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Solo 401(k) Plan – Individual 401k for the Self-Employed

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This article is part of a series on self-employed retirement plans, and was written by Robert D. Flach. Robert has been preparing business and individual tax returns for people in all walks of life since 1972. He writes the tax blogs THE WANDERING TAX PRO and the NJ TAX PRACTICE BLOG.

Article assumptions: Self-employed individuals have many types of retirement plans from which to choose. While these plans are available regardless of the type of business “entity” chosen, I will be discussing them from the point of view of the Schedule C filer. In such a situation the determination of the amount of the allowable contribution begins with the “net profit” reported on Line 31 of Schedule C or Line 3 of Schedule C-EZ.

All of the retirement plans that I will discuss are available to the one-man business with no employees, and I will limit my discussion to the contributions of the business owner. However these plans will require coverage of any qualifying W-2 employees of the business, and special rules will apply to contributions for employees.

Solo 401(k) Plan

A recently added self-employed retirement plan option is the Single-Participant 401(k) Plan, also called a Solo 401(k). The Solo 401(k) was created by the Economic Growth and Tax Reconciliation Act of 2001, and is similar to a traditional 401(k) plan that would be offered by a corporation or other large business. However, the Solo 401(k) plan is designed for a self-employed individual and requires less administrative upkeep compared to the corporate version of the 401(k).

Where can you open a Solo 401k? Small business retirement plans are found with many major brokerage houses, including Vanguard, Fidelity, Merrill Edge, TD Ameritrade, Charles Schwab Investments and more.

Solo 401(k) plan eligibility. The Solo 401(k) plan is only available to an individual business owner and his/her spouse. Part time workers that work less than 1,000 hours per year are excluded. If you have full-time employees, you will need to select another self-employed retirement plan.

Plan establishment and contribution deadlines. Like the Keogh Plan, a Single-Participant 401(k) must be established by December 31st.  And, also like a Keogh Plan, an annual Form 5500 is required when your plan reaches $250,000 in assets. You have until the tax filing deadline (plus extensions) to make contributions.

Contribution limits. The Single-Participant 401(k) allows for a combination of “employee” deferral of up to the regular 401(k) maximums, $15,500 with a $5,000 catch-up for 2008 and $16,500 with a $5,500 catch-up for 2009, and a discretionary employer match of up to 25% of compensation (20% of net earnings as with the SEP IRA and other plans).  The combined maximum cannot exceed $46,000 for 2008 and $49,000 for 2009 plus the appropriate “catch-up” additions if applicable.

Example Solo 401(k) contribution:

Let us say that for 2008 John Q Proprietor, a 53 year-old Schedule C filer, had $60,000 in net earnings from self-employment after the ½ of SE tax deduction.  With a SEP IRA John can contribute $12,000 ($60,000 x 20%).  However, with a single-participant 401(k) plan John can make a $20,500 “elective deferral contribution” as an “employee” and a $12,000 “employer” contribution, for a total of $32,500.

IRS Publication 560 (Retirement Plans for Small Business) has a worksheet to determine the deductible amount of contributions to a single-participant 401(k).

Benefits of Solo 401(k) plans

Maximize retirement contributions. Depending on your income, the solo 401(k) gives you the potential to put away more of your income than the SEP IRA, which has the same maximum contribution limit ($46,000 in 2008). Like the SEP IRA, Solo 401(k) plan owners can contribute 25% of their compensation as profit sharing, but Solo 401(k) plan owners can also contribute up to the first $15,500 as tax deferred contributions. So unless you can max out the entire $46,000 with a SEP IRA, the Solo 401(k) will allow you to contribute more money toward retirement. These are additional benefits of the individual 401(k) plan.

  • Minimal administrative work. The associate paperwork is easy to file and maintain.
  • Discretionary contributions; immediate vesting. Members are not required to contribute to their Solo 401(k) account. Your contributions are 100% vested immediately.
  • Traditional and Roth options. The Solo 401(k) plan comes in two flavors – traditional and Roth. Like Traditional and Roth IRAs, the different versions of the Solo 401(k) give you different options for managing your taxes both now and in the future.

Here is more information about different self-employed retirement plans.


