Your Solo 401k Beneficiaries Carefully Explained
As the owner of a Solo401k plan, you are the administrator as well as the trustee of your plan. This means you have total control over the plan. Not only do you decide where your retirement savings are invested, but documenting your Solo 401k beneficiaries that will inherit your plan is also important.
Among different retirement accounts, naming Solo 401k beneficiaries is especially important. Without a named beneficiary, the account could end up in probate and may not be distributed according to your wishes. To help you plan for the distribution of your Solo 401k, here we cover how to designate a primary beneficiary, a contingent beneficiary, and the tax implications.
You may also be interested in the article Succession Planning and the Solo 401k.
Primary 401k Beneficiaries: Your Spouse
Naming a spouse as the primary Solo 401k beneficiary is the most common designation for account owners. If the business sponsoring the Solo 401k will continue operating, the spouse can simply move the existing account into their name. But the spouse does have multiple options. If he or she is self-employed, they could roll over the Solo 401k funds to their own Solo 401k or transfer to another qualified plan. Alternatively, they can roll over to an IRA in their name or an inherited IRA . The spouse can also take a full distribution at the time of the Solo 401k account owners death. However, different rules apply depending on which option is selected.
If the spouse continues operating the business in their name, rolls it over into an existing Solo 401k in their name, or transfers to another qualified plan, the rule for that particular plan should apply. If a spouse chooses an inherited IRA, this can allow the spouse to take distributions from the account without a 10% penalty for early distribution if they are under age 59 ½. This beneficiary election requires an IRA rollover and subjects the account to Required Minimum Distributions using the spouses life expectancy table. A beneficiary IRA of this type cannot be consolidated with other retirement plans in the spouses name.
Should I Choose A Traditional Or Roth Solo 401
For many investors, deciding between a traditional or Roth solo 401 comes down to whether you believe youre in a lower tax bracket today than you will be in retirement. If you think you are paying lower taxes now, you might choose a Roth solo 401. If you anticipate being in a lower tax bracket in retirement, a traditional solo 401 may be a better bet.
Theres another wrinkle with a Roth solo 401 account: You can only contribute up to $19,500 in 2021 , plus catch-up contributions of $6,500 if youre 50 or older. If youre able to save more than this amount, you will need to contribute the extra into a traditional solo 401 account. You can make both employer and employee contributions to a solo 401, but your employer contributions cannot be saved in a Roth account.
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How To Open An Individual 401 Without An Employer
For decades most people assumed that they would find a job after college, work hard for 30-40 years, and retire comfortably with a pension. But that assumption has long since gone by the wayside. Pensions are largely a thing of the past in the private sector, job stability is not what it used to be, and retirement saving is now almost solely the responsibility of employees themselves.
Not only do people today hop from job to job more often than in the past, many more are even joining the ranks of the self-employed. While there are many advantages to being your own boss, there are numerous drawbacks too.
First and foremost among them is that by being self-employed, you dont have access to retirement plans that employees at many companies do. A workplace 401, employer matching, and all those other benefits are something that you dont have when you work for yourself. But if you thought you wouldnt be able to take advantage of tax-advantaged retirement savings options as a self-employed person, youd be wrong.
Those who are self-employed are eligible to set up whats known as a solo or individual 401. Its essentially a 401 plan just for you, and investing in it allows you many of the same benefits as those who invest through a workplace 401 plan. If youre self-employed and wondering how to start saving for retirement, you might look into setting up a solo 401 plan for yourself.
Solo 401 Tax Advantages
All 401 plans offer tax advantages. How that works with a solo 401 depends on the type you use.
Traditional solo 401: One of the advantages of a traditional solo 401 is that you can reduce your taxable income. For instance, “if your income is $80,000 and you defer $20,000 into your solo 401, you would have an adjusted tax base of $60,000 on your W-2,” Lee says.
The money you invest grows tax-deferred until retirement, and you’ll pay taxes when you distribute the funds.
Roth solo 401: Unlike a regular Roth IRA, there are no income limits with a Roth solo 401. And Lee stresses that one of the advantages is that you fund the account with after-tax earnings. “This is a beautiful thing because you will never have to pay tax on the money that grows.”
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What Alternatives Are There To A Solo 401
If you’re on the fence about opening a solo 401, here are some other options you can consider:
- A Simplified Employee Pension IRA is a good option for anyone who’s self-employed. This plan comes with much higher contribution limits than a traditional IRA.
- Keogh plan: Keogh plans are retirement plans for self-employed individuals and come with high contribution limits. However, there are more administrative tasks than you’ll find with other plans.
- Traditional IRA: With a traditional IRA, you can let your money grow on a tax-deferred basis. You won’t pay taxes on the savings until you begin withdrawing the funds at retirement.
