What is a Solo 401k?
A Solo 401k is a great retirement plan for self-employed individuals or business owners with no employees or part-time employees only. Business types such as sole proprietorships, family businesses, partnerships and corporations can take advantage of what the Solo 401k has to offer–maximized savings at a low cost and the flexibility to invest in traditional and alternative investments tax free or by deferring taxes.
There are many features of the solo 401k that make it attractive to business owners:
Alternative Assets & Equity Investments
A Solo 401k allows you to invest in many types of investments including; stocks, mutual funds, real estate, hedge funds, gold, private loans, private equity, and more.
Participant Loans
With a Solo 401k, you can take out a loan or borrow from your retirement funds. Loans can be processed from the Solo 401k at 50 of the account balance but cannot exceed $50,000.
Who is eligible to open a Solo 401k?
Any business owner and their spouse can open a Solo 401k. There can be no participation from full time employees in the business.
What type of business must I own to qualify for a Solo 401k?
Eligible businesses must:
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- Be self-employed without any employees
- Have part-time employees who work less than 1,000 hours per year
- Be trying to put away as much as possible for retirement.
Company types that can adopt a Solo 401k:
These include Sole proprietorships, Partnerships, Corporations, LLCs, and family businesses.
Solo 401k versus Self-Directed IRA
After extensive research and talking to different companies, I recommend a Solo 401k over a Self-directed IRA for the following reasons:
1. Contribution is higher with Solo401K than SDIRA.
To me, the most important difference is the contribution limits. The max for a SEP-IRA is up to 25% of compensation with a cap of $49,000. On the other hand a Solo 401(k) allows profit sharing contributions of up to 25% of compensation plus tax-deductible salary deferrals to the plan of up to $16,500. The cap is the same at $49,000.
So while the caps are the same, you can make very little self-employed income and basically defer it all, which you can’t do with the SEP-IRA. This gives you that added flexibility which is especially beneficial for those who have some self-employed income as secondary income and want to get the most tax advantages. For example, if you made $15,000 of eligible compensation, you could sock all $15,000 of it away with a Self-Employed 401(k), but only $3,750 with a SEP-IRA.
2. Solo 401k Allows for Loans
A Solo 401k loan is permitted at any time using the accumulated balance of the Solo 401k as collateral for the loan. Loans in a Solo 401k are permitted up to 1/2 of the total balance of the Solo 401k up to a maximum of $50,000.
3. Administrative burden is minimal.
There is no need to hire a custodian for a Solo 401k. While IRA & 401k plans are both technically trusts, only IRAs require a bank or trust company to serve the role of trustee. As a qualified plan, a 401k carries no restrictions on who can serve as trustee.
Trusts and trustees. 401(k) plans are funded through a trust established to hold and invest the plan’s assets. At least one trustee is appointed to have responsibility for the activities of the trust and its assets. This is a serious responsibility with considerable potential for liability. Trustees might include the business owner, an employee, or a financial or trust institution.
4. Low set up cost since you do not have to pay the typical fees that you would pay to custodians and trustees. Solo 401ks are easy to set-up and inexpensive to maintain – Unlike larger 401(k) plans, there are no complicated administrative requirements. You have to file an IRS Form 5500-EZ when plan assets exceed $250,000.
5. Flexibility and speed in investing since you bypass custodian approvals
6. Plan can be set up by 12/31 but contributions can be made up to tax extension time depending on your entity structure
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