The Solo 401(k) from Rocket Dollar

Solo 401(k) Basics

In 2001, the U.S Congress passed the Economic Growth and Tax Relief Reconciliation Act (EGTRRA). EGTRRA reduced taxes and amended the tax law to allow self-employed individuals to have a special 401(k) retirement plan similar to a Simple 401(k).

This new plan was an improvement over a self-employed person using a Simplified Employee Pension Plan - Individual Retirement Account (SEP-IRA) or a self-directed IRA.

Solo 401(k) Plan

The special 401(k) plan for the self-employed mimics the traditional 401(k) plans already enjoyed by many companies’ employees who receive W-2 income. Employees contribute a portion of their pre-tax earnings to their 401(k) plan, and the employer matches this amount.

A qualified self-employed small business owner may contribute both the employer’s (as profit sharing) and the employee’s share to this type of 401(k) plan for themselves and their spouse.

This special 401(k) retirement plan for self-employed individuals and their spouses became commonly known as a Solo 401(k) or Solo 401(k). This account type may also be known as a Self-Employed, Personal, Self-Directed, Individual, or a one-participant 401(k).

History of Regular 401(k) Plans

The 401(k) in the name comes from section 401(k) of the IRS Tax Code. The Internal Revenue Code changed in 1978 through ERISA legislation and made these accounts possible. However, the first 401(k) plan did not exist until 1981.

The 401(k) concept was invented in 1981 by an accountant as an interpretation of the ERISA laws. There are many types of 401(k) plans, such as a defined contribution plan for employers with many full-time employees and the Solo 401(k) for a self-employed person with no full-time employees except a spouse.

401(k) Plan Responsibilities

For the self-employed looking to get the most out of their retirement accounts, savings, tax deduction management, and investment efforts, the Solo 401(k) is the best retirement plan option currently available compared to a traditional 401(k).

As a self-directed 401(k) plan manager, if you are a clever investor, you can build up plan assets, so there is plenty of fixed income funding when you retire. You must take the required minimum distributions starting from the age of 72.

If you qualify for the Solo 401(k) you can contribute up to $61,000 annually in 2022 ($6,500 more as a catch-up contribution for those who are 50 or older). As allowed by the IRS, you may invest in many assets as long as the investment is not a prohibited transaction. You also enjoy the benefits from having a tax-deferred retirement fund account while not paying exorbitant fees.

Who qualifies for a Solo 401(k)?

The rules to qualify for a Solo 401(k) are straightforward and more flexible than a Simple IRA account. A person must have self-employment income from their business efforts. Self-employment may be full-time or part-time. A Solo 401(k) plan participant may earn W-2 wages from self-employment, profit sharing, or IRS form 1099 income as an independent contractor.

What type of business entity can set up a Solo 401(k)?

The business may be a sole proprietor, a partnership, a Limited Liability Company LLC, or a closely-held corporation (C or S). The entity of a sole proprietorship or any other type will suffice. All that matters is that all the business owners, who are participants in the Solo 401k plan, pay self-employment tax.

Example: Barbara works for an advertising agency and receives a salary as W-2 wages. She also has a freelance business and earns self-employed income. She may qualify for a 401(k) plan at the advertising agency and a Solo 401(k) for her freelance business. If her husband helps her with the freelance business, he may participate in the Solo 401(k) plan too.

What are the technical requirements for a Solo 401(k) plan?

The business entity may not have any full-time employees besides the business owners and their spouses. The business may have as many part-time employees as desired without a limit. This rule comes from the IRS “discrimination testing” policy. Any full-time employee must receive the same retirement benefits as other full-time employees.

The IRS considers an employee full-time if the person earns wages for more than 1,000 work hours in a tax year.

Exceptions to this rule are for persons under 21, non-resident aliens, and some union workers who have retirement benefits from collective bargaining efforts.

FAQs

Who is eligible?

To be eligible for the Self-Directed Solo 401(k) account, you must be self-employed and have no full-time employees, except for your spouse. Further eligibility requirements and exceptions are here. When setting up your account plan, you may want to work with your CPA or another financial advisor.

What is the annual contribution limit?

Up to $61,000 annually in 2022 of tax-advantaged retirement dollars per participant are allowed to deposit in a Solo 401(k) account if you choose to maximize your personal and company contributions. Learn how Rocket Dollar can help you capitalize on these contributions.

Can I borrow from my Solo 401(k)?

The Self-Directed Solo 401(k) allows for loans. The loan option will enable you to borrow from your retirement funds up to 50% of the plan value or $50,000, whichever is less. Solo 401(k) holders may use loans to pay off personal debt, fund a business, or use as the holder sees fit. If you want to take a loan from your 401(k), fill out the loan application provided on your online Dashboard.

What if I need funds in an emergency?

If the funds you need exceed the allowed amount of a loan, then there is a 10% penalty for the amounts withdrawn before you reach age 59½, plus you must pay income tax on the amount of the withdrawal as ordinary income.

Exceptions to this 10% penalty rule are:

• If you become permanently disabled.
• The withdrawn funds pay for qualified higher education expenses.
• To pay the amount of unreimbursed medical expenses greater than 10% of your adjusted gross income (for those under 65).
• Specific distributions for reserve military members called up to serve in active duty.

If you qualify for an exception to the 10% penalty, you still have to pay the ordinary income tax on the amount withdrawn unless the funds are held as Roth contributions as after-tax funds by the rules under your Solo 401(k) plan.

How fast can I open an account?

Rocket Dollar can open a self-directed Solo 401(k) in two to four weeks for a silver account or two weeks for priority processing with the Rocket Dollar Gold Plan.