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Solo 401(k): What You Need to Know

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What is a Solo 401(k) plan?

A solo 401(k) also called an individual, self-employed, or owner-only 401(k)  is a great solution for the owner-only business because it allows considerable contribution flexibility and plan design. 

The passage of the SECURE Act now allows an employer to set up a plan and make deductible contributions for 2020 until the due date of the employer’s tax return plus extensions.

Finally the 401(k) plan is relatively easy to administer, making it an attractive option for small-business owners or sole proprietors who want to be able to save aggressively for the future.

What to Know Before Opening a Solo 401(k)

A Solo 401(k) plan offers many of the same benefits of a traditional 401(k) with a few distinct differences.

You can use your Solo 401(k) plan to cover both you and your spouse.

However, you can’t contribute to a solo 401(k) if you have full-time employees. 

Employee salary deferrals and employer contributions are allowed.

For 2020 and 2021, as an employee, you can make salary deferral contributions up to $19,500. If you’re at least 50 years old, you can add an extra $6,500 in catch-up contributions each year.

Then, as the employer, you can contribute up to $57,000 in 2020 and $58,000 in 2021 in combined contributions each year. If you are over 50, your combined employee and employer annual contributions can’t exceed $63,500 for 2020 and $64,500 in 2021.

Tip: Under the right circumstances, a combination of the Solo 401(k) Plan and a Defined Benefit Plan can help you save a lot of money for retirement in a short period of time.

Employer profit sharing contributions can generally be made until the date the tax return is filed, including extensions.

Depositing employee deferrals will vary based on the business structure.

Your contributions may be eligible for tax breaks. 

If your business is not incorporated, you can generally deduct contributions for yourself from your personal income. If your business is incorporated, you can count the contributions as a business expense.

Design your plan for different priorities.

Plans can be structured to allow loans or hardship distributions, as well as a Roth option.

Mind the Solo 401(k) rules.
  • You cannot take withdrawals from the plan until a “trigger” event occurs, such as turning age 59½, disability or death. 
  • You’ll need to pay a 10% early withdrawal penalty on any distributions made under age 59½. 
  • Required minimum distributions start at age 72.
  • Understand your administrative responsibilities.

    Sponsors must file an IRS Form 5500 after plan assets exceed $250,000.

    Enjoy flexibility with rollovers.

    Plans can be structured to accept rollovers from other retirement accounts, including SEP IRAs and traditional 401(k)s, into your Solo 401(k).

    You can also roll your Solo 401(k) assets into another 401(k) (assuming the employer’s plan allows rollovers) or an IRA.

    Thinking about hiring new employees?

    You’ll either need to convert your Solo 401(k) to a Traditional 401(k), or terminate it. 

    Remember to abide by the Solo 401(k) contribution deadline.

    In order to make a contribution for this year, you must establish your Solo 401(k) plan by December 31, 2021 and make your employee contribution election by the end of the calendar year.

    Avoid a Solo 401(k) Audit Surprise

    Solo 401(k) plans are among the Internal Revenue Service’s current audit targets. Your Advisor will help you review your Solo 401(k) plan to determine whether there are operational or qualification failures, income and excise tax adjustments, or plan document violations.

    Common Solo 401(k) Compliance Problems

    Employees eligible for benefits

    The business has or acquires employees who meet the eligibility under the plan document, but aren’t included in the plan.

    Controlled group/affiliated service group

    The business that sponsors the Solo 401(k) plan is under common control with a business that has common law employees.

    Form 5500 filing

    Solo 401(k) plans are exempt from filing Form 5500-EZ until the plan assets reach $250,000. If a Form 5500-EZ is not filed, significant penalties could be assessed by the IRS.

    Exceeding contribution and deduction limits

    Employee salary deferrals cannot exceed $19,500 in 2021, plus $6,500 for those 50 and older. Total contributions for a plan year cannot exceed to the lesser of 100% of compensation or $58,000 ($64,500 with catch-up). The maximum deduction is 25% of eligible plan compensation.

    Plan Document errors

    Your Plan Document must be updated periodically to comply with the law and adopted on a timely basis. Amendments also must be properly documented and adopted on a timely basis.

    We Can Help

    If you are a Solo 401(k) sponsor: We can help you check your Solo 401(k) plan for these issues. We are available to assist with the review and correct any failures. This must be done before an IRS audit occurs to avoid stiff penalties!

    If you would like to open a Solo 401(k): We’ll ask you a few questions about your business to help determine the 401(k) plan type that best aligns with your particular business needs. Then, we’ll create your Plan Document and install the plan for you.

    For any and all questions about your Solo 401(k), please fill out the form below. We look forward to hearing from you!

    DISCLAIMER: Advisory Services offered through Prosperity Financial Group, Inc., an Independent Registered Investment Advisor. Securities offered through Fortune Financial Services, Inc. Member FINRA/SIPC. Prosperity Financial Group, Inc. and Fortune Financial Services, Inc. are separate entities. 

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