Everything You Need to Know About Solo 401k’s

What is an individual 401k plan?

Individual 401k plans — often called “solo” 401k’s — are very similar to regular or “traditional” 401k plans offered by large companies and SEP IRAs for the self-employed. “Solo” 401k’s aren’t that much different from traditional 401k plans, they just offer greater control and management for self-employed individuals and couples.

However, individual 401k plans are strictly for business owners who have no employees (an exception applies if your spouse works full-time for the business; then he/she may contribute their income to the account). If you employ any full-time or part-time employees age 21 or older (other than your spouse) or any part-time employees that work over 1,000 hours a year, you must include them in your 401k plan.

What are the benefits of solo 401k plans?

Individual 401k plans are ideal for those who plan to make larger contributions to their account than you would be able to under other types of retirement plans. With an individual 401k plan, you can defer as much as $17,500 to the plan or $23,000 if you’re age 50 or older by the end of the calendar year. As the owner of the business, you can contribute an additional 25% of total compensation up to a maximum of $52,000 (the amount of compensation deferred doesn’t count toward the 25% limit).

Individual 401k plans are simpler to manage and control than other types of retirement plans since they cover only the self-employed individual and his/her spouse. These plans avoid the complicated rules and discrimination testing often required for regular 401k plans.

What are the disadvantages of solo 401k plans?

Individual 401k plans are appealing if you desire to make larger contributions toward your retirement plan, but they generally require more paperwork than SEP IRAs. When your account exceeds a certain amount, you must file a special tax return for the plan, which can add frustration to annual tax-preparation.

Additionally, some firms that help set up an individual 410k will have expensive annual fees up to $400 and setup charges around $100 to $375. Lastly, if you plan to hire another employee in the future, you’ll have to include them on your plan, which will result in losing the benefits of an individual 401k plan.

When do I get access to the money?

Typically, the money in the account is invested until you reach about 60 years old. Withdrawing the money before then will result in a 10% early withdrawal penalty. Additionally, you’ll have to pay income taxes on the withdrawal.

There are a few exceptions to the withdrawal rule and each plan’s rules vary. Generally, you will be able to withdrawal from the account only if you use it to buy a house, pay for higher education, pay for certain medical expenses, pay for burial or funeral expenses, or to provide payment for your dwelling in order to prevent eviction or foreclosure. If you need to take the money out before you are 60 years old, the best solution is to take out an individual 401k loan (which uses the balance of the account as collateral).