The self-directed solo 401(k) is a highly flexible and profitable plan for long-term wealth creation. The combination of flexible investments, high contribution limits, payroll deductions, tax-deferred growth, and liberal allowances for employer contributions makes self-directed solo 401(k) a smart move for small businesses with substantial income potential and free cash flow.
Designed for small businesses, the self-directed solo 401(k), allows entrepreneurs to contribute up to $56,000 pretax, including $19,000 of salary deferrals made by employees. Setting up a self-directed solo 401(k) requires just 6 simple steps that can be completed in a matter of a few days.
Step1 – Understand the Eligibility Requirements of Self Directed Solo 401(k)
As the name implies, a self-directed solo 401(k) plan is specifically designed for just one participant. It is only available to self-employed individuals or small business owners without full-time employees. And, it is best for entrepreneurs whose annual income is less than $75,000.
Step 2 – Select a Solo 401(k) provider
When identifying the best solo 401(k) provider to establish your self-directed IRA, consider a trusted and experienced company that can meet your unique business needs. Cost-effectiveness, reputation, investment flexibility, and checkbook control are 4 important factors to consider when finalizing a solo 401(k) provider.
Step 3 – Draft Your Plan Documents
You will receive an employer kit from your solo 401(k) provider. Within this kit will be all the paperwork that you need to complete in order to set up a self-directed solo 401(k). This will include a plan adoption agreement, IRS Form 5500, loan terms, and contribution rates along with other technical rules. Your provider will walk you through the process and help you with the plan design while ensuring that you get maximum flexibility and tax benefits.
Step 4 – Prepare Disclosures
Even if you don’t have fulltime employees, you are still required to prepare employee disclosures that outline certain important information on the plan. It should include the advantages of tax-free savings, an explanation of how employer-sponsored retirement plans work, details about your plan, employee rights, and responsibilities, eligibility information, the timeline for employer contributions and any vesting schedules that you plan to use.
Step 5 – Set up Your Solo 401(k) Account
A self-directed solo 401k account can be established at any time before the tax-filing deadline. And it should be in accordance with the guidelines laid out in your plan document. Technically, you can set up your solo 401(k) after the year-end and make advance contributions for the upcoming year to avoid any red flags.
Step 6 – Start Making Contributions
Once you have set up your account, you can schedule automated electronic contributions or you can make a single contribution of up to $56,000 before your tax-filing deadline. You can choose to pay all at once or spread out your contributions throughout the year. Once your self-directed solo 401(k) reaches $250,000 in assets, it will be subject to new requirements.
Benefits of Self-Directed Solo 401k
- Hassle-free administration – You are the trustee of the plan and IRA is your record keeper.
- Higher contribution limits – You can make an annual contribution of up to $56,000 and those who are over age 50 can make an additional catch-up contribution of $6,000.
- Loans are tax-free – You can borrow up to $50,000 from a self directed solo 401(k) without inviting any taxes or penalties provided, the loan is repaid within 5 years.
- Roth IRA is included – Solo 401(k) comes with an inbuilt Roth provision where you can make contributions without any income constraints.
- Checkbook Control – With self-directed solo 401(k) plan, participants can manage their self directed IRA with checkbook control.
If you want to establish a self-directed solo 401(k) and enjoy all of the above-mentioned benefits, then you can roll over one or more of your IRA accounts to your new solo 401(k) plan. And you may also be eligible for a tax credit of $500 every year, for up to 3 years!
Rick Pendykoski is the owner of Self Directed Retirement Plans LLC, a retirement planning firm based in Goodyear, AZ. He has over three decades of experience working with investments and retirement planning. Over the last 10 years has turned his focus to self-directed accounts and alternative investments. Rick regularly posts helpful tips and articles on his blog at SD Retirement. You can also find his writing on Business.com, SAP, MoneyForLunch, Biggerpocket, SocialMediaToday, and NuWireInvestor. If you need help and guidance with traditional or alternative investments, email him at [email protected]