Solo 401(k) Plan
The tax attorneys at the Bergman Law Group have worked with thousands of self-employed and small business owners with no employees establish IRS compliant solo 401(k) plan.
401k plans are defined in the Internal Revenue Code (Section 401) as retirement savings trusts. A 401(k) Plan is an IRS approved qualified retirement plan. As the name implies, the Solo 401(k) plan is an IRS approved qualified 401(k) plan designed for a self-employed individual or the sole owner-employee of a corporation. A solo 401(k) plan is also known as an individual 401(k) or self-employed 401(k) plan.
To access these benefits an investor must meet two eligibility requirements:
1. The presence of self-employment activity.
2. The absence of full-time employees.
A Solo 401(k) offers a self-employed business owner the ability to use his or her retirement funds to make virtually any type of investment on their own without requiring the consent of a custodian. The IRS only describes the type of investments that are prohibited, which are very few. In addition, a Solo 401(k) plan offers a high annual contribution limit (up to $55,000 if under the age of 50 and $61,000 if over the age of 50), allows you to borrow up to $50,000 for any purpose, and imposes no custodian fees.
Is the Solo 401(k) plan a new plan?
A Solo 401(k) plan is an IRS approved retirement plan, which is suited for business owners who do not have any employees, other than themselves and perhaps their spouse. The “one-participant 401(k) plan” or individual 401(k) Plan is not a new type of plan. It is a traditional 401k plan covering only one employee. Like a SEP IRA, a Solo 401k Plan offers the Plan participant the ability to contribute up to $61,000 each year. Before the Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA) became effective in 2002, there was no compelling reason for an owner-only business to establish a Solo 401(k) Plan because the business owner could generally receive the same benefits by adopting a profit sharing plan or a SEP IRA. After 2002, EGTRRA paved the way for an owner only business to put more money aside for retirement and to operate a more cost-effective retirement plan than a SEP IRA or 401(k) Plan.
The Advantages of Using a Solo 401(k)
The Solo 401(k) plan offers most of the characteristics of the Self Directed IRA LLC, including having the ability to make almost any type of investments, including real estate, but without the need to establish an LLC or pay custodian fees. The Solo 401(k) Plan is the most tax-advantageous retirement plan available because of its very high annual contribution limits that can be made in pre-tax or Roth (after-tax). The Solo 401(k) plan also allows you to borrow money from your retirement funds (up to $50,000) and use the funds for any purpose, including help finance your business or pay personal bills.
A Solo 401(k) is perfect for sole proprietors, small businesses and independent contractors such as consultants. A Solo 401(k) Plan can be adopted by any business with no employees other than the owner(s). The business can be established as a sole proprietorship, LLC, corporation, or partnership.
The Solo 401(k) plan is unique and so popular because it is designed explicitly for small, owner-only business. The determination of the features available under the solo 401(k) plan depends on the plan documents and the features adopted by the adopting employer. Most solo 401(k) plans provided by the major financial institutions only offer the most basic features, such as employee deferrals and profit sharing contributions, but generally do not allow for Roth contributions, loan feature, or the ability to make on-traditional investments, such as real estate. Whereas, a trustee directed solo 401(k) plan will generally allow the adopting employer to include all of the most popular feature which has made the solo 401(k) plan the most popular plan for the self-employed, including the ability to make Roth contributions, loan feature, checkbook control, as well as the ability to make traditional and non-traditional investments.
There are many features of the Solo 401(k) Plan that make it so appealing and popular among self-employed business owners.
- High Contribution Limits: While an IRA only allows a $5,500 contribution limit (with a $1,000 additional “catch up” contribution for those over age 50), the Solo 401(k) annual contribution limit is $55,000 for 2018 with an additional $6,000 catch-up contribution for those over age 50. In addition, if your spouse generates compensation from the business, he or she can also make high contributions to the Plan.
Under the 2018 Solo 401(k) contribution rules, a plan participant under the age of 50 can make a maximum employee deferral contribution in the amount of $18,500. That amount can be made in pre-tax or after-tax (Roth). On the profit sharing side, the business can make a 25% (20% in the case of a sole proprietorship or single member LLC) profit sharing contribution up to a combined maximum, including the employee deferral, of $55,000.
For plan participants over the age of 50, an individual can make a maximum employee deferral contribution in the amount of $24,500. That amount can be made in pre-tax or after-tax (Roth). On the profit sharing side, the business can make a 25% (20% in the case of a sole proprietorship or single member LLC) profit sharing contribution up to a combined maximum, including the employee deferral, of $61,000.
- Investment Opportunities: With a Solo 401(k) Plan, you will be able to invest in almost any type of investment opportunity that you discover, including: real estate (rentals, foreclosures, raw land, tax liens etc.), private businesses, precious metals, hard money & peer to peer lending as well as stock and mutual funds; your only limit is your imagination. The income and gains from these investments will flow back into your Solo 401(k) Plan tax-free. Making an investment with your Solo 401(k) Plan is as simple as writing a check. As trustee of the Solo 401(k) Plan, you will have total control over your retirement assets to make real estate and other investments tax-free and without custodian consent.
