How Solo 401(k)s Work

Estimated reading time: 3 minutes(Last Updated On: June 18, 2021)

Since the creation of the Solo 401(k) in 2002, self-employed individuals and small business owners have been able to utilize these accounts to grow their retirement wealth exponentially. 

The Solo 401(k) is one of the most powerful IRA accounts to self-direct and has many financial benefits. These advantages include exemptions from certain Unrelated Business Income Tax (UBIT) and the ability to have checkbook control. 

While the Solo 401(k) may be very beneficial to some, it is critical that you understand all of the qualifications and maintenance required by a 401(k) before deciding to open the account at a financial custodian.

To establish a Solo 401(k), certain qualifications must be met. An individual must be either self-employed, a company owner that receives W-2 wages, or an individual with no common-law employees. Once these requirements have been met, you can start to take a look at whether a solo 401(k) is the best option for you. 

Benefits of a Solo 401(K)

Solo 401(k)s are powerful investments and wealth-building vehicles. Some of their advantages include:

Checkbook Control:

Maintaining this type of checking account allows for check writing authority by the trustee. Using a 401(k) is a great way to obtain checkbook control, without the dangers of the IRA LLC Checkbook Control model that has come under fire recently. 

Larger Contribution Limits:  

The business owner wears two hats in a Solo 401(k) plan: employer and employee. Contributions can be made to the plan in both capacities, allowing up to $58,000 in contributions for 2021. 

Loans to yourself: 

Unlike with your IRA, you can borrow money from your Individual 401(k). You are able to loan yourself the lesser of 50% of your account balance or a maximum of $50,000. Loans are based on a 5-year amortization at market rates.

Exemption from UDFI:  

One of the major benefits of real estate investing through your Individual 401(k) is the exemption from Unrelated Debt-Financed Income (UDFI) taxation.

Disadvantages of a Solo 401(K)

Conversely, there are some serious potential disadvantages that come along with maintaining a Solo 401(k). Some key dangers to be aware of while evaluating your need for a 401(k) include: 


In order to legitimize a newly established 401(k), the employer or employee must make a contribution for the tax year in which the account was established. See IRS Publication 560 for minimum funding requirements.

Reporting requirements:

The account holder has sole responsibility when it comes to tax reporting requirements. A 1099-R must be filed if any distributions are taken from the 401(k) and a 5500 or 5500EZ must be filed once the account value reaches $250,000+.

Dangerous responsibility:

Your transactions are not overseen by your custodian, allowing more room for potential trouble or prohibited transactions. 

Record keeping:

Careful record keeping must be kept for the multiple accounts held in the 401(k). Often time this bookkeeping is tedious, so it’s important to make sure good records are kept. 

In Summary

The Solo 401(k) is one of the most powerful retirement accounts you can have, and understanding how they work is the first step in deciding if it’s the right investment strategy for you. 

To learn more about how to get started investing with a self-directed IRA, schedule a 1-on-1 consultation with an IRA Specialist by clicking HERE. Click here to view our Solo 401k FAQ page.

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