A Solo 401(k) is perfect for sole proprietors, small businesses and independent contractors such as consultants. Any business with no employees can adopt a Solo 401(k) plan. The business can be a sole proprietorship, LLC, corporation, or partnership. A Solo 401(k) plan offers the same advantages as a Self-Directed IRA LLC, but without the need of custodian. You also do not have to establish an LLC (limited liability company).
Solo 401(k) Advantages
The Solo 401(k) plan (also known as the one participant plan) is unique and popular because it’s designed for small, owner-only business. It’s a tax-efficient and cost-effective plan that offers all the benefits of a Self-Directed IRA plan, and includes additional benefits. There are many features of the Solo 401(k) Plan that make it so appealing and popular among self-employed business owners.
Higher Contribution Limits
An IRA only allows a $6,000 contribution limit, with a $1,000 additional “catch up” contribution for those over age 50. However, the Solo 401(k) annual contribution limit is $56,000 for 2019. There’s an additional $6,000 catch-up contribution for those over 50. In addition, your spouse can make high contributions to the plan if he/she generates compensation from the business.
Under the 2019 Solo 401(k) contribution rules, a plan participant under the age of 50 can make a maximum employee deferral contribution in the amount of $19,000. Make this amount in pre-tax or after-tax (Roth). Then, on the profit sharing side, the business can make 25% contribution up to a combined maximum. This includes the employee deferral of $56,000. For a sole proprietorship or single member LLC, the contribution is 20%.
For plan participants over 50, you can make a maximum employee deferral contribution in the amount of $25,000. Again, you can make this amount in pre-tax or after-tax (Roth). The business can make a 25% profit sharing contribution up to a combined maximum. This includes the employee deferral of $62,000. For sole proprietorships or a single member LLC, the contribution is 20%.
A World of Investment Opportunities
With a Solo 401(k) Plan, you will be able to invest in almost any type of investment opportunity that you discover. Your only limit is your imagination. The income and gains from these investments will flow back into your Solo 401(k) Plan completely tax-free. Making investments with your Solo 401(k) plan are fast and simple. As trustee of the Solo 401(k) Plan, you gain complete control over your retirement assets. This allows you to make alternative investments and traditional investments tax-free and without a custodian.
IRA offers no participant loan feature, the Solo 401(k) allows participants to borrow up to $50,000 or 50% of their account value – whichever is less. You can use this for any purpose at a low interest rate. The lowest interest rate is Prime, or 5.50% as of 1/1/19. This offers a Solo 401(k) Plan participant the ability to access up to $50,000 for any purpose, such as paying a personal debt or funding a business.
“Checkbook Control” and No Custodian Fees
With a Solo 401(k) Plan, you can serve as trustee of the Plan giving you “checkbook control” over the Plan’s funds. Another significant benefit of the Solo 401(k) plan is that it does not require the participant to hire a bank or trust company to serve as trustee. This flexibility allows the participant to serve in the trustee role. As a result, all assets of the 401(k) trust are under the sole authority of the Solo 401(k) participant. A Solo 401(k) plan allows you to eliminate the expense and delays associated with an IRA custodian, enabling you to act quickly when the right investment opportunity presents itself.
Because you can open the Solo 401(k) Plan trust at any local bank or credit union, such as Chase and Wells Fargo, there’s no requirement to pay custodian fees for the account. This would be the case, however, for an IRA.
Flexible Contribution Options
Contributions to a solo 401(k) plan are completely discretionary. You always have the option to try to contribute as much as legally possible, but you always have the option of reducing or even suspending plan contributions if necessary. In other words, you have the ability to make contributions to your Solo 401(k) Plan (up to an aggregate amount of $56,000 if you are under the age of 50), but are not required to do so.
Roth Type Contributions
With IRAs, those who earn high incomes cannot contribute to a Roth IRA or convert their IRA to a Roth IRA. However, the Solo 401(k) plan contains a built-in Roth sub-account which can be contributed to without any income restrictions. With a Roth Solo 401(k) sub-account, you can make Roth type contributions while having the ability to make significantly greater contributions than with an IRA.
Cost Effective Administration
In general, the solo 401(k) plan is easy to operate. There is generally no annual filing requirement unless your solo 401(k) plan exceeds $250,000 in assets, in which case you will need to file a short information return with the IRS (Form 5500-EZ).
Offset the Cost of Your Plan with a Tax Deduction
By paying for your Solo 401(k) with business funds, you would be eligible to claim a deduction for the cost of the plan, including annual maintenance fees. The deduction for the cost associated with the Solo 401(k) Plan and ongoing maintenance will help reduce your business’s income tax liability, which will in-turn offset the cost of adopting a self-directed Solo 401(k) Plan. The retirement tax professionals at the IRA Financial Group will help you take advantage of the available business tax deduction for adopting a Solo 401(k) Plan.
Exemption from UDFI
When an IRA buys real estate that is leveraged with mortgage financing, it creates Unrelated Debt Financed Income (“UDFI”). This is a type of Unrelated Business Taxable Income (also known as “UBTI or UBIT”) on which you must pay taxes. The UBTI tax is approximately 40% for 2019. But, with a Solo 401(k) plan, you can use leverage without being subject to the UDFI rules and UBTI tax. This exemption provides significant tax advantages for using a Solo 401(k) Plan versus an IRA to purchase real estate.
Retirement Saving Consolidation through Rollovers
A Solo 401(k) plan can accept rollovers of funds from another retirement savings vehicle, such as an IRA, a SEP, or a previous employer’s 401(k) plan. Thus, you can directly rollover your IRA or qualified plan funds to your new 401(k) Plan for investment or loan purposes. Note – only Roth IRA funds cannot be rolled into a Solo 401(k) Plan.
As you can see, the Solo 401(k) Advantages are numerous and the plan should be considered by anyone with self-employment income.