Published or updated January 6, 2014.
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{ 35 comments… read them below or add one }

1 Miranda

The one I’ve been waiting for! Next year’s big goal is to open a Roth solo 401(k). I’m getting very excited about this…

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2 Ryan

Miranda: you can actually open one this year as long as you send in your paper work before December 31st. You would have until the tax deadline to make any contributions, so you could contribute some this year and some next year.

I just opened a Solo 401k via Vanguard, and the process was easy – though I did call customer service to go over a few details. They were very helpful.

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3 Miranda

Actually, I’m not concerned about the tax stuff for this year. I just want the Roth option :0) Which I will greatly enjoy next year.

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4 Dalton

I have a Sep, i sell/ buy stock inside the account,my question is: Can my Sep own real estate? I’mtold you can but how?

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5 Ric Hinkie

Dalton, I have an all paid for rental home in my IRA. The IRA owns it, and rent is paid to the administrator. Entrust Midwest LLC is a very reasonable and trustworthy administrator. They pay the insurance, taxes, etc. I still find the renters, but can not handle any of the money.

The cool thing is that the rent goes in like an extra IRA contribution, that I could not make myself as I am maxed out. When I need to take a distribution from the IRA, the money will come out to me, but my principal…in this case the house is still an asset that will always be there. I can also always sell it and the appreciation adds to my IRA’s value. The only down side is the expenses and appreciation are not deductible, but the other benefits outway this.

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6 Ryan

Dalton: I believe it can be done, but I don’t know the details. Here is a little information about it: http://www.realtor.org/archives/featuresept03ira

After reading the article, it appears as though it is complicated and out of the scope of my knowledge. This article is for general information and I’d recommend contacting an accountant or retirement plan specialist for your specialized needs.

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7 Ric Hnkie

In 2010 it may make sense to either convert a house already in a realestate IRA or to buy real estate into the Solo Roth. If you are converting regular 401k or IRA money into a regular Roth, you have two years to pay taxes on the conversion (the amount of money you pay for the real estate). Again this is based on advice from CPA, but we anticipate converting at least one home. The rent income goes into the Roth like an additional contribution. Can’t take it our for 5 years, but that is OK as the house should increase in value and the rent income also builds the value of the Roth. Then when you need it it comes out tax free.

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8 Ric

Yes, you can have realestate in an IRA. I have a rental house in mine and my wife has one too. The advantages are that the rental income becomes an added contribution to the IRA that is not subject to limits of contribution. It is treated like it was a dividend or gain in stock price.

The key is to find a place that will handle all the details for you at a low price. You can not accept money from the renters directly, it must go to a manager “for the benefit of YOU and your account number must be on the checks”.

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9 Greg

Would I have had to establish a solo 401k during 2008 to take advantage of it for my 2008 taxes?

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10 Ryan

Greg: Yes, you would have had to establish the Solo 401(k) account by Dec 31, 2008 to take advantage of it for your 2008 taxes. However, as long as it is established, you can contribute to it up to the tax deadline to lower your 2008 tax obligations.

If you missed the deadline, I would encourage you to start looking for a company to maintain your solo 401(k) now so you don’t get rushed trying to do it at the end of this year.

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11 Sham

Since I didn’t open solo 401(k) before 12/31/08 and I made contribution to 401K (wrong advice from my broker) in 2008 return & submitted. Now, can I file 1040-x to switch from solo 401 K to SEP IRA to recify the mistake.

Thanks,

Sham

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12 Mike

I’ve already contributed to a SIMPLE IRA for 2009. Am I allowed to also contribute to a solo 401(k) during the same tax year?

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13 Ryan

Mike: I don’t believe there are any restrictions that prevent you from having both plans, but there are restrictions regarding how much money you can invest in tax deferred retirement accounts each year. I’d recommend visiting a professional CPA or other person well versed in tax laws for more information. Best of luck to you.

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14 David

What would be the best plan for me? I am a 51 year old self-employed rancher and investor. The ranching business generally reports a loss. Most of my income comes from investments in stocks, bonds, oil & gas both working interest and royalty interest. I also have some income from a bookkeeping business on schedule C. I am expecting a large amount of income on schedule E for this year and the next. I’m looking for the best way to defer the taxes on my income for the next couple of years.
David

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15 Ryan

David, Your situation is fairly complicated and requires a professional tax advisor and/or financial planner – someone who can dig into your books, run some numbers, and come up with a plan to help you both now and in the future.
I recommend looking for someone in your area that has experience working with situations similar to yours.