- Roth IRA: With a Roth IRA, your money will grow tax-free, and you won’t have to pay any taxes at retirement. And you’ll have the flexibility to use your contributions for certain qualified expenses.
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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Can A Solo 401 Buy Real Estate
The investment opportunities in real estate include foreclosures, short sales, rental homes, vacation rental properties, raw land, commercial real estate, first trust deeds, commercial paper, mortgage notes, hard money lending, tax liens, and more.
When using mortgage financing for leveraged investments in real estate, a Solo 401 does not have to pay tax on Unrelated Debt-Financed Income if the real estate loan meets the requirements noted in the IRS publication about IRS Code section 514.
Besides real estate, investment in an alternative asset is also possible such as cryptocurrencies, precious metals, commodities, futures, options, oil and gas leases, venture deals, hedge funds, private equity, and private debt.
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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Contact Us Today For A Free Consultation
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.
Who Qualifies For A Solo 401
The rules to qualify for a Solo 401 are straightforward and more flexible than a Simple IRA account. A person must have self-employment income from their business efforts. Self-employment may be full-time or part-time. A Solo 401 plan participant may earn W-2 wages from self-employment, profit sharing, or IRS form 1099 income as an independent contractor.
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Drawbacks To The Solo 401
The solo 401 has the same drawbacks of typical 401 plans, plus a couple others that are specific to itself. Like other 401 plans, the solo 401 will hit you with taxes and penalties if you withdraw the money before retirement age, currently set at 59½. Yes, you can take out a loan or may be able to access a hardship withdrawal, if needed, but those are last resorts.
In addition, it can take more paperwork to open a solo 401, but its not especially onerous. You usually wont be able to open the account completely online in 15 minutes, as you would a typical brokerage account. Plus, youll need to get a tax ID from the IRS, which you can do online quickly. On top of this, youll have to manage the plan, choose investments and ensure that you dont exceed annual contribution limits.
Another wrinkle: Once you exceed $250,000 in assets in the plan at the end of the year, youll need to start filing a special form with the IRS each year.
These drawbacks arent especially burdensome, but you should be aware of them.
Make Contributions To Your Solo 401
Once all the paperwork is completed and the disclosures are reviewed, its time to fund your account. Most providers will accept a check, wire transfer, or automated clearing house payment to fund the Solo 401. Its up to you to decide whether you want to make monthly installments or fully fund the account in one lump-sum payment.
There are two pieces to the contribution strategy with a Solo 401. First, you are allowed to contribute up to $19,500 from your salary. If you are over 50 years old, you can contribute an additional $6,500. The second piece comes from the employer as a profit-sharing contribution of up to 25% of your net self-employment income. This earned income is your net profit minus your plan contribution to the Solo 401 and one-half of your self-employment tax.
The limit on compensation that can be used to determine your contribution is $290,000 in 2021. Consult your tax advisor to develop an optimal strategy thats IRS-compliant. Penalties for excessive contributions are applied in the year the contribution is made and when the money is distributed, so its important to get your contribution correct.
Once your account reaches $250,000 in assets, youll have new requirements, including filing Form 5500 with the IRS. If you ever hire employees who become eligible for your plan, youll need to make adjustments to accommodate these new participants.
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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 .
How To Start A Solo 401
Follow the steps below if you’re interested in opening up a solo 401.
Once you’ve done these four things, you may begin choosing your investments and making regular contributions to your account. You can also roll over funds from other retirement accounts in your name if you choose.
You must make your solo 401 employee contributions by Dec. 31, but you have until the tax filing deadline for the year — usually April 15 of the following year — to make your employer contribution.
One last thing to note is that if you have $250,000 or more in your solo 401 by the end of the year, you’re required to submit a Form 5500-EZ information return to the IRS with your taxes for that year so you don’t run into trouble with the federal government.
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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.
You Can Rollover Previous 401s
Lastly, you can rollover your old 401s-even from previous employer-sponsored plans-into your Solo 401.
When managing your retirement savings, consolidating your accounts makes it easy to monitor how well your investments are performing.
Beagle does the hard work for you to find your old 401s, identify any hidden fees you might be paying, and gives you advice on how best to consolidate them. for free to get started organizing your retirement accounts.
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How To Contribute To The Solo 401k
The real difference between a Solo 401 and a traditional 401 is that you can make two types of contributions: employer contribution and employee contribution. This gives you the ability to increase your retirement savings faster.
If you are under the age of 50, you can make a maximum employee contribution in the amount of $19,000. The business can make a 25% profit sharing contribution up to a combined maximum of $56,000. This includes the employee contribution. For a sole proprietorship or single member LLC, the contribution is 20%.
For individuals 50 and over, you can make a maximum employee contribution in the amount of $25,000. Again, the business can make a 25% contribution 20% in the case of a sole proprietorship or single member LLC. The combined maximum contribution is $62,000.