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The Complete Guide to Starting Your Solo 401k

Learn about the Solo 401k and its advantages, qualifications, and what you need to know before opening this account.

Posted on March 17, 2023 by Sarah Shellam

solo 401k

A Solo 401k is a retirement account designed for self-employed individuals or small business owners with no common law employees other than themselves and their spouse. Sometimes considered the most sought-after account, a Solo 401k can be extremely useful for those who qualify and has many benefits including high contribution limits and tax advantages.  

Employer vs Employee Solo 401k 

With a Solo 401k, you can make contributions as both the employer and employee. As the employee, you can contribute up to 100% of your earned income, up to the annual contribution limit (click here to see the contribution limits for a Solo 401k). As the employer, you can make additional contributions up to 25% of your net self-employment income up to the contribution limit. One of the advantages of a Solo 401k is that you can make larger contributions than you could with other types of retirement accounts, such as a traditional or Roth IRA. Additionally, the contributions you make to a Solo 401k can be tax-deductible, meaning you can reduce your taxable income for the year. 

Unrelated Business Taxable Income 

Another benefit of a self-directed Solo 401k is it provides an exemption from Unrelated Business Taxable Income (UBTI), which includes Unrelated Debt-Financed Income (UDFI). UDFI refers to income that is generated by debt-financed assets that are held within a tax-exempt entity, such as a retirement account. This type of income can be subject to UBTI tax, which can significantly reduce the investment returns within your IRA. However, if you set up a Solo 401k plan, you may be able to avoid UDFI and UBTI tax altogether. It’s important to note that while a Solo 401k can provide exemption from UDFI and UBTI tax, you should still carefully consider any debt-financed investments and ensure that they align with your overall investment strategy and risk tolerance. 

Checkbook Control Over Your Account 

A unique and arguably the most sought-after feature of a Solo 401k is that it allows you to have checkbook control over your retirement funds. Checkbook control is the ability to write checks directly from your retirement account, allowing the account holder the ability to: 

  • Pay expenses 
  • Manage your retirement funds 
  • Have direct access to your retirement funds providing greater flexibility 

If you find a real estate investment opportunity you want to pursue, you can write a check directly from your Solo 401k to fund the investment, rather than having to go through a custodian or administrator. Having checkbook control also means that you can make investments quickly and efficiently, without having to wait for approval from a custodian or administrator. This can be particularly useful if you’re investing in time-sensitive opportunities, such as real estate or private equity deals. 

In order to have checkbook control over your self-directed 401k, you’ll need to do the following. 

  • Set up a separate bank account for your retirement funds, known as a Solo 401k checking account. 
  • Ensure that you follow all IRS rules and regulations for managing your retirement funds, including maintaining accurate records and avoiding prohibited transactions. 
  • Familiarize yourself with IRS rules and regulations. 

It’s important to note that checkbook control can come with some risks. Improper use of checkbook control could result in significant tax penalties and other legal consequences. Therefore, it’s important to work with a qualified financial advisor or tax professional who can help guide you through the process and ensure that you’re following all applicable rules and regulations. 

Financial Responsibilities 

While having more control over your retirement savings and investment decisions is a major benefit of a Solo 401k, it also comes with additional responsibilities that must be carefully managed. As the plan administrator of a Solo 401k, you’re responsible for ensuring that the plan is properly established, maintained, and administered. This includes keeping accurate records, filing annual reports with the IRS, and ensuring that all plan contributions are made on time. The reporting requirements and administrative responsibilities associated with a Solo 401k plan can be seen as a potential negative for some self-employed individuals. 

Setting up and managing a Solo 401k plan requires time and effort. You’ll need to carefully consider the plan design, choose a custodian or trustee, and ensure that all plan contributions and distributions are properly recorded and reported. For some self-employed individuals, this additional administrative burden can be a barrier to setting up a Solo 401k. You’re responsible for ensuring that the plan is fully compliant with all IRS regulations. This includes filing an annual Form 5500-EZ with the IRS, making timely contributions, and ensuring that all plan investments are permissible. If you fail to comply with these regulations, you could face significant penalties and tax consequences. 

Opening a Solo 401k 

A Solo 401k can be a great tool for saving for retirement, but before you open an account it’s a good idea to consult with a financial advisor or tax professional to ensure that it’s the right retirement account for your specific needs and goals. 

To address the common areas of concern with administering this plan, Quest is launching a new Solo 401k platform. This platform will help you create plan documents, establish a bank account connected to your plan, simplify recordkeeping, prepare required IRS forms, and keep you current with compliance requirements. If you would like to learn more about Quest’s new platform or if you qualify for a Solo 401k plan, schedule your free consultation with an IRA Specialist today.  

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