Overview
An Individual 401(k), also known as a Solo 401(k) or, as defined by the IRS, a One-Participant 401(k), is like other 401(k) plans in that it is an employer-sponsored retirement savings plan. However, in the case of a Solo 401(k), you or your business is the plan sponsor, and you are the sole employee/beneficiary. There are several criteria to be able to qualify for such a plan, which we will go over later in this article.
Self-Directed?
My favorite aspect of a Solo 401(k) is, depending on how its structured, it can actually be self-directed, meaning that you can also act as the “Administrator” of the plan and can direct the retirement savings/funds into investments allowable by the IRS. This means you can use your Solo 401(k) to invest in things like stocks, bonds, securities, and even real estate!
Taxes and Contribution Limits
There is so much potential for a Solo 401(k) in terms of saving up for retirement. Another consideration is that within your Solo 401(k), if structured properly, you can elect to make both pre-tax (Traditional) and after-tax (ROTH) contributions. These funds must obviously be kept separately due to their different tax statuses, but what this means is that similar to an IRA, you can make tax-free gains on ROTH investments, which can provide tax-free income at retirement! Also, compared to an IRA, a 401(k) has much higher contribution limits. For example, where currently the limit for an IRA is $6,000, the limit for a Solo 401(k) is $61,000. That’s over 10 times more!
Participant Loans
As the participant in a One-Participant 401(k) you are allowed to take a loan in the amount of 50% of your savings or $50,000, whichever is less. This is the total allowable amount you can lend yourself across all loans outstanding with the 401(k). Meaning if you had $100,000 in your 401(k), you could take out a single loan of $50,000, or 2 loans of $25,000, but if you only had $50,000, your maximum loan amount (totalled across all outstanding/open loans) can only be $25,000. Also, it’s important to note that you should must charge interest on the loan, and that it must be equal to or greater than the current prime rate plus 1%, and the loan must be repaid in no more than 5 years, unless the loan was used to purchase your primary residence. This can be especially useful for business owners looking to buy a new home, and is in addition to the $10,000 withdrawal you can take from an IRA in the event the purchase can be considered a first-time home purchase. You can learn more about IRAs by navigating to our post here.
Criteria
As mentioned earlier, there are some criteria you need to meet in order to qualify for a Solo 401(k). One such criteria is that you or any business in which you own more than 50% cannot have any employees besides yourself and your spouse. This means that even if you have own Business A and have no employees for that business, but own more than 50% of Business B, which has employees, you are not eligible for a Solo 401(k) plan. This can be disappointing for some, but there are several alternatives that could be just as effective at saving/planning for retirement.
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