Solo 401(k) Benefits and Definition
What is a Solo 401(k)?
According to the Internal Revenue Code (Section 401), 401(k) plans are retirement saving trusts. A 401(k) Plan is an IRS (Internal Revenue Service) approved qualified retirement plan.
But what is a Solo 401(k), which is also referred to as a Self-Employed 401(k) Plan?
As the name implies, the Solo 401(k) plan is an IRS approved qualified 401(k) plan for a self-employed individual or sole owner-employee of a corporation. The plan works best when there are no other employees, or a very small number of employees.
Important retirement plan changes took place In 2001, when the Economic Growth and Tax Relief Reconciliation Act (EGTRRA) was passed. This act explains how self-employed participants with no full-time employees can benefit from a 401(k) plan.
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
Solo 401(k) Benefits for Self-Employed Individuals
The Solo 401(k) benefits for individuals who are self-employed and small business owners are numerous. If you fall under these categories, the Solo 401(k) Plan (or Self-employed 401(k) Plan) offers the ability to use your retirement funds for traditional and nontraditional investments without custodian consent.
The IRS (Internal Revenue Service) only describes the type of investments that are prohibited in a Self-Directed individual retirement account, which are very few. A major advantage of a Self-Directed IRA, such as a Solo 401(k), 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.
Additional Advantages of Using a Solo 401(k) Plan
As we said before, there are numerous benefits to establishing a Solo 401(k) retirement account. One such advantage is that the plan offers higher annual contribution limits. The Solo 401(k) annual contribution limit for 2019 is $56,000 if your age 50 and younger. The contribution limit is $62,000 if you’re 50 and older.
Do you need additional funds? Take out a loan! The Solo 401(k), or self-employed 401(k), retirement account allows you to borrow up to $50,000 for any purpose – tax and penalty-free.
The Solo 401(k) retirement plan offers most of the characteristics of the Self Directed IRA LLC, including the ability to make almost any type of investments, such as real estate. And there’s no need to establish an LLC or pay custodian fees.
It’s the most tax-advantageous retirement plan available because of its high annual contribution limits.
Am I Eligible to use the Solo 401K Retirement Plan?
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.
Use the Solo 401(k) Plan to Take out a Loan
Again, a great advantage of the Solo 401(k), also known as the self-employed 401(k) plan, is that you can use it to take out a loan. Under Internal Revenue Code Section 72(p), a Solo 401(k) 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 reason and it’s completely tax-free.
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 1/1/19, 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.
The Solo 401(k) For Real Estate Investors
Like the Self-Directed IRA LLC structure, the Solo 401K Plan offers participants the ability to invest in real estate tax-free! All income and gains generated by the investment will flow back to the 401(k) Plan without tax!
In the case of an IRA using nonrecourse debt to finance a real estate purchase, income or gains generally from the investment 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 a 40% tax for 2019. However, a 401(k) Plan using nonrecourse financing for a real estate investment is exempt from the UDFI tax (Internal Revenue Code Section 514(c)(9).
How do I Initially fund the Solo 401K 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.
How much Money Can I Contribute to the Solo 401(k) Plan?
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. Participants can make this amount in pre-tax or after-tax (Roth).
On the profit sharing side, the business can make a 25% profit sharing contribution up to a combined maximum of $56,000. And this includes employee deferral. It is 20% in the case of a sole proprietorship or single member LLC.
For plan participants over the age of 50, an individual can make a maximum employee deferral contribution in the amount of $25,000. Again, participants can make that amount in pre-tax or after-tax (Roth).
On the profit sharing side, the business can make a 25% profit sharing contribution up to a combined maximum of $62,000. And, of course, this includes the employee deferral. It is 20% in the case of a sole proprietorship or single member LLC.
For a Solo 401(k) plan, a Trustee must hold the assets of the retirement plan. In the case of the Solo 401(k), you are able to act as your own Trustee. This means you’re responsible for investing trust assets prudently and productively. In other words, as Trustee of the individual retirement 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. Note – The Trustee is prohibited from benefiting directly from the trust. The Trustee cannot co-mingle personal funds with the trust or enter into a transaction with the trust.
The Solo 401k retirement plan offers a self-employed business owner the ability to use his or her retirement funds to make almost any type of investment. This includes:
You can do this on your own without custodian consent. Again, it’s completely tax-free.
For more information on the Solo 401k 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 401(k) In A Nutshell” available on Amazon.
Get in Touch
Do you still have questions regarding the Solo 401(k) Plan 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.
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.