Not All Solo 401(k) Plans Are The Same
March 26th, 2018
Here’s the latest article by Adam Bergman that originally appeared on Forbes.com –
A Solo 401(k) plan is not a new type of retirement plan. It is a traditional 401(k) plan covering only one employee. In general, in order to be eligible to establish a Solo 401(k) plan, one must be self-employed or have a small business with no full-time employees (over 1000 hours during the year) other than a spouse or other owner(s).
As the name implies, the Solo 401(k) plan is an IRS approved qualified 401(k) plan designed for a self-employed individual or the sole owner-employee of a corporation. It works best when there are no other employees or a very small number of employees.
One of the primary reasons the Solo 401(k) plan is so popular with the self-employed is because it includes all the attractive options of a conventional 401(k) qualified retirement plan, but without the costly administrative requirements. This is because the Employee Retirement Income Security Act of 1974 (ERISA) rules and regulations do not apply to a Solo 401(k) plan since there are no non-business owner(s) to protect. ERISA is a body of federal law that sets minimum standards for pension plans in private industry.
The growing interest in the Solo 401(k) plans is a result of the passage of the Economic Growth and Tax Relief Reconciliation Act (EGTRRA) of 2001. EGTRRA added certain features to the Solo 401(k) plan which significantly increased its appeal, such as (i) changing how salary deferral contributions are treated when calculating the maximum deduction limits for contributions, (ii) creating a Roth option, and (iii) extending the loan feature.
When it comes to determining what type of Solo 401(k) plan is best for you, it is important to look at all the options the plan provides to make sure it will satisfy your retirement planning, tax, and investment goals.
Most banks and financial institutions will provide you with complimentary Solo 401(k) plan documents for opening an account. The Solo 401(k) plan documents are important because they dictate what you can and cannot do under the plan. Accordingly, in the case of most banks and financial institutions, the plan documents will be quite basic and will typically only allow you to make pre-tax contributions and invest in the financial products they offer, such as mutual funds. For many investors, that works, as it still allows the retirement account holder to contribute up to $55,000 or $61,000 if over the age of fifty, for 2018.
However, for those self-employed individuals or small business owners seeking more retirement and investment options for his or her plan, they have choices. The Self-Directed Solo 401(k) plan has become the popular choice for such individuals.
The Self-Directed Solo 401(k) plan is generally offered by self-directed trust companies or facilitators, such as the IRA Financial Group, who are not in the business of providing investment advice or selling investment products. As a result, the plan documents typically offer the self-employed individual with very flexible retirement and investment options:
High Contribution Limits & Roth Option: Under the 2018 Solo 401(k) contribution rules, a plan participant can make a maximum employee deferral contribution in the amount of $18,500 or $24,500 if over the age of fifty. That amount can be made in pre-tax, after-tax, or 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 $55,000 or $61,000 if over age fifty.
Investment Options: Most Self-Directed Solo 401(k) plan documents will allow you to invest in almost any type of investment opportunity that you discover, subject to the prohibited transaction rules under Internal Revenue Code Sections 408 & 4975, including: real estate, private businesses, precious metals, hard money & peer to peer lending, cryptocurrency, as well as stock and mutual funds. The income and gains from these investments will flow back into your Solo 401(k) Plan without tax.
Tax and Penalty free loan: Unlike most Solo 401(k) plans offered by traditional financial institutions or banks, a Self-Directed Solo 401(k) plan typically allows plan participants to borrow up to $50,000 or 50% of their account value (whichever is less) for any purpose, including paying credit card bills, mortgage payments, or anything else. The loan has to be paid back over a five-year period; at least quarterly; and at a minimum Prime interest rate (you have the option of selecting a higher interest rate).
Over the last several years, the Solo 401(k) plan has become the most popular retirement plan for the self-employed, surpassing the SEP and SIMPLE IRA. Any self-employed individual or small business owner that is eligible to adopt a Solo 401(k) plan for his or her business should consider his or her retirement, tax, and investment goals before selecting a Solo 401(k) plan provider.