A Solo 401(k) plan is an IRS approved retirement plan, which is suited for business owners who do not have any employees, other than themselves and perhaps their spouse. The “one-participant 401(k) plan” or individual 401(k) Plan is not a new type of plan. It is a traditional 401k plan covering only one employee. Unlike a Traditional IRA, which only allows an individual to contribute $6,000 annually or $7,000 if the individual is over the age of 50, a Solo 401k Plan offers the Plan participant the ability to contribute up to $62,000 each year. Before the Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA) became effective in 2002, there was no compelling reason for an owner-only business to establish a Solo 401(k) Plan because the business owner could generally receive the same benefits by adopting a profit sharing plan or a SEP IRA. After 2002, EGTRRA paved the way for an owner only business to put more money aside for retirement and to operate a more cost-effective retirement plan than a Traditional IRA or 401(k) Plan.
Solo 401(k) vs. Self Directed IRA LLC
There are a number of options that are specific to Solo 401(k) plans that make the Solo 401(k) plan a far more attractive retirement option for a self-employed individual than a Traditional IRA for a self-employed individual.
1. Reach your Maximum Contribution Amount Quicker
A Solo 401(k) Plan includes both an employee and profit sharing contribution option, whereas, a Traditional IRA has a very low annual contribution limit.
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. That amount can be made in pre-tax or after-tax (Roth). On the profit sharing side, the business can make a 25% (20% in the case of a sole proprietorship or single member LLC) profit sharing contribution up to a combined maximum, including the employee deferral, of $56,000.
For plan participants over the age of 50, an individual can make a maximum employee deferral contribution in the amount of $25,000. That amount can be made in pre-tax or after-tax (Roth). On the profit sharing side, the business can make a 25% (20% in the case of a sole proprietorship or single member LLC) profit sharing contribution up to a combined maximum, including the employee deferral, of $62,000.
Whereas, a Traditional Self-Directed IRA would only allow an individual with earned income during the year to contribute up to $6,000, $7,000 is the individual is over the age of 50.
For example, Joe, who is 60 years old owns 100% of an S Corporation with no full time employees. Joe earned $100,000 in self-employment W-2 wages for 2019. If Joe had a Solo 401(k) Plan established for 2019, Joe would be able to defer approximately $50,000 for 2018 (a $25,000 employee deferral, which could be pre-tax or Roth, and 25% of his compensation giving him $50,000 for the year). Whereas, if Joe established a Traditional Self-Directed IRA, Joe would only be able to defer approximately $7,000 for 2019.
2. No Roth Feature
A Solo 401(k) plan can be made in pre-tax or Roth (after-tax) format. Whereas, in the case of a Traditional Self Directed IRA, contributions can only be made in pre-tax format. In addition, a contribution of $19,000 ($25,000, if the plan participant is over the age of 50) can be made to a Solo 401(k) Roth account.
3. Tax-Free Loan Option
With a Solo 401(k) Plan you can borrow up to $50,000 or 50% of your account value what ever is less. The loan can be used for any purpose. With a Traditional Self-Directed IRA, the IRA holder is not permitted to borrow even $1 dollar from the IRA without triggering a prohibited transaction.
4. Use Non-recourse Leverage and Pay No Tax
With a Solo 401(k) Plan, you can make a real estate investment using non-recourse funds without triggering the Unrelated Debt Financed Income Rules and the Unrelated Business Taxable Income (UBTI or UBIT) tax (IRC 514). However, the non-recourse leverage exception found in IRC 514 is only applicable to 401(k) qualified retirement plans and does not apply to IRAs. In other words, using a Self-Directed SEP IRA to make a real estate investment (Self Directed Real Estate IRA) involving non-recourse financing would trigger the UBTI tax.
5. Open the Account at Any Local Bank
With a Solo 401(k) Plan, the 401(k) bank account can be opened at any local bank or trust company. However, in the case of a Traditional Self Directed IRA, a special IRA custodian is required to hold the IRA funds.
6. No Need for the Cost of an LLC
With a Solo 401(k) Plan, the plan itself can make real estate and other investments without the need for an LLC, which depending on the state of formation could prove costly. Since a 401(k) plan is a trust, the trustee on behalf of the trust can take title to a real estate asset without the need for an LLC.
7. Better Creditor Protection
In general, a Solo 401(k) Plan offers greater creditor protection than a Traditional IRA. The 2005 Bankruptcy Act generally protects all 401(k) Plan assets from creditor attack in a bankruptcy proceeding. In addition, most states offer greater creditor protection to a Solo 401(k) qualified retirement plan than a Traditional Self-Directed IRA outside of bankruptcy.
8. Easy Administration
With a Solo 401(k) Plan there is no annual tax filing or information returns for any plan that has less than $250,000 in plan assets. In the case of a Solo 401(k) Plan with greater than $250,000, a simple 2 page IRS Form 5500-EZ is required to be filed. The tax professionals at the IRA Financial Group will help you complete the IRS Form.
9. IRS Approved
The Solo 401(k) Plan is an IRS approved qualified retirement plan. IRA Financial Group’s Solo 401(k) Plan comes with an IRS opinion letter which confirms the validity of the plan and is a safeguard against any potential IRS audit.
10. Open Architecture Plan
IRA Financial Group‘s Solo 401(k) Plan is an open architecture, self-directed plan that will allow you to make traditional as well as nontraditional investments, such as real estate by simply writing a check. As trustee of the Solo 401(k) Plan, you will have “checkbook control” over your retirement assets and make the investments you want when you want.
The Solo 401(k) plan is unique and so popular because it is designed explicitly for small, owner only business. The many features of the Solo 401(k) plan discussed above is why it so appealing and popular among self employed business owners. Choosing a Solo 401(k) vs. Self Directed IRA LLC makes sense if you are eligible.