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Beginner’s Guide to Solo 401k

beginner's guide to Solo 401(k)

If you have interest in establishing a Solo 401(k), you’re most likely self-employed, or someone who makes a portion of your income through self-employment activities. You may also be a small business owner with no full-time employees. If so, you can take advantage of a Solo 401k. But what exactly is a Solo 401k? This beginner’s guide to Solo 401k is a great place to start. Here, we’ll explain what it is and just how you can benefit.

What is a Solo 401k Plan?

Some people call it an individual 401(k) or self-directed 401(k). Some even call it the one-participant 401(k). While it comes with many names, it provides one function, which is to benefit self-employed individuals, small business owners, contractors, etc. The Solo 401k is a retirement plan that’s similar to a traditional 401(k). The main difference is it only covers one employee. However, it has the same rules and requirements as a traditional 401(k). The Internal Revenue Service created it for sole owners of a corporation and self-employed individuals. If you have employees, you can’t contribute to a Solo 401k, according to the IRS. But the plan does cover you and your spouse, if he/she is a partner in your business.

You may ask, why not use an IRA for your retirement funds? Learn more about that in Solo 401(k) How Can I Benefit.

SEP IRA, SIMPLE IRA or Solo 401k?

Why is the Solo 401k, (or individual 401(k)) better than a traditional IRA, SEP IRA or SIMPLE IRA?

With the Solo 401k:

  1. You can save more money
  2. Have more options to grow your retirement account
  3. It’s cheap and easy to overseas in comparison to the other retirement accounts
  4. Borrow more money for investments tax-free and without penalties
  5. Access to a Solo 401(k) loan feature

Furthermore, you don’t have to start an LLC, which can be costly, particularly depending on where you live. You become the trustee and can make any investment decisions you wish to make. Also, most states offer better creditor protection for the Solo 401k than a traditional IRA, so you gain strong creditor protection. Your assets are also protected against creditor attack in a bankruptcy proceeding.

Should You Choose Roth?

You have two types of Solo 401k retirement plans. The Solo 401k is pre-tax. However, you have the Roth option, which is after-tax. As you may know, you only have the pre-tax option with a traditional IRA (yet another benefit of the Solo).

If you choose Roth, you most likely know that the money in your retirement account will accumulate tax-free. So, when you withdraw at retirement age, you pay no additional taxes. This can be a benefit to many. Of course, with the Solo 401k, your retirement account is tax deferred. So, although you pay taxes when you withdraw at retirement, you don’t pay taxes for your investments.

Learn More: Benefits of a Roth Solo 401(k)

Contribution Limits

A Solo 401k has two types of contributions:

  1. Employee: Because you are self-employed, you’re essentially an employee. Therefore, you have the deferral contribution.
  2. Employer: With the Solo 401k, you are also seen as the employer. As a result, you have the profit-sharing contribution.

For 2022, the Solo 401k contribution limit is $61,000 with a $6,500 catch-up contribution if you’re 50 and older.

Deferral Contribution: As employee, you can contribute up to $18,500 or all of your compensation – whichever is less.

Profit-sharing Contribution: As employer, you can also contribute an additional 25% of your compensation.

Prohibited Transactions

There are certain transactions you cannot make with your Solo 401k account. These are called the prohibited transaction rules. The IRS has to ensure that you aren’t taking advantage of the tax benefits provided to you. The main goal of the retirement account is to contribute funds and watch it grow, and the IRS makes certain you’re participating in activities that benefit the growth of your retirement account.

Most prohibited transactions, however, involve disqualified persons. But what is a disqualified person?

Disqualified Persons

The IRS states the following as disqualified persons.

  • You
  • A trustee (or custodian)
  • Owner of the business who establishes the Solo 401k Plan (you, most likely)
  • Employee organization covered by the Solo 401k Plan
  • 50% owner the business or employee organization
  • Family member (excluding brothers, sisters, aunts, uncles, cousins, step-siblings and friends)
  • Partnership, corporation, trust or estate more than 50% owned by you, a trustee/custodian, employee organization, and 50% owner of the business that establishes the 401(k) or the employee organization whose members are covered by this retirement plan
  • 10% owner, officer, director or highly compensated employee of the business, employee organization, 50% owner of the business or employee organization, or the partnership, corp., trust or estate

Along with disqualified persons, there are prohibited assets. These assets are ones you cannot purchase with the funds from your retirement account.

  • Works of art
  • Metal or gems
  • Alcoholic beverages
  • Rugs and antiques
  • Stamps
  • Most coins

Diversify Your Assets & Take the Next Step Towards Retirement with a Solo 401(k)

At IRA Financial Group, we know that Self-Directed retirement plans, such as the Solo 401k may be somewhat daunting. This is especially the case when you get into the prohibited transaction rules and disqualified persons. This area is somewhat murky, as the IRS doesn’t tell you what you can invest in – only what you can’t invest in. We hope this Beginner’s Guide to the Solo 401k retirement plan was helpful, but when you’re ready to talk about establishing a Solo 401k, you can speak to one of our specialists at 800-472-0646.


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