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16 Jeff

If I want to make contributions for 2009 for both my wife and myself [we are eligible to do this] do I need to open seperate Solo 401K accounts for both of us prior to 01/01/2010?

Also, what do you think about companies who claim they can st-up accounts that offer “check-book control”. Is this legitimate in you opinion?

Thanks,

Jeff

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17 Ryan

I opened one account for both my wife and I, but it is a joint account. Contact your 401k provider for more information. And yes, the account needs to be opened by December 31st, but you can make contributions up to the filing deadline, or October 15th if you file for an extension, otherwise April 15th.

I’ve never heard of “check-book control,” but it sounds like something you could do yourself through careful management.

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18 Ric Hnkie

To the question about both spouses and year end 2009 contributions to a Solo 401k. First, yes the contributions must be made by year end. Second, when I set mine up a year ago, I set it up as an employer. Edward Jones has a boiler plate plan. So this year my wife worked independently with me. Therefore, I had to amend the plan to add her to it. Now I will make my contribution (consulting income-expenses) for 2009 and here contribution will be made on the same basis. This is the advice from my CPA and money manager.

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19 John Mazzei

I have a question about the spousal contribution. Do you have to go through the formality of paying your wife in order for her to be able to participate in your self-employed 401k? If so, do you have to pay pay-roll taxes on the amount you pay her? From a SS standpoint, I already contribute the max SS contribution per year for myself and I would rather not have to contribute more SS tax on behalf of my wife unless I have to.

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20 Ryan

John, great question. Based on my understanding, your wife must be employed to be eligible for Solo 401k contributions. I don’t think that necessarily means that she needs a W-2 because you can be a sole proprietor and not issue W-2s. However, if you already have that payroll system set up for your company, then it might be required. This is a situation where I recommend speaking with your accountant for more details about contribution requirements.

And paying additional Social Security tax isn’t necessarily a bad thing. My wife helps with my business, so I pay her a salary and from that we contribute to her Solo 401k. While it’s true we do pay additional SS tax on her salary, she also gets SS tax credits working toward her SS benefits for when she retires. Something to keep in mind.

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21 Ric Hinkie

Just to add to my earlier comment. Solo401ks are available for self employed people. Therefore, the husband can have one and so can the wife if she also has self employed income. As mentioned earlier, I set up the plan with Edw Jones and defer a portion of my consulting income (I am otherwise retired and draw SS). My wife works with me part of the time. Her income can also be deferred and contributed to the plan. Yes, both of us have to pay into SS and Medicare, but the long term benefits of having the Roth outway that cost for us.

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22 Mike

Looking to establish a Roth Solo 401k next year but my broker (TDAmeritrade) isn’t planning on offering one. Bummer…

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23 Ryan

Mike, Solo 401k plans need to be established by the end of the calendar year, so if you are planning on establishing on for 2010, it is possible they may offer it by the end of the year. I have mine with Vanguard, and I opened it last year, which was the first year they offered it. Fidelity also offers a Solo 401k plan, and they are a top notch firm to deal with.

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24 bonnie johnson

could you email some information on solo and roth solo k. thanks

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25 Amish

I have had a SEP as a self employed, single employee company. I recently hired an employee and read that after 3 years of employment completed I have to make contributions into the SEP for this employee. Could I transfer to a Solo 401k and only contribute for myself as owner/employee and exclude the hired employee?

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26 Ryan

Amish, you can only open a 401k if you are the sole employee of the company. The only exceptions to this are employing your spouse, or a part-time employee (less that 1,000 hours per year). I recommend visiting with your tax professional or seeking the guidance of a small business consultant or financial professional for your best options.

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27 Mike

I believe the exemption extends to employing one child, as well.

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28 Ryan

Mike, I believe exemptions extend to employing children, up to a certain number of hours.

