What is a Solo 401(k) Plan?

A Solo 401(k) plan is a 401(k) qualified retirement plan that was designed for self-employed individuals and small business owners with no full-time employees, excluding a business partner and spouse. Much like the traditional 401(k), this unique plan encourages individuals to save for retirement in a tax-advantaged environment. When participants contribute funds into the Solo 401(k), taxes on the funds will be deferred until the participant takes a qualified distribution.

The Solo 401(k) is an IRS-approved plan that has the same rules and requirements as a traditional employer-sponsored 401(k). However, the Solo 401(k) allows participants to make annual contributions to the plan as both an employee and employer, which ultimately increases the yearly maximum contribution limit.

Also known as a self-employed 401(k) or individual 401(k), individuals can benefit even if they generate a portion of their total income through self-employment activities, such as a freelance gig. What are the Benefits of the Solo 401k?

Am I Eligible?

If you’re a business owner with no full-time employees, or you earn self-employment income, you can establish a Solo 401(k). The Solo 401(k) plan is perfect for independent contractors, such as consultants, home businesses and real estate agents. If you qualify for the Solo 401(k) retirement plan, your spouse can also contribute as long as he or she is an employee of the business.

Did you know you can adopt a Solo 401(k) plan even if you have a full-time job? As long as self-employment income exists, you can establish a Solo 401(k).

Popularity of Retirement Plan

Important retirement plan changes took place in 2001, with the passing of the Economic Growth and Tax Relief Reconciliation Act (EGTRRA). This act explains how self-employed participants with no full-time employees can benefit from a Solo 401k.

Additionally, the EGTRRA clarifies that the Self-Employed 401(k) participant can make contributions as both employee and employer. This results in very high contribution limits.To access these benefits, an investor must meet two eligibility requirements:

1. The presence of self employment activity

2. The absence of full-time employees

What are the Benefits of the Solo 401(k) Plan?

The Solo 401(k) plan provides many benefits to individuals who are eligible for the plan, including the ability to make higher contributions. For example, the total annual contribution for a Solo 401(k) is $66,000 for participants who are under 50. Participants who are age 50 and over can contribute up to $73,500 to the plan in 2023. This is because the Solo 401(k) has two types of contributions:

• Employee salary deferral contribution: Employees can contribute up to $22,500
• Employer profit-sharing contribution: Depending on the type of entity of your business, you may contribute either 20% or 25% of your income as the employer.

Catch-up contributions allow individuals age 50 and older to contribute up to $73,500 to the plan.

Additional benefits of the Solo 401(k) plan include:

• $50,000 tax and penalty-free loan (or 50% of account value, whichever is less) to be used for any purpose.
• Ability to make alternative investments, such as real estate and traditional investments, such as stocks.
• No need to establish a Limited Liability Company (LLC) to make investments, which can be costly.
• Exemption from UBTI tax when using leverage for real estate investments.
• Stronger creditor protection than individual retirement accounts (IRAs).
• Not subject to ERISA rules, as the business of the Solo 401(k) holder does not have employees.
• Cost-effective and easy administration.

A major advantage of a self-directed retirement account, such as a Solo 401(k) retirement plan, is that you no longer have to make stock market investments. With this type of retirement account, you can make investments in real estate, tax-liens, private funding, and more. Essentially, you can invest in assets you know and understand.

For Real Estate Investors

Like the Self-Directed IRA structure, the Solo 401(k) plan offers participants the ability to invest in real estate tax-free. That means, all income and gains you generate from your investments will flow back to the 401(k) plan without tax.

In the case of an IRA using non-recourse debt to finance a real estate purchase, income or gains from the investment typically will trigger a penalty tax.

This is known as the Unrelated Debt Financed Income (UDFI) tax. UDFI is a type of unrelated business taxable income which, if triggered, can subject the IRA to close to a 40% tax for 2023. However, a 401(k) Plan using non-recourse financing for a real estate investment is exempt from the UDFI tax.

Why not Use an Individual Retirement Account (IRA)?

