What is a Solo 401(k) Plan?

Created by the Economic Growth and Tax Relief Reconciliation Act of 2001, or EGTRRA, the Solo 401(k) was designed specifically to give lone-wolf entrepreneurs a better shot at joining the world of tax-deferred retirement savings. Thus, its restrictions.

A self-employed 401(k) is basically limited to companies with one employee - the owner - although spouses can also contribute to the plan. Partners or shareholders can be included in the plan as well. In some cases, the company can have part-time employees who are excluded from the plan, as long as they work less than 1,000 hours a year, or (under certain circumstances) belong to a union or are non-resident aliens. But as a rule of thumb, as soon as the company takes on full-time employees who aren't married to the boss (or bosses), the self employed 401(k) will have to be converted to a cumbersome traditional 401(k) plan. In other words, The Solo 401(k) plan is available to any individual who is already a business owner or who will be establishing a sole proprietorship and does not have, or plan to have, full-time employees. The plan is well suited for consultants, home businesses and independent contractors. The owner’s spouse may also contribute to the plan.

For the salary deferral portion in 2012, you can contribute the regular 401(k) maximum of $17,000 (with an additional $5,500 if over the age of 50 at year end). And, you can add up to 25% of compensation for the profit-sharing portion. The combined maximum of these contributions can’t exceed $50,000, plus catch-up additions, if applicable ($55,500 if over the age of 50). Also, your Solo 401(k) Plan can be designed with a “designated Roth component”, if you desire it allowing you to make Roth type contributions (after-tax) to your Solo 401(k) Plan.

Under the 2013 new Solo 401(k) contribution rules, a plan participant under the age of 50 can make a maximum employee deferral contribution in the amount of $17,500. That amount can be made in pre-tax or after-tax (Roth). On the profit sharing side, the business can make a 25% (20% in the case of a sole proprietorship or single member LLC) profit sharing contribution up to a combined maximum, including the employee deferral, of $51,000, an increase of $1,000 from 2012.

For plan participants over the age of 50, an individual can make a maximum employee deferral contribution in the amount of $23,000. That amount can be made in pre-tax or after-tax (Roth). On the profit sharing side, the business can make a 25% (20% in the case of a sole proprietorship or single member LLC) profit sharing contribution up to a combined maximum, including the employee deferral, of $56,500, an increase of $1,000 from 2012.

The Solo 401(k) plan accepts two types of contributions: salary deferrals and a profit sharing contribution. Both contributions are generally tax deductible and they grow tax deferred until withdrawals which may begin penalty-free after age 59 1/2. Withdrawals after age 59 1/2 are taxed as ordinary income. Withdrawals must begin at the age of 70 1/2 (this rule would not apply to the designated Roth component of the Plan).

As with the Checkbook IRA, in order to initially fund the Solo 401(k) you can 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 and Rollover IRAs. This is accomplished by setting up a Trust account for the Solo 401(k) and directly transferring the funds from the Custodian to the trust bank account.

A Trustee must be designated to hold the assets of the retirement plan. In the case of the Solo 401(k), you are able to act as your own Trustee and are charged with investing trust assets prudently and productively. Legally barred from benefiting directly from the trust, the Trustee cannot co-mingle personal funds with the trust and cannot enter into a transaction with the trust.

IRS qualified retirement plans under ERISA are required to have a written 401(k) plan document that establishes the provisions of the plan. This plan must be put into place, with rules and guidelines that state how the plan will operate. While the plan itself is lengthy, the Summary Plan Description explains, in plain terms, how the plan works.

The plan document has a loan provision permitting you to take out a loan. You are able to borrow up to 50% of the total 401(k) value up to a maximum of $50,000, tax free. Repayment of the loan is according to a loan amortization schedule provided when the loan is initiated and must be paid back into the account (including interest). Failure to make the loan payments may cause a loan default causing taxes and IRS penalties.

Please contact one of our 401(k) Experts at 800-472-0646 for more information.