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29 Self employed missed deadline

Ryan,

I have missed my deadline to open solo 401K to open the account.
I badly need to contribute to 401 K to avoid taxes.What are my options.
Can I just open for this year and contribute or any other options left for me.
Thanks in advance

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30 Ryan

You should still be able to open a SEP IRA, which will give you some of the same benefits, such as the tax deduction. However, depending on your income, you may or may not be able to contribute as much. Even if you can’t contribute as much, opening a SEP IRA should still be a good option to reduce your tax bill this year and still save money in a self-employed retirement plan.

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31 deborah frank

Hi I recently opened a solo401k for my business where I am the only employee. My 4 children work with me too but all work less than 1000 hours…will that still fall under the guidelines of solo401k? someone above mentioned it may only be for if you have only one child. Can you clarify?

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32 Ryan Guina

Deborah, I know you can add a spouse to your Solo 401k if he or she is on the company pay roll, but I am unsure how that works with children. I recommend speaking with your accountant or the company that helps run your Solo 401k for more information.

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33 jesse

What I dont like about this article is that it is not new information. This also doesnt tell you how hard it is to actually get the account. I was told to go to any bank and bring the plan agreement with its associated TID and that was it. Not so!!! I called Bank of America and they told me to talk to Meril Edge and Merril doesnt have a clue what to say. They are completely useless. I am told Wells Fargo is also a place where you can walk in with your plan agreement docs and just like that walk out with a checking account. After months of research on where to get the plan agreement written professionally for IRS compliance and for a reasonable price and calling and talking to clueless people, finally I spoke to someone at Vanguard who said I needed to open a individual retirement pool account, put the minimum of 3,000 to open into a money market fund, then send their forms with my plan documents and include a check writing option form. After all this clears, then the trustee, me, can write a check to purchase investment income property or certificates. However those at Vanguard are conflicted as they say only if you are approaching 60 years of age can you write a check without is being a distribution. If you are under this age requirement then any purchase of investment property using a check will be consider a distribution. Talk about that and how crazy that is. As a single member LLC and years away from even 50 this bothers me that I am going to be certifying I am of the required age to write checks not considered distributions for the purpose of purchasing investment property. If I go to an auction and purchase a condo for a great price, write a check from the 401k and then all the rental income goes into the 401k but the 401 has to pay the association dues, which could be monthly, and taxes and any repairs then every check written is not or should not be a distribution. All that is simple business accounting right? What also bothers me is no one wants to show me the boiler plate plan agreement docs that I would be purchasing until I actually purchase them. And then explain why I need to pay every year to certify the boiler plate docs are compliant when I have a CPA who can easily tell me if any IRS code has changed that directly affects this area, which by the way hasnt changed in over 5 years. And may not change for many more years as it takes and act of congress to do so. Talk about something new, something no one is writing about. This is all repetitive stuff, easily copied and pasted here. Yes, I am frustrated and with cause. There is just no one putting out the scope of information that is needed and it is soooo lame to tell someone not to think but go to someone else and ask them to think for you like telling me to go talk to my tax advisor.

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34 Ryan Guina

Jesse, this article is aimed at people who are interested in learning about retirement plan options for self-employed individuals. Owning real estate in a Solo 401k is a highly specific type of investment that only applies to a very small segment of the population. My recommendation is to search for companies that specialize in this type of plan administration (I found several via a quick Google search, but I won’t link to them as I don’t have the time to research and vouch for each of them; this needs to be done on an individual basis).

Another option is to simply bite the bullet and consult with a tax advisor. A quick phone call will let you know if they have the experience of working with this situation (experience is helpful as it will take fewer man hours and cost less in the long run).

The tax code is incredibly complex, and I personally prefer getting things done correctly the first time. With taxes, I find that consulting with a professional often saves me a lot of time and money in the long run.

If you don’t want to speak with a tax specialist, then consider frequenting online forums and researching there, or creating a thread to ask pros how they do it. You can also ask on a site like Quora.com, which is a crowd sourced Q&A forum.

Best of luck with finding the information you seek, and if you feel so inclined, you are welcome to put together and article about your experience to share with our readers.

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35 Len Blaifeder

Hi Ryan.
My wife is a self employed speech language pathologist. We have 3 boys in college and are trying to qualify for maximum financial aid. Last year we opened a solo 401K for her.

Question…Can the employer contribution that she makes into her own 401K appear as an expense on her Schedule C, thus reducing her income?

Thank you.

Len Blaifeder

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