Banking » Investing » What Is a Solo 401(k) And How To Open An Account?
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What Is a Solo 401(k) And How To Open An Account?

Learn about Solo 401(k)s: how do they work, their advantages, eligibility criteria, and a simple roadmap to opening one.
Author: Baruch Mann (Silvermann)
Baruch Mann (Silvermann)

Writer, Contributor

Experience

Baruch Silvermann is a financial expert, experienced analyst, and founder of The Smart Investor.  Silvermann has contributed to Yahoo Finance and cited as an authoritative source in financial outlets like Forbes, Business Insider, CNBC Select, CNET, Bankrate, Fox Business, The Street, and more.
Interest Rates Last Update: June 3, 2024
The banking product interest rates, including savings, CDs, and money market, are accurate as of this date.
Author: Baruch Mann (Silvermann)
Baruch Mann (Silvermann)

Writer, Contributor

Experience

Baruch Silvermann is a financial expert, experienced analyst, and founder of The Smart Investor.  Silvermann has contributed to Yahoo Finance and cited as an authoritative source in financial outlets like Forbes, Business Insider, CNBC Select, CNET, Bankrate, Fox Business, The Street, and more.
Interest Rates Last Update: June 3, 2024

The banking product interest rates, including savings, CDs, and money market, are accurate as of this date.

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Table Of Content

What Is a Solo 401(k)?

A Solo 401(k) is a retirement savings account designed specifically for self-employed individuals and small business owners with no full-time employees, besides potentially their spouse.

It functions similarly to a traditional employer-sponsored 401(k), offering tax advantages and the potential for tax-deferred growth on your contributions.

Here's a breakdown of its key features:

Sole proprietors, freelancers, independent contractors, and small businesses with part-time employees or contractors who work less than 1,000 hours per year.

Also, part-time employees working at least 500 hours per year for 3 consecutive years are qualified.

Solo 401(k)s offer tax advantages depending on the chosen plan type:

  • Traditional Solo 401(k): Contributions are tax-deductible, reducing your current taxable income, but withdrawals in retirement are taxed as ordinary income.
  • Roth Solo 401(k): Contributions are made with after-tax dollars, so they are not tax-deductible in the year of contribution. However, qualified withdrawals in retirement are tax-free.

Contribution limits for Solo 401(k)s consist of two components: employee salary deferral contributions and employer profit-sharing contributions.

As of 2024, individuals under 50 years old can contribute up to $23,000 annually as elective deferrals, while those 50 and older can make an additional catch-up contribution of $7,500, bringing their total elective deferral limit to $30,500.

On the employer side, contributions can be made up to 25% of net self-employment income (or compensation if incorporated) for sole proprietors, or 20% of net earnings for partnerships and LLCs.

The combined total of employee and employer contributions cannot exceed $69,000 for individuals under 50 or $76,500 for those 50 and older in 2024.

Pros and Cons

Similar to other self employed retirement accounts, the solo 401(k) has its own set of pros and cons:

Pros
Cons
High Contribution Limits
Administrative Burden
Tax Benefits
Limited to Self-Employed Individuals
Flexibility
Employer Contributions Required
Loan Option

Solo 401(k) plans allow for substantial contributions, potentially allowing individuals to save more for retirement compared to other retirement plans for the self-employed.

Contributions to a Solo 401(k) are typically tax-deductible, reducing taxable income in the year of contribution. Additionally, investment earnings within the plan grow tax-deferred until withdrawal.

Solo 401(k) plans offer a wide range of investment options, including stocks, bonds, mutual funds, and even alternative investments like real estate or precious metals, providing flexibility to tailor investments to individual goals and risk tolerance.

Many Solo 401(k) plans allow participants to borrow from their account balance, providing access to funds in times of need without early withdrawal penalties.

Unlike employer-sponsored 401(k) plans, Solo 401(k)s require the individual to handle administrative tasks, including plan setup, record-keeping, and annual reporting.

Solo 401(k) plans are designed for sole proprietors, freelancers, and small business owners with no full-time employees other than a spouse, restricting eligibility for businesses with employees.

Unlike SEP-IRAs, which allow for discretionary employer contributions, Solo 401(k) plans require mandatory employer contributions based on income, potentially increasing financial obligations for the business owner.

How To Open a Solo 401(k)?

Opening a Solo 401(k) involves several steps, but the process can be relatively straightforward.

1. Choose a Provider

Start by selecting a financial institution or provider that offers Solo 401(k) plans. Look for a reputable provider that offers competitive fees, a wide range of investment options, and excellent customer support.

Common providers include banks, brokerage firms, mutual fund companies, and specialized retirement plan providers.

2. Complete the Plan Documents

Once you've chosen a provider, you'll need to complete the necessary plan documents to establish your Solo 401(k) plan.

These documents typically include an adoption agreement and a plan document, which outline the terms and conditions of the plan, including contribution limits, investment options, and distribution rules.

Some providers may offer pre-drafted plan documents, while others may require you to customize the plan to fit your specific needs.

3. Fund the Account

After completing the plan documents, you'll need to fund your Solo 401(k) account.

