Solo 401k plans offer self-employed individuals an excellent way to invest their retirement funds independently and protect against debts.
Your business must not employ anyone for your Solo 401k to be eligible. Many assume this means sole proprietors qualify, but this isn’t true: LLCs, S corporations and C corporations all qualify too!
Eligibility
A Solo 401k is an IRS-approved retirement plan tailored specifically for small business owners with no full-time employees. It offers higher savings potential than SEP IRAs and supports Roth contributions; additionally, its eligibility requirements cover an array of entity types.
Even a one-member LLC qualifies, provided it doesn’t employ anyone; all revenue flows through as disregarded entity to Schedule C (click here for more information on this form).
Owners of multiple-member LLCs, partnerships, C corporations or S corporations also qualify as long as their businesses fulfill the definition of self-employment; full-time employees do not count toward this definition compared to what’s used for SEP IRA plans; this restriction could prevent some owners from participating simultaneously while creating further complications if one spouse works at another business.
Contributions
Although a Solo 401k is most often associated with single-owner businesses, LLC businesses may also use it. Before opening one however, it’s essential that they understand its restrictions and limitations in order to create the ideal retirement plan strategy for them.
To qualify for a Solo 401k, your income must come solely from your business, trade, or profession – this can be verified through tax records – not employment by another individual or corporation.
As well as elective deferral contributions, an employer contribution of up to 25% of your compensation or net self-employment income may also be made through your 401(k). Unlike with corporate plans, this amount does not reduce by the elective deferral contributions made, nor guaranteed payments reported on Schedule K-1 or net profits of an LLC – these amounts are subject to tax withholding for income and FICA taxes while guarantee payments do not.
Taxes
Small business owners may find a Solo 401(k) more suitable to their needs than a traditional IRA; however, early withdrawals of contributions may incur a 10% penalty and income tax payment as the IRS considers an early withdrawal as distributions from investment earnings.
Solo 401(k)s are more commonly associated with sole-owner businesses; however, partnerships and other business structures may also adopt them provided they meet IRS guidelines. These rules include having no full-time employees other than owners as well as filing Schedule C forms with the IRS.
One of the main draws of a Solo 401(k) plan is its unique feature – spouse participation is allowed! This can be especially helpful for couples with multiple sources of income that generate self-employment, as their elective deferrals up to employee limits plus 50-and-over catch-up contributions can be made, while businesses can make profit-sharing contributions of up to 25% of compensation, up to an aggregate maximum amount of $345,000.
Funding
Solo 401k plans offer ways to optimize your income by minimizing taxes and fees while offering tax-free compounding, a Roth option, and higher contribution limits than other retirement accounts. They’re also flexible – you can invest in everything from traditional assets such as mutual funds and stocks to real estate and crypto with this account type – although some considerations must be kept in mind before opening one.
Ideally, a Solo 401k works best with businesses that meet several key criteria: they must be sole proprietorships or single-member LLCs without non-owner full-time employees, partnerships, S corporations and C corporations that do not employ full-time non-owner employees, partnerships and S corporations that don’t hire more than two full-time non-owner employees; partnerships or S corporations (but no C corporations); these retirement plans would work better. If your business employs employees though, other forms of retirement plans such as Keogh Plans or SIMPLE IRAs allow up to two employees. Borrow from your Solo 401k accounts but be mindful to pay back all borrowed amounts within five years for primary residence purchases; loans would need to be paid back within 15 years (for loan repayment).