The Solo 401(k) is an IRS approved retirement plan that was specifically designed for self-employed individuals and small business owners with no full-time employees other than themselves, a business partner and perhaps their spouse. There are more advantages of establishing a Solo 401(k) over an IRA.

Other benefits of the Solo 401(k) vs a Traditional IRA include:

• Tax-Free Loan Option: Borrow up to $50,000 or 50% of your account value (whichever is less) to use for any purpose.
• Easy Administration: There is no annual tax filing or information returns for a plan that does not exceed $250,000 in assets.
• No need to establish an LLC: LLCs can be costly, especially depending on which state you live in. With a Solo 401(k), the trustee (you) can make investments without the need of an LLC.
• Strong Creditor Protection: Most states offer better creditor protection for this retirement plan than a Traditional IRA. Additionally, Individual 401(k) Plan assets are protected against creditor attack in a bankruptcy proceeding.
• Roth After-Tax Benefit: You have two formats with a Solo 401(k): pretax, or Roth (after-tax). With a Traditional IRA, you only have the option of pretax. With the Roth option, your money can grow in its retirement account tax-free. And of course, when you withdraw at retirement, you pay no additional taxes.
• Non-recourse Leverage Exception: You can invest in your own business and real estate investments without penalty. By using non-recourse funds, you won’t trigger the Unrelated Debt Financed Income Rules and the Unrelated Business Taxable Income (UBTI and UBIT). This exception doesn’t apply to IRAs.

Compare the Solo 401(k) to other individual retirement accounts:

• Solo 401(k) vs. Self-Directed IRA
• Solo 401(k) vs. SEP IRA
• Solo 401(k) vs. SIMPLE IRA

Use the Plan to Take out a Loan

A great advantage of the Solo 401(k) is that you can use it to take out a loan tax and penalty-free. Under Internal Revenue Code Section 72(p), a Solo 401k Plan participant can borrow up to 50% of the total 401(k) value or $50,000 (whichever is less). Participants can borrow this for any purpose, such as paying off debt or funding your business.

Repayment of the loan is based on a schedule provided when the loan is initiated. You must pay the loan back (including interest) over a term of up to five years. Participants must make loan payments at least quarterly and at a minimum interest rate of Prime. As of 08/30/22, the Prime interest rate as per the Wall Street Journal is 5.50%.

Failure to make the loan payments may cause a loan default causing taxes and IRS penalties.

How do I Initially Fund the Solo 401(k) Plan?

Like the Self-Directed IRA LLC, to initially fund the Solo 401(k) you may rollover funds from:

• Traditional IRAs
• SEP Plans
• Previous employer 401(k) plans
• Money Purchase plans
• Profit Sharing plans
• Keogh plans
• Defined Benefit plans
• 403(b) plans
• Rollover IRAs

You can roll over all of these funds tax-free. Accomplish this by setting up a Trust account for the Solo 401(k). Then directly transfer the funds from the current Custodian to the trust bank account. You can open the trust account at any local bank or credit union.

Read More: Solo 401(k) Contribution vs. Rollover

How Much Can I Contribute to My Solo 401(k) in 2023?

Annual contributions as an employee to the Solo 401(k) plan in 2023 cannot exceed $22,500 for participants under age 50 and $30,000 if 50 and older. Contributions made as an employee is known as the “elective deferral.”

As an employee of a self-employed business or small business with no full-time employees (other than an owner or a spouse), you have the option to make the Employee Contribution. This is also known as the Elective Deferral. For 2023, the Solo 401(k) maximum contribution limit for the elective deferral is 22,500 if you’re under age 50. This is a $2,000 increase from the 2022 contribution limit. Whereas, the elective deferral contribution if you’re 50 and older is $30,000, an increase of $3,000. Employee deferral contributions can be made in pretax or Roth.

The 2023 Solo 401(k) plan states that an individual who is under the age of 50 can make a maximum employee deferral contribution in the amount of $22,500. If you qualify, you can make this contribution pretax or after-tax. This is great when you reach retirement age and your taxable income is most likely lower.

