What Is A Solo 401(k) and How to Easily Set One Up

solo 401k

Your employer is usually the one in charge of handling your 401(k) plan or something similar.

But being your own boss means you are in charge of planning and funding your 401(k).

A solo 401(k) is a plan that allows self-employed individuals to invest on their retirement. Regardless of whether or not a business owners has employees, they can set up a solo 401(k) as long as they meet the requirements.     

Solo 401k Rules

Setting up a solo 401(k) account doesn’t require you to prepare a mountain of documents. In fact, the qualification process isn’t complicated at all.

To open up a solo 401(k) account, you are simply required to meet the following conditions:

1. You should be self-employed.

Being self-employed means that you provide the income, instead of having an employer take responsibility for it.

Examples of jobs that fall under self-employment are freelancers, independent contractors, small business owners with no other employees, sole proprietors, and influencers.

However, an exception is made for the spouses of business owners who work for the business. This exception gives them the ability to contribute to the plan.

2. You must have earned income.

This is usually verified through tax records.

Once these are met and proven, you will be able to open a solo 401(k) account.

Solo 401k vs. Sep IRA

There are two retirement options worth considering for people who are self-employed.

First is the simplified employee plan or the SEP IRA. This type of plan is commonly used by small business owners.

They work similarly to the traditional IRA wherein they are given the same treatment for tax purposes and usually have the same investment options available.

However, the main reason a SEP IRA is ideal for a small business owner is because it has less operating costs that you would usually have from employer-sponsored retirement plans.

There are also certain requirements that determine if a small business owner is eligible for opening the plan:

  • The contributor must be at least 21 years old.
  • The contributor has been employed for at least three years.
  • There is a compensation minimum of $600.

This investment plan allows contributions to be interrupted in the event that the business fails to do well during a certain period of time.

A SEP IRA account can also be opened and funded until the date your tax return gets filed, which includes extensions for the following year.

However, one of the downsides to a SEP IRA is that no loans are available for this type of plan. Another is that there is no Roth option either.

On the other hand, the solo 401(k) is often used by individuals who work solely with themselves. This plan is often identified as a one-participant 401(k) plan or an individual 401(k).

While most major custodians support solo 401(k)s, some of them may have certain restrictions which you would need to check out before you open an account.

In a solo 401(k) plan, your salary deferral is based on the structure of your business. This, along with employer profit sharing contributions, can generally be made until the date of your next file return.

Unlike the SEP IRA, loans and Roth options are permitted with a solo 401(k), although the rules for this may differ depending on your custodian.

There are also less government filing requirements, which usually don’t come up until the plan exceeds $285,000.

Solo 401k Contribution Limits

The contributions for a solo 401(k) is typically made by the employee and employer.

One way to understand the contribution limits of a solo 401(k) is by thinking of yourself as both your employer and the employee. As a self-employed individual, you would have to make both of these contributions.

The limit for an employee’s contribution is $19,500. People who are 50 and older can contribute as much as $25,000 because of a catch-up contribution of $6,500.

As the employer, the maximum amount you can contribute is 25% of your net income.

The total contribution limit for a solo 401(k), as of 2020, is $57,000. This includes both your contribution as an employer and employee but not the catch up contributions.

Individuals who are already employed but have other side businesses can make use of a solo 401(k). They would be covering the employer’s contributions with the income they receive from their business.

Solo 401k Contribution Deadline

The deadline for contributions usually depends on the type of business you are working and the due date for your self-employed tax return.

Your contributions should be made and completed before your self-employed tax return due date.

Assuming you file your taxes on an extension, you will have a year or more to fund your solo 401(k) account.

For employee deferral contributions, the plan participants must make a formal election by December 31. However, they can make their contributions until the personal tax-filing deadline unless a tax-filing extension is made.

The pretax and after-tax funds can be used to make the employee deferral contributions.

On the other hand, with a profit sharing contribution, certain deductions should be taken into account. First is the deduction for half of the self-employment tax, and second is the deduction for contributions on your behalf.

