How to Open a Solo 401k?

Being an entrepreneur has many benefits. However, one drawback is the lack of a traditional 401(k) plan many Americans participate in through their employer. A Solo 401(k) solves this problem and provides an excellent retirement savings tool for self-employed individuals. 

An entrepreneur or self-employed individual can open a Solo 401(k) with any financial institution that provides one. All you’ll need is your business’s tax EIN, and you can open a Solo 401(k) quickly and easily.

Before we get into how to open a Solo 401(k), let’s go through some details.

What is a Solo 401(k)?

A Solo 401(k) is a retirement account designed for small business owners, entrepreneurs, and self-employed individuals. Solo 401(k)s generally operate in the same way as traditional employer-sponsored 401(k) plans and carry the same rules set by the IRS.

You can elect to contribute pre-tax income into a Solo 401(k), or you can contribute after-tax earnings into a Roth 401(k).

Like traditional 401(k)s, Solo 401(k)s also allow matching contributions by your “employer.”

Solo 401(k)s are the same as any other 401(k); however, there are some limitations on who can participate in them.

Who Can Open a Solo 401(k)?

As mentioned, Solo 401(k)s provide self-employed individuals a place to save for their retirement. The term individual is vital because Solo 401(k)s are limited to small business owners with zero employees.

Freelancers and the self-employed tend not to have any employees; however, small businesses with even one other employee on the books are not eligible.

There is one caveat to this rule. If your spouse is the only other person employed by your small business, both of you can contribute and receive matching contributions from the business-but more on that in a bit.

What are the Tax Benefits of a Solo 401(k)

Solo 401(k)s share the same tax benefits as their traditional 401(k) counterparts.

You can elect to contribute pre-tax earnings to your Solo 401(k) and pay taxes when you distribute your funds during retirement. In turn, you’ll lower your immediate income tax obligation. 

Or, you can choose to contribute after-tax earnings into a Roth Solo 401(k), then your distributions during retirement would be tax-free.

Additionally, any matching contributions you make as your employer are tax-deductible for your business, lowering its tax obligation as well.

How Much Can I Contribute to a Solo 401(k)?

As a business owner or freelancer, you can act as two different entities; the employee AND the employer. Meaning you can contribute to your Solo 401(k) in two ways.

The IRS caps your total contributions at $58,000 for 2020 and 2021. Your elective deferral limit is $19,500. If you are over 50, an additional $6,500 catch-up contribution is permissible.

The most your employer's nonelective contribution can be is 25% of your compensation from the business, or until you reach $58,000 total, whichever is less.

The IRS has a useful example to illustrate how this works:

“Ben, age 51, earned $50,000 in W-2 wages from his S Corporation in 2020. He deferred $19,500 in regular elective deferrals plus $6,500 in catch-up contributions to the 401(k) plan. His business contributed 25% of his compensation to the plan, $12,500. Total contributions to the plan for 2020 were $38,500. This is the maximum that can be contributed to the plan for Ben for 2019.”

In other words, you can contribute $58,000 into your Solo 401(k) without paying taxes first. This will be able to grow tax-free until it’s time to withdraw during retirement.

Keep in mind that if your business is a side-business, these limits are tied to the person, not the account. If you participate in a 401(k) with another company, these limits apply to contributions you make to that account as well.

How to Open a Solo 401(k)

Opening a Solo 401(k) is pretty simple. Many online brokerages provide Solo 401(k)s in their menu of account offerings. All you'll need in order to sign up are your Employer Identification Number (EIN), a plan adoption agreement, and an application.

Once you're approved, you can go ahead and set up your contributions.

You'll have access to many of the available investment options that brokerage provides, like mutual funds, index funds, and ETF's.

After your Solo 401(k) commences, you may need to file some additional paperwork. The IRS requires you to complete Form 5500-SF if your 401(k) plan exceeds $250,000 by the end of the year.

You Can Rollover Previous 401(k)s

Lastly, you can rollover your old 401(k)s-even from previous employer-sponsored plans-into your Solo 401(k).

When managing your retirement savings, consolidating your accounts makes it easy to monitor how well your investments are performing.

Beagle does the hard work for you to find your old 401(k)s, identify any hidden fees you might be paying, and gives you advice on how best to consolidate them. Sign up for free to get started organizing your retirement accounts.