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The Solo 401k


I figured I would get back on an industry-related article this week as opposed to doing books reviews or getting philosophical on things.  I mean, I don’t think you want to hear me on a soapbox every week.  Let’s talk about a Solo 401k.  What’s a Solo 401k?  Well, I’m glad you asked.

As you know, I work for myself.  There are pros and cons with this.  Pros are I never have to suffer through another staff meeting where my boss spends 75% of the allocated meeting time telling me all about what he did over his long weekend.  A con is no one else wins employee of the month.

When it comes to financial items, there are also pros and cons.  One con is I do not have access to an employer sponsored retirement plan, like a company 401k.  However, on the pro side the IRS has created what is referred to as a one-participant 401k, better known as a Solo 401k.  I wanted to share some highlights of this savings vehicle as I know quite a few of my readers are solo businesses such as myself.

The Solo 401k is designed just as it sounds – it is a 401k for businesses who have no employees besides the owner, however, your spouse is permitted if they are an employee.  Contributions are pre-tax and there are no age or income limitations.  For 2019, you can contribute $56,000 (not too shabby).  If you are 50 years old there is the catch-up bonus of $6,000.  Just like a traditional employer sponsored 401k, distributions from Solo 401ks are treated like ordinary income.  Please remember, your contributions are before taxes (reduce your immediate tax bill) and Uncle Sam will eventually get his share.

I want to stress you need to confirm your Solo 401k contribution with your CPA and CFP®.   Why?  Well, because that $56,000 contribution is based on employee and employer contribution calculations.  The short version is you as an employee of your own business can contribute $19,000, or 100% of compensation, whichever is less.  However, the employer contribution is a profit-sharing calculation based on compensation or net self-employment income.  

Now, you can open a Solo 401k at most brokerages, such as Vanguard and TDAmeritrade.  However, be sure to talk to them about whether they have any specific rules.  For example, if you happen to have an old SEP IRA balance and you want to roll it into your Solo 401k at Vanguard, they will only allow it if the SEP IRA is also at Vanguard.  This is not a federal rule, but an internal one at Vanguard.

There is also a Roth Solo 401k option.  Similar to a Roth IRA, contributions are made after taxes and distributions are tax-free.   If you think your income will be the same or higher in retirement, it may make sense to opt for the Solo Roth option.   Otherwise, if your expectation is for lower taxes in retirement you may want to take the traditional route and get your reduced taxes now by making pre-tax contributions to your Solo 401k.

One final note, the IRS requires what is called a form 5500-SF if your Solo 401k balance reaches $250,000 or more in assets at the end of the year.  This isn’t super complex, however, there will be a reasonable cost to have someone prepare the form.  

So, while as a solo employee you may miss out on company picnics and being able to talk about the latest Game of Thrones episode around the water cooler, know you at least one have great retirement savings tool available to you as your own boss.