The 401k is one the most well known, and most heard of, retirement accounts. Almost every major company offers them as a retirement benefit to their employees, and most employees have come to expect 401k plans as part of their overall compensation package.
But what if you are self-employed?
Specifically, what if you are a 1 person business?
Can you still do a 401k for your own business?
The answer is yes, you can still do a 401k. You can actually set up and contribute to what’s called a Solo 401k.
The Solo 401k, also known as the one-participant 401k plan, is a 401k plan designed specifically for one-participant, usually a 1 person business owner.
The Solo 401k is similar to the traditional 401k plan that most people are familiar with in a variety of ways.
Contributions:
Contribution limits are generally the same with the solo 401k as the traditional 401k.
The maximum amount that can be contributed to the solo 401k plan is $69,000 for 2024, just like the traditional 401k plan or any other defined contribution plan.
The $69,000 contribution limit is quite a bit higher than the annual IRA contribution limit and allows you to save and invest more than an IRA alone.
With the solo 401k you can also make elective deferrals out of your compensation, and the business can make nonelective contributions (also known as employer contributions) up to 25%.
Taxation:
Whatever you contribute to your Solo 401k will be deductible on your tax return. This will lower your taxable income, both at the business level when you make employer contributions, and on a personal level when you make elective deferrals out of your salary/compensation.
This will potentially lower your current year tax liability, and will help you build retirement assets for your future.
Also, whatever your contribute will grow tax deferred, so when you invest your contributions inside the solo 401k you won’t pay taxes on any of the dividends, interest or investment returns throughout the year.
You will eventually end up paying ordinary income tax on whatever you withdrawal from your Solo 401k in the future if it's a traditional pre-tax 401k.
Investing:
You’re able to invest the funds within the 401k (and it’s important that you do so you can take advantage of time and the opportunity to grow your account).
You can invest what your contribute to your Solo 401k in a variety of Stocks, Bonds, Mutual Funds and ETFs.
Traditional 401k plans tend to be more limited in your investment options. Usually you are limited to target date funds and/or a few other mutual fund options.
At Didion Wealth Management, we can, and do, manage Solo 401ks with the ability to invest in a much more diverse investment selection than traditional 401k plans. We can help you invest in almost anything such as stocks, bonds, mutual funds and ETFs.
Important Considerations
However, there are some very important logistics and considerations you need to be aware of when it comes to establishing a Solo 401k for your business.
1) You need to have a Third Party Administrator (TPA) and record keeper.
The TPA is someone who administers, or oversees, the plan's day-to-day operations. The TPA can help with things like plan documents, reporting and compliance.
401ks require a certain level of compliance that is higher than other retirement plans so it’s important to make sure the plan is compliant to maintain its status and benefits.
The recordkeeper “keeps record” of contributions made, whose in the plan, etc.
As a self-employed business owner you can act as your own TPA, but you can hire a TPA and most usually hire a recordkeeper as well.
Both of these services, TPA and recordkeeper, come with their own fees so it’s important that you understand the services you are receiving for the fees you pay when you hire someone to do this work for you.
2) You need to file your annual form 5500 with the IRS.
This is a standard form that gives the IRS information about the plan such as, the qualification of the plan (active/terminated), it’s financial condition, assets in the plan and operations of the plan.
Failure to file this form can result in financial penalties.
3) You’ll also need to make sure you have 2 important documents for your solo 401k plan.
The Adoption Agreement and the Trust and Custodial Agreement.
The Adoption Agreement is what spells out the terms of the 401k plan between the employer (your business) and it’s employees (you). Essentially, this is officially adopting the 401k plan and how it operates.
The Trust and Custodial Agreement spells out where the plans assets can be held (custodian), services of the custodian, how assets are managed, etc.
Plan Assets
Once you start contributing to the Solo 401k your plan now has assets.
It's important to not "set and forget" about these assets. You need to make sure these assets get invested and get invested appropriately.
You have the freedom to choose where you want your assets in the Solo 401k plan held and who has custody of those assets.
You also have the freedom to choose a wealth advisor or financial planner that you trust to help you with your Solo 401k plan.
A wealth advisor can help you determine how to manage the assets according to your investment objective and risk tolerance, and help you achieve your overall goals with the solo 401k plan assets.
Bottom Line
The Solo 401k can be a great opportunity for business owners to get current year tax deductions for contributions made and to help grow retirement assets that will be available to you when you exit your business, or even if you just want to intentionally slow down in your business at some point.
However, they can be complicated to correctly navigate and you do not want to mess them up.
It's critical that you work with a professional to help you.
If you have a Solo 401k, or are considering a Solo 401k for your business, and would like help and guidance on how to manage it or how to get started, please reach out to me.
I’d love to see how I can help.
Cheers.
*This material was prepared for Michael Didion’s use
*Investing involves risk, including the potential loss of principal
*This material was created to provide accurate and reliable information on the subjects covered but should not be regarded as a complete analysis of these subjects. It is not intended to provide specific legal, tax or other professional advice. The services of an appropriate professional should be sought regarding your individual situation.
*Dividend payments are not guaranteed and may be reduced or eliminated at any time by the company.
*Bonds are subject to market and interest rate risk if sold prior to maturity. Bond values will decline as interest rates rise. Bonds are subject to availability, change in price, call features and credit risk
*Investing in mutual funds involves risk, including possible loss of principal. Fund value will fluctuate with market conditions and it may not achieve its investment objective.
*ETFs trade like stocks, are subject to investment risk, fluctuate in market value, and may trade at prices above or below the ETF's net asset value (NAV). Upon redemption, the value of fund shares may be worth more or less than their original cost. ETFs carry additional risks such as not being diversified, possible trading halts, and index tracking errors
*The principal value of a target fund is not guaranteed at any time, including at the target date.
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