A Solo 401(k) plan is an IRS-approved retirement plan, which is designed for the self-employed and small business owner without full-time employees. It has become the most popular retirement plan for the self-employed, largely because one can contribute as much as $66,000 ($73,500 if at least age 50), borrow up to $50,000 tax-free, as well as gain the ability to make alternative investments as the trustee. This is the reason some business owners inquire about establishing multiple Solo 401(k) plans. This article will explore the major advantages of the plan and then explain why the IRS controlled group rules limit most business owners from establishing more than one Solo 401(k) plan.
- Technically, you are permitted to have two or more Solo 401(k) plans
- Due to the controlled group rules, there’s really no advantage in having multiple plans
- If you have a workplace retirement plan, AND self-employment income, having multiple 401(k) plans make sense
The Solo 401(k) Advantages
Any business owner who is self-employed and does not have any employees that work more than 1,000 hours, excluding a spouse or other partner, can set-up a Solo 401(k) plan. Below are the chief reasons the Solo 401(k) plan has become the most popular retirement plan for the self-employed:
For 2023, the maximum one can contribute to an IRA is $6,500 (with a $1,000 additional “catch up” contribution for those age 50+). The Solo 401(k) annual contribution limit is $66,000 with an additional $7,500 catch-up contribution. In addition, if your spouse generates compensation from the business, he or she can also make high contributions to the plan.
Based on the 2023 contribution rules, a plan participant under the age of 50 can make a maximum employee deferral contribution in the amount of $22,500. That amount can be made in pretax 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) contribution up to a combined maximum, including the employee deferral, of $66,000.
If you are at least age 50, you can make that additional catch-up contribution of $7,500 as the employee, for a total of $30,000. Added to the profit sharing, you may contribute up to $73,500 this year.
The Loan Feature
You are not allowed to borrow a single penny from an IRA. However, if your plan documents allow for it, you can borrow up to $50,000, or one-half of your account balance (whichever is less) from your 401(k). The loan can be used for any purpose and is tax- and penalty-free. Interest rates are much lower than a traditional bank loan, and that interest is paid back into the plan.
Related: Solo 401(k) Loan Option
Self-Directed Investment Options
When you self-direct your 401(k) plan, you can invest in almost anything you want. You’re only limited by the IRS prohibited transactions, which include collectibles and transactions involving a disqualified person. You can invest in any kind of real estate, both foreign and domestic, residential and commercial, precious metals & coins, private businesses, tax liens, cryptos, investments funds, and so much more.
A growing number of business owners are attracted to the Solo 401(k) plan in order to gain the ability to invest in alternative investments and better diversify their retirement portfolio.
Related: Solo 401(k) Investments
Use Leverage to Buy Real Estate without Tax
If you are interested in holding real estate in your retirement plan, the Solo 401(k) is the best option because it is exempt from UDFI. Unrelated Debt-Financed Income is a type of tax assessed when using leverage to make a real estate investment. However, that only applies to IRAs, since the Internal Revenue Code (IRC) exempts this form of UBTI tax from 401(k) plans.
Related: Popular Investments in a Solo 401(k)
Own Two Businesses and Want Two Solo 401(k) Plans?
Because of the enormous benefits of establishing a Solo 401(k) plan, the question often arises if a business owner with two or more businesses can establish two or more Solo 401(k) plans. The answer is…maybe?
The IRC established its Controlled Groups Provisions as part of the Revenue Act of 1964. A control group relationship exists if the businesses have one of the following relationships:
- Combination of the above
- Affiliated Service
A parent-subsidiary controlled group exists when one or more chains of corporations are connected through stock ownership with a common parent corporation; and 80 percent of the stock of each corporation, (except the common parent) is owned by one or more corporations in the group; and Parent Corporation must own 80 percent of at least one other corporation. For example: John owns 100% of Corporation A, which owns 90% of Corporation B = controlled group rules will apply. This means that the IRS will treat company A and Company B as one corporation for purposes of the 401(k) plan. In other words, all employees in Company A and Company B would be eligible to be part of any 401(k) plan established by either company.
A brother-sister controlled group is a group of two or more corporations, in which five or fewer common owners (a common owner must be an individual, a trust, or an estate) own directly or indirectly a controlling interest of each group and have “effective control.”
- Controlling interest – 1.414(c)-2(b)(2) – generally means 80 percent or more of the stock of each corporation (but only if such common owner own stock in each corporation); and
- Effective control – 1.414(c)-2(c)(2) – generally more than 50 percent of the stock of each corporation, but only to the extent such stock ownership is identical with respect to such corporation
IRC Section 414(m) was enacted to expand the idea of control to separate, but affiliated, entities. Proposed Treas. Reg. § 1.414(m) provides that all employees of the members of an affiliated service group shall be treated as if they were employed by a single employer. The affiliated service rules are very broad and complex and essentially groups together a set of companies that are somewhat interconnected.
Hence, if a business owner has two or more business that will be deemed parent-subsidiary, brother-sister, or treated as affiliated, the controlled group rules would apply and treat all companies as one for purposes of 401(k) eligibility. In other words, all eligible employees of these businesses would need to be offered plan benefits. While, having two or more plans would be okay, it would not offer any additional benefit.
Double Dipping 401(k) Contributions
The primary reason a business owner would want to establish two plans is to be able to make excess 401(k) plan contributions. The issue is that IRC Section 402(g) limits the employee deferral amount per individual, not per plan. This means even if one were able to establish two or more plans, once the individual reached the maximum 402(g) limit, no additional employee deferral contributions would be allowed.
However, in the case of the employer profit sharing contribution, that amount is per plan, which could make having multiple plans advantageous. The problem is that the IRS controlled group rules, as explained above, would limit a business owner’s ability to have two businesses treated as unrelated, for purposes of 401(k) contributions. Although, it is possible.
Generally, this would occur when one has a “regular” job at a business, plus additional self-employment income on the side. In that instance, you can contribute to your full-time 401(k) plan as the employee, and then use a Solo 401(k) for your side job. You could make profit sharing contributions to that plan, plus top off your elective deferral if you did not max it out with the regular 401(k) plan.
While having two or more Solo 401(k) plans is technically possible under certain circumstances, the benefit of doing so is often underwhelming. Because of the controlled group rules, it’s going to be hard to treat two separate businesses as separate for 401(k) contribution advantages. Of course, if you work both a regular job and have self-employed income, you can take advantage of multiple plans.
The one benefit of the controlled group rules is that you can combine multiple business incomes to reach the maximum contribution faster. Additionally, your 401(k) contributions do not affect any IRAs you may have; you can still contribute the maximum allowed to your IRA, in addition to maxing out your 401(k).