What is a Solo 401(k) Plan?
The 401(k) is an employer-sponsored retirement plan under section 401(k) of the Internal Revenue Code. A 401(k) plan allows a worker to save for retirement while deferring income taxes on the saved money and earnings until withdrawal.
What is a Self-Directed 401(k)?
A self-directed 401(k) is technically no different than any other 401(k) or IRA. It’s unique because of the available investment options.
Most custodians only allow approved stocks, bonds, mutual funds and CDs. A truly self-directed IRA/401(k) account, such as uDirect IRA Services offers, allows those types of investments PLUS real estate, notes, private placements, tax lien certificates and much more.
What Types of Investments Are Allowed With a 401(k)?
The IRS dictates what a 401(k) cannot invest in, instead of what they can invest in. For more information regarding allowable investments, please see IRA Investment Options.
What Investments are Not Allowed?
For more information regarding the rules governing allowable investments, please see IRA Rules.
Who Can Open an Individual 401(k)?
The Individual 401k is the newest and most exciting retirement plan to benefit the self-employed, thanks to the recent tax law created by the Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA). This tax law became effective beginning January 1, 2002 and provides significant advantages to small businesses whose only employee is the owner or the owner and their spouse. These self-employed business owners can establish an Individual 401k plan and take advantage of this powerful retirement savings tool.
What makes the Individual 401k unique is that compared to other self-employed retirement plans greater contributions may be made at identical income levels, therefore maximizing retirement contributions and valuable tax deductions.
The annual Solo 401k contribution consists of 2 parts a salary deferral contribution and a profit-sharing contribution. The total allowable contribution adds these 2 parts together to get to the maximum Solo 401k contribution limit.
Solo 401k contributions are flexible. Both the salary deferral and the profit-sharing contributions are discretionary and can be changed at any time based on business profitability.
The contribution limits can be doubled for husband and wife businesses. Businesses with a spouse on the payroll can also contribute to the Solo 401k. There would be one Solo 401k for the business with two participants.
Contribution limits in a one-participant 401(k) plan
The business owner wears two hats in a 401(k) plan: employee and employer. Contributions can be made to the plan in both capacities. The owner can contribute both:
- Elective deferrals up to 100% of compensation (“earned income” in the case of a self-employed individual) up to the annual contribution limit:
- $18,500 in 2018, or $24,500 in 2018 if age 50 or over; plus
- Employer non-elective contributions up to:
- 25% of compensation as defined by the plan, or
- for self-employed individuals.
Total contributions to a participant’s account, not counting catch-up contributions for those age 50 and over, cannot exceed $55,000 (for 2018; $54,000 for 2017).
Please Discuss Contributions with Your Tax Advisor
Self-employed business owners with no W-2 employees may be well suited for an Individual 401k if their objective is to maximize their retirement contributions or if they would like to borrow from their retirement plan using their 401k balance as collateral via a tax free Individual 401k loan.
Procedure for Setting Up a Solo 401(k) Plan
A Solo 401(k) account has several moving parts. The first steps to setting up a solo 401(k) plan are to complete the Traditional Application (or the employee account) and the Solo (k) Application (or employer account). These two applications are what begins to create the Solo (k) and have any funds transferred.
The next step in the process is the creation of an EIN Application and what we refer to as a DPS Report. The DPS Report (Data Proof Sheet) is an accumulation of all the information provided on the Solo (k) Application. This is a quick way to compile all the data, and have the account holder review it for accuracy prior to setting up the Plan Binder. The EIN application is sent to the account holder for signature, to obtain an EIN number for the Solo(k) plan, as the IRS requires each entity to have its own EIN number.
After we have completed and shipped you the Plan Binder, there will be adoption documents within the Binder you will need to sign and send back to us. Once those have been signed you have officially adopted the plan. A Solo (k) Plan is not considered an active plan without these adoption documents being signed. At this point the final application is submitted, this is the Plan Participant Application. The Plan Participant Application is what generates the actual Solo (k) Plan Account number.
If you have a spouse that is a Participant in the Solo (k) Plan, your spouse will also be required to complete the Traditional Application as mentioned above, along with a Plan Participant Application. The spouse however is not required to complete a Solo (k) Application. This will generate an independent account number under the Solo (k) Plan for the spouse.
The last part in setting up a solo 401(k) plan is the actual In-House rollover of the funds placed initially in the Traditional (or employee account) into the Solo (k) account. Once these funds have been placed in the Solo (k) account you will be ready to invest.
Once the Solo 401(k) account number has been established and all the funds have been passed through the Traditional account, you no longer have a need for the Traditional account.