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What is a Solo 401(k) Plan

What is a Solo 401(k) Plan?

A Solo 401(k) or Individual Solo 401(k) is a special type of retirement plan for small business owners who don’t have any W2 employees on payroll (besides their spouse). As a tax planner and business owner myself, the solo 401(k) is one of my favorite tools to incorporate. In this guide, we will unravel how solo 401(k)s work, spotlighting their unparalleled benefits and how they can transform your tax and financial plan.

The Solo 401(k) Versus SEP IRA Debate

Before we dive in, one of the most common questions I get from business owners is “Why don’t I open a SEP IRA instead?”. While a SEP IRA shares similar contribution limits, the solo 401(k) has a critical edge: it permits employee contributions. For example, if you’re an S-Corp paying yourself a $70,000 salary, you can contribute both as an employee (up to $23,000 in 2024) AND as the employer (25% of your salary). In this case, you would be able to put in a total of $40,500 in employee and employer contributions into the plan for 2024. If you had a SEP IRA, you would only be able to put in 25% of your salary which would be $17,500.

Unique Features of Solo 401(k) Plans

But we’re just getting started. Beyond the ability to put more into the plan through employee contributions, solo 401(k) plans boast several unique features:

  • Mega Backdoor Roth Option: Solo 401(k)s can be set up to allow for voluntary after-tax deferrals. If the plan has this set up, in addition to the ability to do in plan Roth conversions, you’ll be able to execute the Mega Backdoor Roth. So, using the prior example of a solo S-Corp paying themselves a $70,000 salary, you could in theory put $23,000 in Employee contributions into the plan + $17,500 in employer contributions + $28,500 in voluntary after-tax deferrals that could be immediately converted over to a Roth Solo 401k without any additional tax consequences.
  • Auto Enrollment Tax Credit: Plans can be configured to allow for auto-contributions. This would allow you to potentially claim a $500 tax credit for up to 3 years, for a total of $1500.
  • Loan Provisions: Solo 401(k)s can offer loan options where you borrow from yourself tax free, providing a potential financial safety net for you and your business.
  • Investment Flexibility: They allow for investment in real estate and other non-traditional assets, opening up new avenues for growing your retirement nest egg. For example, you can in theory buy a rental property with assets in your Solo 401(K) plan.
  • Preserve Backdoor Roth IRA: Solo 401ks are not subject to IRA aggregation rules for the purposes of executing a Backdoor Roth IRA.

Setting Up Your Solo 401(k)

The journey to establishing a solo 401(k) is nuanced. Most people when they set up a Solo 401(k), opt for a plan from a major custodian because they are free and easy to set up, however when you do this you often limit your potential. For example, these custodians have cookie cutter language in the adoption agreements of these plans. The reason why this matters is that these plans give you the bare minimum to do employee and employer contributions. If you want to have a Roth Solo 401(k), have the ability to do the mega backdoor, do loans, buy real estate, get the auto enrollment credit, etc. you will need to work with a company to craft a custom adoption agreement for your Solo 401(k) plan. Once you have the custom adoption agreement set up, you can then use that information to set up a plan virtually anywhere you’d like.

Understanding Regulatory Requirements

Navigating the regulatory landscape of solo 401(k)s, particularly the Form 5500 filing requirements if applicable, can be daunting. In addition to this, you’ll want to make sure the language in your plan is up to date with federal regulations. An oversight here can lead to hefty penalties, underscoring the value of professional guidance when setting up and maintaining your plan.

Conclusion: The Solo 401(k) is a Game-Changer

So now you can see why I am such a huge fan of Solo 401(k)s. They are a versatile and powerful retirement and tax planning tool. While it may require a more hands-on approach to set-up and maintain, the potential tax savings and contribution flexibility likely make it a worthwhile investment in your financial future.

This article is just scratching the surface. If you are eager to explore how a solo 401(k) can benefit your financial plan and would like professional guidance, reach out to us for a complimentary hour consultation.



This information is general education only and is not to be construed as specific tax, legal or investment advice.

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