 401 plans and is not a comprehensive resource of all requirements. It offers practical information concerning the subject matter and is provided with the understanding that ADP is not rendering legal or tax advice or other professional services. For specific details about any 401 they may be considering, employers should consult a financial advisor or tax consultant.
Unless otherwise agreed in writing with a client, ADP, Inc. and its affiliates do not endorse or recommend specific investment companies or products, financial advisors or service providers engage or compensate any financial advisor or firm for the provision of advice offer financial, investment, tax or legal advice or management services or serve in a fiduciary capacity with respect to retirement plans. All ADP companies identified are affiliated companies.
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