You can typically fund the account through contributions from your self-employment income, including salary deferrals and employer contributions.

Ensure that you adhere to the contribution limits set by the IRS to avoid any penalties or tax implications.

4. Choose Investments

With your Solo 401(k) account established and funded, you can start investing your contributions.

Most providers offer a wide range of investment options, including stocks, bonds, mutual funds, ETFs, and more. Consider your risk tolerance, investment goals, and time horizon when selecting investments for your retirement portfolio.

It's also essential to regularly review and adjust your investment strategy as needed to stay on track toward your retirement goals.

5. Maintain Compliance

Once your Solo 401(k) plan is established, it's crucial to stay compliant with IRS rules and regulations to avoid penalties and maintain the tax-advantaged status of your account.

This includes annual reporting requirements, such as filing Form 5500-EZ if your plan exceeds certain asset thresholds, as well as ensuring that contributions and distributions comply with IRS guidelines.

Withdrawal Rules and Penalties

Withdrawal rules and penalties for a Solo 401(k) are subject to specific regulations set forth by the Internal Revenue Service (IRS). Here's an overview of the key withdrawal rules and penalties associated with Solo 401(k) plans:

  • Age Restrictions: Generally, withdrawals from a Solo 401(k) are subject to age restrictions. Participants must typically reach age 59½ to take distributions from their Solo 401(k) plan without incurring early withdrawal penalties.

  • Early Withdrawal Penalty: If a participant withdraws funds from their Solo 401(k) before reaching age 59½, they may be subject to an early withdrawal penalty of 10% on the amount withdrawn unless the reason for withdrawal falls under the IRS exceptions. 

  • Required Minimum Distributions (RMDs): Participants in Solo 401(k) plans are generally required to begin taking required minimum distributions (RMDs) from their account by April 1st, following the year they reach age 72 (or 75 for those born after 1950). Failure to take RMDs as required may result in substantial penalties.

Solo 401(k) Rollover Rules and Options

Rollover rules and options for a Solo 401(k) allow participants to transfer funds from their existing Solo 401(k) account to another retirement account without incurring taxes or penalties. Here are the key rules and options:

  • Direct Rollover to Another Retirement Account: Participants can directly transfer funds from their Solo 401(k) to another eligible retirement account, such as a Traditional IRA, Roth IRA, or another employer's retirement plan, through a trustee-to-trustee transfer. This type of rollover is not subject to income taxes or early withdrawal penalties.
  • Indirect Rollover: Alternatively, participants can choose to take a distribution from their Solo 401(k) and then roll over the funds to another retirement account within 60 days. With an indirect rollover, the participant receives the distribution check, and they must deposit the funds into the new retirement account within the 60-day window to avoid taxes and penalties.
  • Limitations on Rollovers: It's important to note that not all retirement accounts accept rollovers, and there may be limitations or restrictions on the types of funds that can be rolled over.

Before initiating a rollover, we recommended participants to consult with a financial advisor or tax professional to understand the implications, tax consequences, and eligibility requirements associated with different rollover options.

Solo 401(k) Alternatives For Small Business Owners

For small business owners or self-employed individuals who are considering retirement savings options beyond a Solo 401(k), several alternatives exist.

Each alternative offers unique features and benefits, catering to different needs and preferences.  Here are some common alternatives:

A SEP-IRA allows employers to make tax-deductible contributions to retirement accounts for themselves and their employees.

It's easy to establish and has high contribution limits, making it suitable for small businesses with employees.

 A SIMPLE IRA is designed for small businesses with 100 or fewer employees. It offers employer contributions, and employees can make salary deferral contributions. While it's less complex than a traditional 401(k), it has lower contribution limits.

FAQs

No, you cannot have both simultaneously. Solo 401k is for self-employed individuals with no full-time employees (except a spouse) who wouldn't be eligible for an employer-sponsored 401k.

No, partnerships are not eligible for Solo 401k plans. They can explore other options like SEP IRAs or traditional employer-sponsored 401k plans.

Yes, you can have both a Solo 401k and a Roth IRA. They cater to different contribution limits and tax advantages, allowing you to diversify your retirement savings strategy.

Generally, Solo 401k to Roth IRA conversions are not allowed due to the limitations and regulations specific to each plan type.

Solo 401(k) contributions for a given tax year generally need to be made by the business's tax filing deadline, including extensions.

For traditional Solo 401k plans, employer contributions are tax-deductible, reducing your current taxable income. However, Roth Solo 401k contributions are made with after-tax dollars and are not tax-deductible.

Yes, a single-member LLC can have a Solo 401(k) as long as the business owner has no full-time employees other than a spouse.

Yes, a spouse can contribute to a Solo 401(k) if they earn income from the business.

Picture of Baruch Mann (Silvermann)

Baruch Mann (Silvermann)

Baruch Silvermann is a financial expert, experienced analyst, and founder of The Smart Investor.  Silvermann has contributed to Yahoo Finance and cited as an authoritative source in financial outlets like Forbes, Business Insider, CNBC Select, CNET, Bankrate, Fox Business, The Street, and more.
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