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Retire Smarter with a Solo 401K

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If you’re self-employed, you may be eligible to take advantage of one of the most powerful retirement tools on the market. This plan is called a Self-directed Solo 401K (Solo-K) and it can help you save more for retirement than a traditional 401K.

June 18, 2020
Author: Amber Ornelas

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What’s a Solo-K and how does it work?

A Solo-K is an IRS-approved and qualified 401k plan. Designed for self-employed sole proprietors and owners of corporations or an LLC, a Solo-K follows the same rules and requirements as any other 401(k) plan. But unlike a traditional 401k, you’re allowed to make contributions as both the employee and the employer. As a result, there are very high contribution limits.

To be eligible to benefit from this plan though, you must meet two requirements:

  • The presence of self-employment activity.
  • The absence of full-time employees.

Better still, if you and/or your spouse are the sole owner(s) of the business, you can both contribute to your individual accounts!

Contribution Limits of a Solo-K

Contribution limits for Solo 401(k) plans are subject to annual adjustments by the IRS and are determined by the type of contributions being made. These include the following:

Elective Deferrals

Elective deferrals are made by the individual from their salary or self-employment income. The limit is tied to the overall 401(k) contribution limit set by the IRS. Individuals under 50 years old can contribute up to $19,500 per year in elective deferrals, while those aged 50 and above can contribute an additional $6,500, bringing their total elective deferral limit to $26,000. 

These contributions are made on a pre-tax basis, reducing your taxable income for the year.

Employer Contributions

In addition to elective deferrals, the Solo-K allows for tax-deductible employer contributions. The maximum allowable employer contribution is 25% of your net self-employment income if you operate as a sole proprietorship or single-member LLC or 20% of your net self-employment income if your business is a corporation or multi-member LLC.

However, the total contribution (elective deferrals plus employer contributions) cannot exceed $66,000 (for individuals under 50) or $76,500 (for individuals 50 and older).

How to Calculate Your Solo-K Contribution

  1. Determine Your Net Self-Employment Income: This is your total income from self-employment activities minus any allowable business expenses and deductions. It forms the basis for your contribution calculation.
  2. Calculate Your Elective Deferrals: Individuals under 50 can contribute up to $19,500 in elective deferrals to their Solo 401(k). If you’re 50 or older, you’re eligible for higher-up contributions of up to $6,500. However, the total elective deferral limit is $26,000. 
  3. Calculate Your Employer Contributions: You can contribute up to 25% of your net self-employment income if you operate as a sole proprietorship or single-member LLC, or 20% if your business is structured as a corporation or multi-member LLC. 
  4. Combine Elective Deferrals and Employer Contributions: Add your elective deferrals to your employer contributions to determine your total Solo 401(k) contribution for the year. Make sure this total does not exceed the annual contribution limits set by the IRS.
  5. Submit Your Contribution: Once you’ve calculated your contribution, you can contribute to your Solo 401(k) account. You have until the tax filing deadline, which is on April 15 of the following year, to make contributions for the current tax year.

What are the advantages of a Solo-K?

  • Higher Contributions— Make annual contributions up to $54,000 with an additional $6,000 catch-up contribution for those over age 50.
  • Tax-And Penalty-Free Borrowing— Borrow up to $50,000 or 50% of your account value (whichever is less) for any purpose. You must pay back loans within 5 years.
  • Checkbook Control— 100% checkbook control over your retirement funds. Use what you need, when you need it. Simply write a check.
  • Easy Administration— You are the trustee of the plan.
  • Expanded Investment Options— You can invest in real estate, private lending, limited liability companies, precious metals, and more!
  • Exemption from UDFI— With a Self-Directed Solo 401k plan, you can use leverage to purchase real estate, which may be exempt from UDFI rules and UBTI tax.
  • Consolidate Accounts— You can transfer most of your other retirement accounts into your Solo-K. This includes you 401k from another employer, SIMPLE IRA, SEP IRA, 403(b), 457(b) or Traditional IRA). You cannot transfer existing Roth funds.

Potential Drawbacks of a Solo-K

  • Complex Setup: Establishing a Solo-K can be more complex and time-consuming than other retirement plans, especially if you want to take advantage of its checkbook control and expanded investment options.
  • Administrative Responsibilities: As the trustee of the plan, you are responsible for ensuring compliance with IRS regulations, including filing annual reports, maintaining accurate records, and following contribution limits.
  • Contribution Requirements: Higher contribution limits are advantageous but require consistent cash flow to maximize contributions. If your income fluctuates, meeting the contribution requirements may be challenging.
  • Limited Eligibility: Solo-Ks are designed for self-employed individuals or small business owners with no full-time employees (except for a spouse). If your business grows and you hire employees, you may need to switch to a different retirement plan.

Solo-K FAQs

Which is/are the best type/s of retirement plan for SMB owners?

For sole proprietors or small business owners with no employees other than themselves or a spouse, Solo 401(k) plans are ideal for their high contribution limits and flexible investment options. Alternatively, SEP IRAs, SIMPLE IRAs, or traditional 401(k) plans might make more sense for businesses with employees.

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Am I allowed to borrow from a SEP IRA, SIMPLE IRA, or 401(k)?

Although rules can vary depending on the type of plan and the plan’s specific terms, you can borrow from a 401(k) plan, including Solo 401(k)s, subject to certain restrictions and limitations. However, borrowing from SEP IRAs or SIMPLE IRAs is typically not allowed.

How much can an SMB owner contribute to a 401(k)?

SMB owners can contribute to a 401(k) plan based on their net self-employment income for Solo 401(k)s or their business structure and compensation for traditional 401(k)s. For Solo 401(k)s, the owner can contribute up to $19,500 (or $26,000 if 50 or older) in elective deferrals, plus employer contributions up to 25% of net self-employment income. Contribution limits for traditional 401(k)s are subject to IRS regulations and plan-specific rules.

Are there compliance regulations for offering my employees a 401(k)?

Yes. These regulations include nondiscrimination testing to ensure the plan does not favor highly compensated employees and compliance with IRS reporting and disclosure requirements. Employers must also fulfill their fiduciary responsibilities, including selecting and monitoring investment options and ensuring that plan fees are reasonable.

The Bottomline

As a business owner, you don’t deserve to go the traditional route with a run-of-the-mill 401(k) or IRA. Consider opening a Self-Directed Solo-K LLC (Solo-K) instead, and let the experts here at NCH facilitate the process from start to finish. 

Turn your dream business into a reality with the help of NCH. Our asset protection strategies are second to none, from business entity formation to accounting and taxes, building business credit, and estate planning, which have proven to help businesses launch and grow.

Contact us today or call 1-800-508-1729 to get started within 24 hours!

DISCLAIMER: The above material has been prepared for informational purposes only and contains the provider’s opinions. It is not intended to provide tax, legal, or accounting advice and should not be relied on for such advice. Please consider consulting tax, legal, and accounting advisors before engaging in any transaction.

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