Understanding Solo 401(k)s: A Retirement Plan for the Self-Employed
If you are self-employed and looking for a way to not only save for retirement but also possibly lower your taxes, you may want to consider establishing a Solo 401(k) retirement plan for your company.
A Solo 401(k) plan is essentially a 401(k) plan for self-employed individuals, which is why they’re also called Solo(k)s, Individual 401(k)s, or One-Participant 401(k)s. While it may be one of the least understood options for self-employed small business owners, Solo 401(k)s may be a great way for self-employed individuals—like freelancers, independent consultants and ‘solopreneurs’—to maximize their retirement savings with either pre-tax or designated Roth contributions.
Here are the basics of a Solo 401(k) plan:
Sole proprietors, businesses formed as partnerships, or small business owners who have no other employees eligible to participate in your company retirement account may be able to establish a Solo 401(k) plan. Spouses may also be able to participate; talk to your tax advisor to determine if your spouse qualifies.
How Does It Work?
Solo 401(k) plans can be a powerful tool for self-employed people with regard to retirement savings. In a Solo 401(k) plan, you will be wearing two hats—one as an employee and one as an employer. This means that as an employee, you may be able to make salary deferral contributions and as the employer, you may be able to do a match or profit sharing contributions.
Similar to opening an IRA, a Solo 401(k) may include a pre-tax or designated Roth option. If someone makes a contribution using pre-tax dollars, taxes may be owed when a withdrawal is made. If you make a designated Roth contribution, contributions are made with after-tax dollars and withdrawals may be tax-free.
Solo 401(k) plans operate under similar rules and requirements as a standard 401(k) plan. This means distributions may begin after the participant reaches age 59 ½. Prior to that, participants may not be able to withdraw funds from the plan without a qualifying event.
What Are Solo 401(k) Contribution Limits?
Solo 401(k) contributions flow from two sources—contributions participants make wearing their employee hat and those they make wearing the employer hat.
- Employee Contributions: Generally speaking, Solo 401(k) participants can contribute up to $19,000 in elective salary deferrals in 2019. Those who are 50 and older can make an additional catch-up contribution of $6,000, resulting in a total salary deferral of $25,000.
- Employer Contributions: The Annual Compensation Limit in 2019 is $280,000 and the employer can contribute no more than 25% of it. There is a combined maximum contribution (employer and employee) of $56,000 in 2019 (or $62,000 for those 50+ and eligible for a catch-up contribution).
What Type of Investments Can I Own in my Solo 401(k)?
Solo 401(k) plan investments vary based on plan documents and the custodian, so be sure to check on the details before establishing one. At PENSCO, we serve as a custodian for various Solo(k) plans that invest in alternative assets, like real estate, private equity and promissory notes. Participants can fund their Solo(k) plan through various contribution types including salary deferrals, and—if elected by the employer—employer discretionary contributions and rollovers.
Additional Items to Keep in Mind:
- PENSCO requires that you have a third-party administrator for certain reporting purposes.
- The deadline to establish a Solo(k) plan is the end of your company’s fiscal year. Keep in mind that additional time is needed to process the plan’s paperwork, so the sooner you can get started with establishing your Solo 401(k), the better.
- As always, you should consult with your tax advisor or financial advisor to be sure you understand the nuances of Solo 401(k)s and to determine which retirement plan option is best for you.
To learn more about how PENSCO can help with a Solo 401(k), please contact our Business Development Center at 866-818-4472.
This Blog does not provide investment, tax, or legal advice nor does it evaluate, recommend or endorse any advisory firm or investment vehicle. Investments are not FDIC insured and are subject to risk, including the loss of principal.
PENSCO Trust Company performs the duties of an independent custodian of assets for self-directed individual and business retirement accounts and does not provide investment advice, sell investments or offer any tax or legal advice. Clients or potential clients are advised to perform their own due diligence in choosing any investment opportunity as well as selecting any professional to assist them with an investment opportunity. Alternative investments are not FDIC insured and are subject to risk, including loss of principal. PENSCO is indirectly affiliated with a registered broker dealer and with a licensed small business investment company through Opus Bank (“Opus Affiliates”). Other than the Opus Affiliates, PENSCO is not affiliated with any financial professional, investment, investment sponsor, or investment, tax or legal advisor.
 Designated Roth distributions are subject to IRS rules related to tax-free Roth distributions. Please consult your tax consultant to determine tax implications from your withdrawal.