If you’re under 50, you can also benefit from the plan on the profit sharing side – your business can make a 25% contribution. In other words, you can take out 25% of your business’ profits and place it into your Solo 401(k). In the case of a sole proprietorship or single member LLC, it’s a maximum 20% profit sharing contribution of $66,000 in 2023. If age 50 or older, it’s $73,500. These contribution numbers include the employee deferral contribution.

A Solo 401(k) Plan Gives You More Options

One of the many benefits of using a Solo 401(k) is that you grow your retirement account by diversifying your investments. The Solo 401(k) retirement plan investments are similar to investments you can make with a self-directed IRA. Step away from traditional investments and spend your money on new opportunities. This can include real estate, tax liens, raw land, rentals, foreclosures, etc. This is possible if you choose a Self-Directed Solo 401(k) Plan.

All income and gains on these investments go back to your Individual 401(k) Plan tax-free. As trustee, you have full control to make any investment you want without custodian consent.

Are contribution options flexible? Absolutely. You can make contributions for any purpose. You also have the option to invest as much as legally possible, reduce, or suspend investments. Basically, you can make contributions but there’s no requirement to do so.

Cheap and Easy Administration

People find the Solo 401(k) more attractive because of how easy it is to manage. Unless it is higher than $250,000 in assets, there are no filing requirements. If it does exceed that amount, then you must file Form 5500-EZ. This is a short information form that you to send to the IRS. If you wanted to, you could establish a Solo 401(k) at a traditional financial group, such as Vanguard. However, you don’t receive the same flexibility as if choosing IRA Financial Group’s Solo 401(k) Plan, or a plan from another self-directed IRA company.

The benefits of IRA Financial Group’s Solo 401(k) Plan vs Vanguard’s Solo 401(k) Plan are noteworthy:

• IRA Financial Group’s Individual 401(k) Plan allows for the conversion of a traditional 401(k) or 403(b) account to a Roth – such is not the case with Vanguard
• Vanguard offers no loan feature, whereas we allow you to borrow up to $50,000 or 50% (whichever is less) from your IRA account
• At Vanguard, you have no checkbook control, therefore, you’re restricted to traditional investments
• Your Individual 401(k) Plan account must be opened at Vanguard – at IRA Financial Group, you can open your account at any local bank

The Trustee

In a Solo 401(k) plan, a Trustee must hold the assets of the retirement plan. You can act as your own trustee in the Solo 401k plan. This means you’re responsible for investing trust assets prudently and productively.

In other words, as Trustee of the individual 401(k) plan, you will have “Checkbook Control” over the Plan assets. This allows you to make investments by simply writing a check from your 401(k) Trust account.

As a result, the Solo 401(k) Plan is perfect for making real estate or tax lien investments. However, the Trustee is cannot benefit directly from the trust. Additionally, the Trustee cannot co-mingle personal funds with the trust or enter into a transaction with the trust.

It’s important to educate yourself on the Prohibited Transaction Rules with a Solo 401(k) retirement plan. Prohibited transaction rules explain what you can and cannot invest in, as well as other transactions the IRS deems prohibited.

It also sheds light on disqualified persons. Below offers a glimpse into the disqualified persons of a self-directed 401(k) retirement plan.

Disqualified Persons: 

The Solo 401(k) benefits self-employed business owners by giving them the ability to use their retirement funds to make almost any type of investment. That includes many non-traditional investments, such as:

• real estate
• tax liens
• private businesses
• precious metals
• foreign currency

You can do this on your own without custodian consent. Again, it’s completely tax-free.

For more information on the Solo 401(k) retirement Plan, check out the books by IRA Financial Group’s Adam Bergman entitled “Going Solo – America’s Best-Kept Retirement Secret For The Self-Employed” and “Solo 401k In A Nutshell” available on Amazon.

Get in Touch

Do you still have questions regarding the Solo 401(k) benefits that were not covered in this article? Contact IRA Financial Group at 800-472-0646. Or fill out the form to speak with a 401(k) specialist.