Solo 401k: 10 Facts you have to know when starting!

A Solo 401(k), (also known as a Self Employed 401(k) or Individual 401(k)), is a 401(k) qualified retirement plan for US-Citizens and people with permanent residency in the US. It was designed specifically for employers with no full-time employees other than the business owner(s) and their spouse(s).

However. If you are self-employed you don’t have the opportunity to get an employer to match your contributions. This is a huge financial disadvantage. 

Facts: If you have been reading my previous articles about the 401(k) basics, you should know by now, that the real benefit of the 401k plan is the match contribution from your employer.

So let’s keep that in mind! A Solo 401k can’t compensate that loss, because, in the end, all contributions are simply put your money you are going to invest.

I know this sounds confusing. Read it twice and try to digest it!

However, let me highlight a few reasons why you still want to consider to invest in a Solo 401(k).

Top-3 Reasons why you want open a Solo 401(k)

The self-employed generally choose a Solo 401k over all other retirement plans such as SEP IRA and SIMPLE IRA for the following reasons:

1. 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 $18,500 (for 2018), which can be applied as Roth Solo 401k contributions.

2. 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. 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.

3. Roth Contributions

Unlike SEP IRA or SIMPLE IRAs, which do not allow for Roth contributions, unless you open a Roth IRA, which comes with income restrictions. 

Roth Solo 401(k): in 2019 you can annually contribute up to $19,000 and up to $25,000 if you’re 50 or over through salary deferral. For 2018 the annual contribute is up to $18,500 and up to $24,500 if you’re 50 or over through salary deferral.

Who qualifies for a solo 401k?

To be eligible to benefit from the Solo 401(k) plan, the investor must meet just two eligibility requirements: The presence of self-employment activity. The absence of full-time employees.

A Solo 401(k) plan is perfect for any sole proprietor, consultant, or independent contractor.

How much can you contribute to a solo 401k?

Solo 401k Contribution Limit increased in 2018 to $55,000 or $61,000 if age 50 or over.

According to the IRS: The owner can contribute both: Elective deferrals up to 100% of compensation (“earned income” in the case of a self-employed individual) up to the annual contribution limit: $18,500 in 2018, or $24,500 in 2018 if age 50 or over; plus

How do I set up a Solo 401k?

In order to set up your own solo 401k you must complete six basic steps:

  1. Understand Solo 401(k) Eligibility Requirements.
  2. Identify a Solo 401(k) Provider.
  3. Create Plan Documents.
  4. Prepare Employee Disclosures.
  5. Open an Account With Your Provider.
  6. 6. Make Contributions to Your Solo 401(k)
  7. Solo 401(k) Costs.

Is a Solo 401k tax deductible?

Solo 401k contributions are not deductible as business expenses when determining the self-employment tax.

Here is a link to the U.S. Tax court in LaFlamee v. Commissioner. 

BUT DO NOT confuse this with a Solo 401k or Individual 401k contribution which qualifies for an income tax deduction. When you open a Solo 401k, you can still take the tax deduction on the annual contribution which is $55,000 for 2018 or $61,000 for those 50 or older in 2018.

For 2019, the contribution limit increased to $56,000 or $62,000 if age 50 or over.

Further, the self-employed taxpayer still qualifies for deductions of expenses in connection with his or her trade or business when calculating self-employment income; just remember that a Solo 401k contribution is not treated as a business expense. 

Find more information about it published by the IRS. 

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