- Loan Feature: While an IRA offers no participant loan feature, the Solo 401(k) plan allows participants to borrow up to $50,000 or 50% of their account value (whichever is less) for any purpose at a low interest rate (the lowest interest rate is Prime which is 4.50% as of 12/14/17). This offers a Solo 401(k) Plan participant the ability to access up to $50,000 for use for any purpose, including paying personal debt or funding a business.
- Trustee Directed: With a Solo 401(k) Plan, you can serve as trustee of the Plan giving you “checkbook control” over the Plan’s funds. To this end, making an investment with your Solo 401(k) Plan is as easy as writing a check. Another significant benefit of the Solo 401(k) plan is that it does not require the participant to hire a bank or trust company to serve as trustee. This flexibility allows the participant to serve in the trustee role. This means that all assets of the 401(k) trust are under the sole authority of the Solo 401k participant. A Solo 401(k) plan allows you to eliminate the expense and delays associated with an IRA custodian, enabling you to act quickly when the right investment opportunity presents itself. Also, because the Solo 401(k) Plan trust account can be opened at any local bank or credit union (i.e., Chase, Wells Fargo, Citibank, etc.), you will not be required to pay custodian fees for the account as you would in the case of an IRA.
- Flexible Contribution Options: Contributions to a solo 401(k) plan are completely discretionary. You always have the option to try to contribute as much as legally possible, but you always have the option of reducing or even suspending plan contributions if necessary. In other words, you have the ability to make contributions to your Solo 401(k) Plan (up to an aggregate amount of $50,000 if you are under the age of 50), but are not required to do so.
- Roth Type Contributions: With IRAs, those who earn high incomes are disallowed from contributing to a Roth IRA or converting their IRA to a Roth IRA. The Solo 401(k) plan contains a built-in Roth sub-account which can be contributed to without any income restrictions. With a Roth Solo 401(k) sub-account, you can make Roth type contributions while having the ability to make significantly greater contributions than with a regular Roth IRA.
- Cost Effective Administration: In general, the solo 401(k) plan is easy to operate. There is generally no annual filing requirement unless your solo 401(k) plan exceeds $250,000 in assets, in which case you will need to file a short information return with the IRS (Form 5500-EZ).
- Exemption from UDFI: When an IRA buys real estate that is leveraged with mortgage financing, it creates Unrelated Debt Financed Income (“UDFI”) - a type of Unrelated Business Taxable Income (also known as “UBTI or UBIT”) on which taxes must be paid. The UBTI tax is approximately 37%. But, with a Solo 401(k) plan, you can use leverage without being subject to the UDFI rules and UBTI tax. This exemption provides significant tax advantages for using a Solo 401(k) Plan versus an IRA to purchase real estate.
How Does it Work?
1. Establish your IRS Compliant Solo 401(k) Plan: The Bergman Law Group can help you establish your IRS compliant Solo 401(k) plan. The Bergman Law Group will help customize your solo 401(k) plan based on your retirement, tax, and investment goals. The Solo 401(k) plan documents will include:
- Plan Adoption Agreement
- Basic Plan Document
- EGTRRA Amendment
- Summary Plan Description
- Trust Agreement
- In-Plan Roth Rollover
- Appointment of Trustee Documentation
- Beneficiary Designation Document
- Loan Procedure Document
- Loan Promissory Note
- Plan Amendments
2. Tax-Free Transfer of Retirement Funds: Bergman Law Group will help you transfer your retirement funds (IRA, SEP-IRA, 401(k), 403(b), etc.) tax-free from your current custodian to any financial institution or credit union that can serve as your custodian for your new Solo 401(k) plan. This transfer, also called a direct rollover, is tax-free.
The Bergman Law Group will assist you in completing all the necessary custodian documents so your retirement funds are transferred to a local bank account established in the name of your Solo 401(k) Plan quickly and without any tax.
3. Open Local Trust Bank Account: The Bergman Law Group will work with you to open a local bank account for your Solo 401(k) Plan at any bank or credit union of your choice. We will work directly with you to guide you through the process.
4. Trustee Directed Solo 401(k) Plan: The Bergman Law Group will help you establish a trustee directed self-directed solo 401(k) plan. As the trustee of the Solo 401(k) Plan, you will have the freedom to make all investment decisions for your Solo 401(k) Plan (“Checkbook Control”). A Solo 401(k) plan allows you to eliminate the expense and delays associated with a traditional financial institution custodian, enabling you to act quickly when the right investment opportunity presents itself. As trustee of the Solo 401(k) Plan, you will be able to write a check or wire money from the 401(k) bank account to make an Investment.
5. Tax-Free Investment is Made: The Bergman Law Group will advise you on the IRS prohibited transaction rules concerning making investments with your Solo 401(k) Plan. The Investment is then made in the name of your Solo 401(k) account. As trustee and administrator of the Solo 401(k) Plan, you will have “checkbook control” to make investments on behalf of your Solo 401(k) Plan.
To learn more about the advantages of adopting a solo 401(k) plan for your business, please contact us at 800-472-0467.
Did you know? The Solo 401(k) Plan is a great vehicle for creditor protection.