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Can a Sole Proprietorship Open a Solo 401(k)?

Can a Sole Proprietorship Open a Solo 401(k)?
3 Minute Read

A Solo 401(k) plan is not a new type of retirement plan. Also known as an Individual 401(k) plan, it’s basically a 401(k) plan that is not subject to the ERISA rules because the plan does not cover any full-time non-owner employees.  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, other than a spouse or other owner(s).

Simply put, 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.

Key Points
  • A sole proprietorship is the default entity of your business
  • Assuming you have no full-time employees, you can establish a Solo 401(k)
  • The Solo 401(k) plan offers multiple benefits for the self-employed over other plan options

Are you a Sole Proprietorship?

According to the IRS, “a sole proprietor is someone who owns an unincorporated business by himself or herself.” In other words, if you run a business and have not established an entity for that business, by default, you are deemed a sole proprietorship. However, if you are the sole member of a domestic limited liability company (LLC), you are not a sole proprietor if you elect to treat the LLC as a corporation.

A sole proprietorship will report its business income or loss using Schedule C on IRS Form 1040 (Federal income tax return). The main disadvantage of using a sole proprietorship to operate a business is that the business owner is not able to benefit from limited liability protection, which would be available via the establishment of an LLC or corporation.

To answer the main question, yes, you can establish a Solo 401(k) plan if you are a sole proprietorship!

What are the Eligibility Requirements for a Solo 401(k)?

A Solo 401(k) plan is well suited for businesses that either do not employ any employees or employee certain employees that may be excluded from coverage. It is the best plan for any sole proprietor, consultant, or independent contractor. To be eligible to benefit from the Solo 401(k) plan, investor must meet just two eligibility requirements:

  1. The presence of self employment activity.
  2. The absence of full-time employees.

The business owner and their spouse are technically considered “owner-employees” rather than “employees.” The following types of employees may be generally excluded from coverage:

  • Employees under 21 years of age
  • Employees that work less than a 1000 hours annually
  • Union employees
  • Nonresident alien employees

Conclusion

If you have a business and operate the business as a sole proprietorship, you would be eligible to establish a Solo 401(k) plan and take advantage of all of its benefits, including:

High Contribution Limits

For 2022, an IRA only allows a $6,000 contribution limit (with a $1,000 additional “catch up” contribution for those at least age 50). Alternatively, the Solo 401(k) annual contribution limit for 2022 is $61,000 or $67,500 for those age 50 or older.

Investment Opportunities

A Solo 401(k) lets you invest in almost anything, including real estate, private businesses, precious metals, cryptos, peer to peer lending, in addition to stock and mutual funds.

Loan Feature

Borrow up to the lesser of $50,000 of 50% of your plan value for use for any purpose without tax or penalty

Checkbook Control

Serve as trustee of the plan and get checkbook control over its funds enabling you the freedom to invest without custodian consent.

Roth Type Contributions

The Solo 401(k) has a built-in Roth sub-account, to which you can contribute up to $20,500 or $27,000 (age 50+) as the employee. The profit sharing contribution can only be made in pretax funds.

Cost-Effective Administration

There is generally no annual filing requirement unless your Solo 401(k) exceeds $250,000 in assets, in which case you will need to file a short information return with the IRS (Form 5500-EZ).

Exemption from UBTI

Use leverage for real estate and pay no UBTI, which applies only to IRAs.

Flexible Funding Options

Fund your plan via contributions or rollover from any type of retirement account, except a Roth IRA.

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[10:44 PM] Valerie Marszalek-Boik