The solo 401k plan, commonly referred to as self-directed Solo 401k because it allows for variety of investment types, is the retirement plan of choice for the self-employed or owner-only business because it allows for high tax deductions and it’s straightforward to administer when compared to traditional 401k plans. While similar small business plans such as SEP IRA and SIMPLE IRA allow for similar benefits of a Solo 401k, the Solo 401k allows for higher contribution limits and Solo 401k Loan, a very attractive benefit to the self-employed business owner looking for readily available funding capital.
The self-employed generally choose a Solo 401k over all other retirement plans such as SEP IRA and SIMPLE IRA for the following reasons:
High Contribution Limits
SEP IRA contribution limit is only 25% of employee compensation and does not permit elective deferrals or catch-up contributions. On the other hand, Solo 401k allows for all three plus elective deferrals of $19,000 (for 2019), which can be applied as Roth Solo 401k contributions. Note that the catch-up contribution of $6,000 (for 2019) can also be applied as a Roth Solo 401k contribution, thus allowing for Roth Solo 401k benefit contribution of $25,000. In order to make the catch-up contribution you must be age 50 or older by the end of the year for which the contribution is applied for.
Solo 401k Loan Option
Another major benefit is the participant Solo 401k loan option which is not afforded to SEP or SIMPLE IRAs. The personal 401k loan option is available to each Solo 401k participant, and the loan limit is 50% of the account value not to exceed $50,000. For example, John and Jane, who live in Washington, both participate in the JJ Solo 401k Plan and both want to process a loan (borrow) from their Solo 401k. Jane’s Solo 401k current balance including non-liquid assets is $120,000 and John’s is $60,000. Jane can borrow up to the maximum amount of $50,000; and John can borrow $30,000. The reason John’s loan benefit is less is because the loan rules only permit the participant to borrow 50% of his solo 401k account balance not or $50,000, whichever is less. Lastly, John and Jane can use the loan proceeds for any purpose including purchasing a vacation home in Vancouver WA.
Business Funding or Investment
Each Solo 401k participant can borrow up to $50,000 for any purpose including to fund or inject funds into a business or make an investment.
Self-Directed Solo 401k Investing
Solo 401k can be invested in not only equities (stock and mutual funds) but also alternative investments such as real estate, precious metals, tax liens, notes, private placements, etc. using checkbook control Solo 401k platform. Lastly, since all earnings and gains from investments flow back to Solo 401k, you do not have to pay taxes until you begin making taxable distributions.
Unlike SEP IRA or SIMPLE IRAs, which do not allow for Roth contributions, unless you open a Roth IRA, which comes with income restrictions, Solo 401k allows for Roth Solo 401k contributions up to $24,000 for 2019 and income restrictions do not apply.
Straightforward and Inexpensive to Administer
Solo 401k is not subject to Form 5498 reporting like SIMPLE and SEP IRAs. Further, unlike all IRAs, the Solo 401k IRS rules allow for the self-employed business owner to serve as Trustee of his or her Solo 401k, hence why you can safe keep the alternative investment paperwork instead of paying a custodian like Pensco Trust, Equity Trust or Entrust to safe keep the investments. Lastly, Solo 401k does not require filing of tax forms unless: you make distributions, or the total Solo 401k account value exceeds $250,000, with the former requiring filing for Form 1099-R to report the distributions and the latter requiring issuance of Form 5500-EZ, which your Solo 401k provider or tax professional can file.
Exemption from UBIT
Unlike a SEP or SIMPLE IRA that uses debt financing (non-recourse loan) to invest in real estate, which has to pay unrelated business income tax on the investment gains, the Solo 401k is exempt from payment of unrelated debt financed income tax (UBIT or UDFI) with respect to real estate investments.
Great for Consolidating SEP, SIMPLE, Traditional IRA and all Qualified Plans
Not widely known, Solo 401k can be used to consolidate all of your retirement accounts including former employer plans such as 401k, 403b, Defined Benefit as well as government plans such as 457b and Thrift Savings Plans, provided you meet the Solo 401k qualification requirements: you are self-employed with not full-time employees.
Visit consolidating retirement plans using solo 401k plan to see full list.