A Guide to Solo 401Ks

The Greatest Tax-Deferred Retirement Program You May Have Never Heard About

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The majority of encore entrepreneurs launch businesses which initially employ only themselves and perhaps their spouse. For a business like this, no other retirement program offers the tax-sheltering advantages and the investment flexibility of a Solo 401K. That's because Solo 401Ks were specifically designed for these kinds of micro-businesses. Yet I find that relatively few business owners know anything about Solo 401Ks. Most, indeed, have never even heard of one. There's good reason for this. Solo 401Ks are never advertised by banks and investment houses, because Solo 401Ks are not as lucrative for them as the more widely-advertised programs. This tutorial therefore presumes that its readers may be investigating a Solo 401K for the first time. It explores the unique benefits of a Solo 401K, how to set one up, your options for rolling other retirement accounts into your Solo 401K, and the exceptional options which you have for investing money that you put in a Solo 401K. And along the way I'll share some lessons which I've learned in managing my own Solo 401K.

What is a Solo 401K?

The IRS provides a number of options for businesses and employees to benefit from tax-deferred retirement plans. These options include Individual Retirement Accounts (IRAs), Savings Incentive Match Plan for Employees Individual Retirement Accounts (SIMPLE IRAs), Simplified Employee Pension Individual Retirement Arrangements (SEP IRAs), 401Ks, and 503Bs. These last two programs derive their name from the section of the IRS code which governs them. Any for-profit or non-profit company can establish a 401K, whereas 503Bs are specifically for non-profits and churches. Collectively all of these programs are referred to as IRA-type plans. The Solo 401K is another IRA-type plan. Solo 401Ks have been part of the Internal Revenue Code for decades. There are clear rules and regulations governing them and a history of court cases that clarify points at which the regulatory code may be subject to differing interpretations. The Congressional purpose for creating the Solo 401K option was to give the owners of micro-businesses similar retirement benefits to those which are provided through big-company 401K plans. Solo 401Ks are ideal for a business owner who wants to sock away large sums of money for retirement. If the owner and his or her spouse both work in the company, they can potentially shelter over $100,000 per year in a Solo 401K. SEPs are the only other IRA-type investment to provide anything near this level of tax-shelter potential. But Solo 401Ks have notable advantages that are not available in a SEP. For one thing, Solo 401Ks allow a far-wider array of investment options than is generally true with SEPs — or any other IRA program, for that matter. By rolling existing 401Ks, 503Bs, IRAs, SIMPLEs, and SEPs into a Solo 401K, business owners position themselves to have much greater investment flexibility over all of their retirement funds.

How Do Solo 401Ks Differ from Other 401Ks

As its name implies, the Solo 401K has strong commonalities with the 401K plans familiar to corporate employees. Like other 401Ks, the Solo 401K plan is owned by the sponsoring company and is funded through a combination of salary reductions on the part of the employee and contributions from the employee's company. And again like 401Ks, the funds themselves are entrusted to a custodian, who receives deposits to the Solo 401K, manages disbursements from it, and makes required annual reports to the Federal government. With a Solo 401K, however, the custodian for the funds is a trust controlled by the business owner, not a third-party financial institution. (That's why these institutions don't advertise this retirement plan option.) Because you, the business owner, double as the custodian of the Solo 401K's, you set our own rules as to where the assets of the Solo 401K may be invested. You're not limited by the common restrictions which third-party custodians normally impose on retirement funds which they manage.

How Much Can Be Contributed to a Solo 401K?

Solo 401Ks are far more generous than traditional 401Ks in terms of how much employees and employers can put into the plan each year. In 2023 the limit for combined salary deductions and employer contributions is $66,000 plus any make-up contributions for which the employee is eligible. The make-up maximum for 2023 is $7500. Thus, for older entrepreneurs, the potential annual cap on additions to their Solo 401K is $73,500. No other IRA-type instrument allows this level of tax-sheltering. To participate, employees sign a salary-reduction agreement. The amount of this reduction is then channeled into the Solo 401K on their behalf. The owner, in this instance, is treated as an employee. Salary-reductions under a Solo 401K can be as much as 100% of the employee's compensation, up to a maximum (in 2023) of $22,500. Next the company supplements the employee's participation with up to 25% of the employee's compensation, so long as the $66,000 ceiling is not crossed.

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