The deadline for the solo 401(k) contributions must also be made by the tax-filing deadline.

Sole proprietorship and c-corporations usually have their deadlines on April 15, and on October 15 if they file for a tax-filing extension.

While s-corporations and partnerships often have their deadlines set on March 15, and on September 15 when they choose to file for a tax-filing extension.

Solo 401k Max Contribution

The maximum amount that a self-employed individual can contribute is $57,000.

If the said individual is 50 years or older, they can add an extra $6,500 per year as a catch-up contribution. This makes their maximum contribution $63,500.

Since you play the role of both the employee and employer when making your contributions, you can put away a great deal of money. However, each type of contribution to the solo 401(k) comes with its own set of IRS rules.

In a year, you can contribute a maximum amount of $19,500 as an employee. If you are 50 or older, your maximum contribution as an employee is $26,000. This applies even when the said amount is your whole self-employed earnings throughout the year.

These contributions are made on a pre-tax basis.

Some solo 401(k) providers offer a Roth option, which allows you to invest some or all of the contributions you’ve made on an after-tax basis.

The pre-tax contributions and the earnings from it will be taxed as regular income when it gets withdrawn during retirement. However, Roth contribution will be completely tax-free in retirement.

In the position of the employer, the maximum amount you can contribute is 25% of your net self-employment income, which is your business income minus half of your self-employment tax.

These pre-tax contributions can help lower your taxable income, therefore cutting your tax bill.

How to Set Up Rocket Dollar for Solo 401(k) Investing

Rocket Dollar is a platform where you can make investments in any asset category that is permitted by the IRS. This platform specializes in investments in unconventional assets such as real estate, cryptocurrencies, loans, and precious metals.

They provide simple steps for you to follow to open up a solo 401(k) account, wherein you can start making investments.

When you get your account set up, you have the ability to invest in any asset of your preference as long as it is allowed by the IRS. It can be anything, even unconventional assets.

The platform makes it easy for you to track your investments by providing you with an investment tracker, which tracks them down for you and shows information about them in summary.

You’ll also need a trust account to invest in your solo 401(k) account. Rocket Dollar will take care of this process for you because this is included when you set up your solo 401(k) account.

The following is a summary of what is involved in the process of setting up a solo 401(k) with Rocket Dollar:

1. Preparation of required documents.

The Rocket Dollar team will be preparing your documents that are needed to set up your plan. This includes information such as your Employee Identification Number (EIN).

Usually, this would take around two to three business days to have ready.

2. Setting up a bank account.

Rocket Dollar is in partnership with banks. This makes it easier for them to open a bank account made solely for the solo 401(k). The partnership also gives them the ability to complete the process within one business day.

They will be providing you with the proper account opening instructions through email.

3. Funding the solo 401(k) account.

Every time you fund your account, you will be in touch with Rocket Dollar’s support team.

They will be assisting you if you want to roll over from an old 401(k) account, an old IRA plan, or set up an annual contribution.

4. Investing.

When your funds have finally reached your new bank account, you will also have the power to control your retirement funds.

Rocket Dollar makes it convenient for you to start investing through your platform without having to look for a different place to make the investment.

This process works for both traditional and Roth options.

The whole process, starting from a zero balance account to funded, takes two to four weeks, starting from your purchase of a Rocket Dollar account.

The time frame includes other processes, such as opening your bank account and your trust account and waiting on your rollover retirement money to transfer.

Some providers may take a while to transfer 401(k)s. This is common because they ask for distribution forms that usually require the approval of your former employer.

Other providers, however, still require the sending of physical checks.

If you don’t want to wait too long, Rocket Dollar offers a gold account in which they will push to have your account open and completed within 15 days.

Dustin Heiner

Dustin Heiner is the founder of Successfully Unemployed and the host of the Successfully Unemployed Show. Dustinquit his J.O.B. by investing in real estate and has a passion to teach others to quit their J.O.B. at Master Passive Income.

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