From the owner-only business’s perspective, the solo 401k plan is a way to reduce current federal and state income taxes. Since a solo 401k is a tax sheltered account, it makes it a popular vehicle for saving for retirement. The business owner may end up having to pay lower taxes because he or she may end up in a lower tax bracket at retirement or when solo 401k distributions commence.
The self-directed solo 401k also offers the owner-only business employee a great deal of flexibility and choice, such as the following:
whether or not to make annual contributions, how much to contribute, types of investments to make (if allowed by the regulations), to change the amount to contribute or investments. These features are important especially as the business owner’s circumstances evolve. The option to take a solo 401k participant loan and to make hardship distributions results in having access to the solo 401k funds as personal financial circumstances change dramatically. Just like IRAs, solo 401k plans can easily be transferred to an IRA once the self-employed business ceases without losing the plan’s tax sheltered status.
A solo 401k is also used by owner only businesses for significant tax planning opportunities by having the option to make Roth solo 401k contributions, which was first made available starting in 2006, in addition to also making voluntary after-tax solo 401k contributions. The voluntary after-tax solo 401k contributions can then be immediately converted to a Roth IRA or to the Roth solo 401k plan. The earnings on the Roth Solo 401k can then be distributed tax free provided it is deemed a qualified Roth solo 401k distribution. By utilizing both of these contribution features (i.e., the Roth and the voluntary after-tax), the Roth solo 401k, the business owner may be able to retire with a substantial solo 401k account balance.
