Solo 401k plans are rapidly becoming the self employed retirement plan of choice due to this plan’s advantages and benefits. Solo 401k plans are available to self employed individuals and to business owners with no full time W-2 employees other than a spouse. Sole proprietorships, partnerships, subchapter S corporations, C corporations and LLCs qualify for Solo 401k plans.
The Solo 401k is not a new type of 401k plan, but is simply a traditional 401k plan covering a business owner with no W-2 employees (other than themselves, their spouse or their partner in a partnership). A Solo 401k is much less expensive administratively then a traditional 401k that has full time W-2 employees.
Solo 401k plans were developed due to the passage of the Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA) that went into effect January 1st, 2002. The new law made several changes to the existing rules of 401k plans. These changes made the Solo 401k a very attractive retirement plan for the self employed.
Simply stated there are 2 primary advantages of the Solo 401k versus other self employed retirement plans.
- Potentially greater retirement contributions at the same income level, therefore maximizing retirement contributions and valuable tax deductions.
- The option of a 401k loan up to a maximum of $50,000 using your 401k balance for the loan.
The maximum Solo 401k contribution limit in 2015 is $53,000 and $59,000 if age 50 or older. Because of the way the contribution is calculated a larger contribution usually can be made into the Solo 401k than to a Keogh plan, SEP IRA or SIMPLE IRA at the same income level. Only the Solo Defined Benefit Plan can potentially allow a greater contribution than the Solo 401k, however a Defined Benefit Plan is much more expensive administratively and has mandatory annual funding requirements. As a result the Solo 401k is popular choice for self employed individuals who want the option of making a significant contribution and having the flexibility of completely discretionary contributions. Solo 401k plan contributions are not mandatory and can be increased or decreased or stopped on a year by year basis.
Who is eligible for a Solo 401k?
An owner only business, an owner and spouse business and partnerships are eligible for a Solo 401k. Independent contractors, self employed individuals and small business owners frequently setup Solo 401k plans.
The business owner must have the presence of self employed activity which generally would include ownership and operation of the business. It is generally believed that the IRS will consider you eligible for a Solo 401k if the business being conducted is a legitimate business that is run with the intention of generating profits.
What type of business entity can setup a Solo 401k?
Sole proprietors such as independent contractors and self employed individuals. Also eligible business entities include partnerships, LLCs, S corporations and C corporations.
Who is ineligible for a Solo 401k?
If a business owner has salaried W-2 employees age 21 or older who work more than 1,000 hours in a calendar year they are ineligible for a Solo 401k. Business owners and their spouse do not apply to the 1,000 hour threshold.
A business owner is still eligible for a Solo 401k if they hire independent contractors who work more than 1,000 hours in a calendar year.
What are the IRS rules about when and how much profit the business must generate before setting up a Solo 401k?
There are no established thresholds for how much profit the business must generate or how soon profits must happen.
What are the IRS rules about how much and when the business owner must make contributions to a Solo 401k?
The intent of the business owner must be to make significant contributions to the Solo 401k plan, however there are no established thresholds regarding how much money is required to be contributed annually. Also there are no IRS rules about how soon contributions must be made after establishing a Solo 401k plan.
I participate in a 401k through my primary employer and I have a part time business. Can I have a Solo 401k for my part time business?
Yes. You are eligible to establish a Solo 401k for a side business even if you participate in a 401k, 403b, 457 or Thrift Savings Plan through your primary employer. It is important to note that contributions made to the employer’s 401k, 403b or Thrift Savings Plan will impact the contributions for the Solo 401k. Contributions to the employer’s 401k, 403b or TSP count towards the Solo 401k salary deferral limit of $18,000 ($24,000 if age 50 or older). Contributions made into a 457 plan do not count towards the salary deferral limit. In addition to a salary deferral contribution, a business owner can also make contributions to the profit sharing portion of a Solo 401k.
Example: Jennifer is age 40 and works as a W-2 employee for ABC accounting firm and contributes $10,000 to the 401k. In addition to working at the accounting firm, Jennifer is the owner of an S corporation. She is the only employee and pays herself a $100,000 W-2 salary in 2015. Based on this information Jennifer would be eligible to make a contribution of $8,000 in salary deferrals (the $10,000 contribution to the ABC accounting firm 401k counts toward the $18,000 salary deferral limit) plus make a profit sharing contribution of $25,000 (25% of 100,000 W-2 salary) for a total of $33,000 in Solo 401k contributions in 2015.
What are the Solo 401k eligibility rules when a business owner has part time W-2 employees?
A business owner who employs part-time W-2 employees may be able to exclude them from plan participation. Generally, under federal law you are permitted to exclude the following types of employees:
- Employees under age 21.
- Employees with less than one year of service.
- W-2 employees who work less than 1000 hours per year.
- Certain union employees.
- Certain nonresident alien employees.
What type of Solo 401k does BCM setup for clients?
If you search online you will find that several types of Solo 401k plans that are available. Some of these self directed 401k plans allow investors to invest in alternative investments like gold, tax liens and real estate. Some Solo 401k plans allow you to do complex transactions in which you can buy shares of stock in your business. These 401k plans are complex, very expensive (sometimes thousands of dollars to setup and have high annual maintenance fees) and may have potential complications with the IRS.
A simple alternative to these complex plans would be to set up a Solo 401k that uses mutual funds as the investment choice within the 401k. US corporations traditionally have had mutual funds as the investment vehicle within their 401k plan and 401k participants are usually familiar with this type of investment option. A Solo 401k that uses mutual funds as the investment option can be inexpensive administratively. BCM works with several Solo 401k providers, however the Solo 401k we recommend most frequently to our clients costs $0 to setup, a $15 annual fee and a $40 fee if you request a 401k loan. Through this 401k there are 40 mutual funds to choose from ranging from conservative bond mutual funds to aggressive stock mutual funds to accommodate investors based on their age, time horizon and personal risk tolerance. Contact us and we would be happy to provide more information about this Solo 401k.
Learn more about the benefits of the Solo 401k
- 401k Loans - A 401k loan up 50% of the total value of the 401k up to a maximum loan of $50,000 is permitted with a Solo 401k plan.
- Rollover - You can rollover your 401k, 403b, 457 and Thrift savings plan from a previous employer. You can transfer a Rollover IRA, Traditional IRA, SEP IRA, Simple IRA and Keogh plan. Rollovers are often popular for those that want a 401k loan.
- Contribution Limits - In 2015 contributions of up to a maximum of $53,000 or up to $59,000 if age 50 or older can be made into a Solo 401k.
- 401k Rules - Frequently asked questions, rules and information about the Solo 401k.
- Roth 401k - There is an option to make Roth 401k contributions with the salary deferral portion of the Solo 401k. In 2015 the Roth 401k salary deferral contribution limit is $18,000 and $24,000 if age 50 or older.
- Self Employed Retirement Plan Comparison - Compare the Solo 401k, SEP IRA, Defined Benefit Plan and Simple IRA.