What is a Solo 401(k)?
401(k) plans, according to the Internal Revenue Code (Section 401), are retirement savings trusts. A 401(k) Plan is an IRS approved qualified retirement plan. But what is a Solo 401(k)?
As the name implies, the Solo 401(k) plan is an IRS approved qualified 401(k) plan for a self-employed individual or sole owner-employee of a corporation. It works best when there are no other employees or a very small number of employees.
In 2001, the Economic Growth and Tax Relief Reconciliation Act (EGTRRA) was passed. This act explains how self-employed participants can use a 401(k) if they have no full time employees. It also clarifies that the self-employed 401(k) participant can make contributions as the role of employee and employer resulting in very high contribution limits.
To access these benefits an investor must meet two eligibility requirements:
1. The presence of self employment activity.
2. The absence of full-time employees.
A Solo 401(k) offers a self-employed business owner the ability to use his or her retirement funds to make several investments without custodian consent. The IRS only describes the type of investments that are prohibited, which are very few. In addition, a Solo 401(k) plan offers a high annual contribution limit (up to $61,000). It allows you to borrow up to $50,000 for any purpose, and imposes no custodian fees.
The Advantages of Using a Solo 401(k)?
The Solo 401(k) plan offers most of the characteristics of the Self Directed IRA LLC, including the ability to make almost any type of investments, such as real estate. And there’s no need to establish an LLC or pay custodian fees. The Solo 401(k) Plan is the most tax-advantageous retirement plan available because of its high annual contribution limits. The Solo 401K plan also allows you to borrow money from your retirement funds (up to $50,000). Then, you can use the funds for any purpose, including to help finance your business or pay personal bills.
Am I Eligible to use the Solo 401K Plan?
Any individual can use the Solo 401(k) plan if they’re a business owner or plan to establish a business and doesn’t have (or plan to have) full-time employees. The Solo 401(k) plan is perfect for independent contractors, such as consultants, home businesses and real estate agents. The owner’s spouse may also contribute to the plan as long as he or she is an employee of the business.
Use the Solo 401K Plan to Take out a Loan
One advantage of the Solo 401K plan is that it allows you to take out a loan from your retirement account. Under Internal Revenue Code Section 72(p), a Solo 401(k) Plan participant can borrow up to 50% of the total 401(k) value or $50,000 (whichever is less). Participants can borrow this for any reason and it’s completely tax-free.
Repayment of the loan is based on a schedule provided when the loan is initiated. It must be paid back into the account (including interest) over a term of up to five years. Also, participants must make loan payments at least quarterly and at a minimum interest rate of Prime. As of 6/26/18, the Prime interest rate as per the Wall Street Journal is 5.00%.
Failure to make the loan payments may cause a loan default causing taxes and IRS penalties.
For Real Estate Investors
Like the Self-Directed IRA LLC structure, the Solo 401K Plan offers participants the ability to invest in real estate tax-free! All income and gains generated by the investment will flow back to the 401(k) Plan tax-free!
Additionally, in the case of an IRA using nonrecourse debt to finance a real estate purchase income or gains generally from the investment will trigger a penalty tax. This is known as the Unrelated Debt Financed Income (UDFI) tax. UDFI is a type of unrelated business taxable income which, if triggered can subject the IRA to close a 40% tax for 2018. However, a 401(k) Plan using nonrecourse financing for a real estate investment is exempt from the UDFI tax (Internal Revenue Code Section 514(c)(9).
How do I Initially fund the Solo 401K Plan?
Like the Self-Directed IRA LLC, to initially fund the Solo 401(k) you may rollover funds from:
- Traditional IRAs
- SEP Plans
- Previous employer 401(k) plans
- Money Purchase plans
- Profit Sharing plans
- Keogh plans
- Defined Benefit plans
- 403(b) plans
- Rollover IRAs
You can roll over all of these funds tax-free! Accomplish this by setting up a Trust account for the Solo 401(k). Then directly transfer the funds from the current Custodian to the trust bank account. You can open the trust account at any local bank or credit union.
How much Money Can I Contribute to the Solo 401K Plan?
Under the 2018 Solo 401(k) contribution rules, a plan participant under the age of 50 can make a maximum employee deferral contribution in the amount of $18,500. Participants can make this amount in pre-tax or after-tax (Roth).
On the profit sharing side, the business can make a 25% profit sharing contribution up to a combined maximum of $55,000. And this includes employee deferral. It is 20% in the case of a sole proprietorship or single member LLC.
For plan participants over the age of 50, an individual can make a maximum employee deferral contribution in the amount of $24,500. Again, participants can make that amount in pre-tax or after-tax (Roth). On the profit sharing side, the business can make a 25% profit sharing contribution up to a combined maximum of $61,000. And, of course, this includes the employee deferral. It is 20% in the case of a sole proprietorship or single member LLC.
For a Solo 401(k) plan, a Trustee must hold the assets of the retirement plan. In the case of the Solo 401(k), you are able to act as your own Trustee. This means you are responsible for investing trust assets prudently and productively. In other words, as Trustee of the 401(k) Plan, you will have “Checkbook Control” over the Plan assets allowing you to make investments by simply writing a check from your 401(k) Trust account.
As a result, the Solo 401(k) Plan is perfect for making real estate or tax lien investments. Note – The Trustee is prohibited from benefiting directly from the trust. The Trustee cannot co-mingle personal funds with the trust or enter into a transaction with the trust.
The Solo 401k Plan offers a self-employed business owner the ability to use his or her retirement funds to make almost any type of investment. This includes:
- real estate
- tax liens
- private businesses
- precious metals
- foreign currency
You can do this on your own without custodian consent. Again, it’s completely tax-free!
For more information on the Solo 401k Plan, check out the books by IRA Financial Group’s Adam Bergman entitled “Going Solo – America’s Best-Kept Retirement Secret For The Self-Employed” and “Solo 401(k) In A Nutshell” available on Amazon.
Did you know?
You can serve as trustee of your Solo 401(k) Plan.