A Solo 401(k) is the perfect retirement plan 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 a custodian. You also do not have to establish an LLC (limited liability company).
- The Solo 401(k) is the best retirement solution for the self-employed
- Higher contribution limits allow you to save more than an IRA
- Invest in just about anything you want, plus pay no UBTI on real estate investments
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 businesses. It’s a tax-efficient and cost-effective plan that offers tons of advantages for the self-employed retirement saver. 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 $7,000 contribution limit, with a $1,000 additional “catch up” contribution for those at least age 50. However, the Solo 401(k) annual contribution limit is $66,000 for 2023. There’s an additional $7,500 catch-up contribution for those at least age 50. In addition, your spouse can make high contributions to the plan if he/she generates compensation from the business.
Under the 2023 Solo 401(k) contribution rules, a plan participant under the age of 50 can make a maximum employee deferral contribution in the amount of $22,500. Make this amount in pretax or after-tax (Roth). Then, on the profit sharing side, the business can make 25% contribution up to the combined maximum. For a sole proprietorship or single member LLC, the contribution is 20%.
For plan participants at least age 50, you can make a maximum employee deferral contribution in the amount of $30,000. Again, you can make this amount in pretax or after-tax (Roth). The business can make a 25% profit sharing contribution up to a combined maximum. 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 401k) plan completely tax free. Making investments with your 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, as well as traditional investments tax-free and without a custodian.
The only investments you cannot make with a Solo 401(k) are collectibles, and any transaction that involves a disqualified person.
IRA offers no participant loan feature, while 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 8.50% as of August 24, 2023. Best of all, you pay the loan back to yourself, including interest.
“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 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 trust are under the sole authority of the plan 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, 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 the 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, but are not required to do so.
Roth Type Contributions
With IRAs, those who have high incomes cannot directly contribute 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 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 plan and ongoing maintenance will help reduce your business’s income tax liability, which will in-turn offset the cost of adopting a 401(k) plan. The retirement tax professionals at IRA Financial will help you take advantage of the available business tax deductions for adopting the 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 (UBTI) on which you must pay taxes. The UBTI tax is approximately 37% for 2023.
However, 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. Of course, you must be the criteria for establishing the plan – you must have self-employment income, and no full-time employees (other than a spouse or co-owner).
As a self-employed individual, it’s your responsibility to save for the future. An IRA may be a good idea when you first get started, but don’t limit your opportunities down the road. Take full advantage while you can!