How To Set Up a Solo 401(k) in 5 Steps
A solo 401(k), also known as a one-participant 401(k) plan, is a retirement plan allowing self-employed individuals to contribute up to $61,000 per year before taxes, including $20,500 of employee contributions. The business owner contributes as both the employer and employee in this type of retirement plan.
Setting up a solo 401(k) requires five steps, ranging from understanding how a solo 401(k) works to funding the account. First, you need to make sure you’re eligible for a solo 401(k), which requires an employer identification number (EIN). Then, choose a solo 401(k) provider, which will give you a plan adoption agreement and an application. Once those are completed, you can open your account. The last step is to set up your contribution amounts and choose your investment options.
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Step 1. Understand the Eligibility Requirements for a Solo 401(k)
Because the IRS limits solo 401(k) plans to only one participant, they’re a good choice for self-employed individuals and small business owners with no full-time employees. They can cover just a business owner with no employees or that person and their spouse.
Solo 401(k) plans require a plan administrator, also known as an investment provider, to help with regulatory paperwork. If you plan to hire employees in the future, a solo 401(k) plan can convert to allow full-time employees within the company’s 401(k) plan.
You’ll need an EIN before you can open a solo 401(k) account. You can obtain one online, by fax, or by mail. If you apply online, you can have your EIN in about 10 minutes.
Solo 401(k) Contribution Limits for 2022
Category | Amount or Percentage |
|---|---|
Elective Deferrals* | Up to 100% of compensation |
Annual Contribution Limit | $20,500 if under 50 years of age $27,000 if age 50 or older |
Employer Nonelective Contributions | Up to 25% of compensation as defined by the plan |
Total Contributions (Not Counting Catch-up) | $61,000 |
* A business owner employed by a second company and participating in its 401(k) plan should note limits on elective deferrals are by person, not by plan. Consider the limit for all elective deferrals you make during a year.
An alternative to the Solo 401(k) is the simplified employee pension individual retirement account (SEP-IRA). While both plans allow you to contribute a maximum of $61,000 each year, the SEP-IRA only allows you to contribute up to 25% of your income or $61,000, whichever is less.
Also, if you have a SEP-IRA and hire additional full-time staff, you’re required to make contributions for those employees whenever you make contributions for yourself. It can be rolled over to a new 401(k) plan, whether it be solo or traditional, should you unexpectedly need to hire staff.
Step 2. Find a Solo 401(k) Provider
The most critical step in the setup process is finding the right solo 401(k) provider. The best solo 401(k) providers should provide a simple, straightforward, affordable plan. You should choose a provider that can also support your business as it grows and its needs change.
When choosing a solo 401(k) provider, you should consider these three factors:
- Costs: Choose a provider with manageable and competitive fees. Be sure to compare the fees of multiple providers to find the most affordable plan that matches your business needs.
- Level of management: Some providers will offer hands-on management for a monthly or annual fee, assisting you with regulatory and compliance filings. However, not all providers actively administer solo 401(k) plans. Consider the level of management needed from your provider before choosing.
- Investment flexibility: Choose a provider that gives you access to the investment options you want in alignment with your financial needs.
If you already have an investment account or IRA plan, ask your current provider if they offer solo 401(k) plans. Otherwise, choose a provider that offers factors that align with your personal needs.
Step 3. Complete Plan Documents & Disclosures
After selecting a provider, you’ll receive a collection of documents called an “employer kit” or “employer application.” These documents will help you set up your plan.
Documents that need to be completed for your provider include:
- Client agreement
- External transfer form
- Participant application and designation of beneficiary
- Establishing a qualified retirement plan (QRP)
- Section 408(b)(2) disclosure
- Rates and fees
- QRP amendment kit
- ERISA 404(c) plan information
- Summary cash balance form
- Privacy statement
- QRP basic plan document
- Adoption agreement
This is the stage in the process when you’ll make initial investment choices. Those initial choices can be changed at any point in the future. You’ll receive disclosures and instructions on how to remain compliant. These disclosures will include information on the plan and the benefits of tax-free savings.
In addition, you’ll receive information regarding items that would go on IRS Form 5500 if you have over $250,000 in your account or have additional plan participants. If you eventually convert your solo 401(k) to a traditional 401(k) with more participants, those participants will also receive the same disclosures from the plan administrator.
The primary disclosures for a solo 401(k) plan include:
- General 401(k) disclosure: This IRS-provided disclosure informs employees on how employer-sponsored retirement plans work, especially from a tax benefit perspective
- Details about your plan: This is the specific information on your plan, including where accounts are being held and the available investment options
- Employee rights and responsibilities: Employee disclosure needs to include the timeline for employer contributions and any applicable employer match, eligibility information, and vesting schedules you want to use
Step 4. Open an Account With Your Provider
Once you have chosen a provider and have obtained all required documents and disclosures, you can open your solo 401(k) account. This account should be opened before your tax-filing deadline and following guidelines in your plan documents.
While you’re allowed to set up a Solo 401(k) account after the year ends and make prior-year contributions similar to IRA funding, it’s best to set up a new account in the year that it’ll be effective and make your first contributions in the same year.
IRS-mandated funding deadlines:
- Employee contributions―Roth, catch-up, or regular―must be made within the business tax year
- Employer contributions (profit share) can be made by the tax deadline for the previous year (usually April 15)
Step 5. Make Contributions to Your Solo 401(k)
Once the account is opened, it can be funded. Most providers accept checks, wire transfers, or automated clearing house (ACH) payments to fund the solo 401(k). You can fund the account monthly or in a lump-sum payment.
The IRS allows you to contribute up to $20,500 from your salary if you’re younger than 50 years old. If you’re 50 or older, you can contribute up to $27,000). The second part comes from employer profit-sharing contributions of up to 25% of your net self-employment income.
The IRS limit on compensation used to determine your contribution is $305,000 in 2022. Consult your tax advisor to develop an optimal strategy that’s IRS-compliant. Penalties for excessive contributions are applied in the year the contribution is made and when the money is distributed, so it’s essential to get your contribution correct.
Once your account reaches $250,000 in assets, you’ll have new requirements, including filing IRS Form 5500. If you ever hire employees who become eligible for your plan, you’ll need to make adjustments to accommodate these new participants.
Solo 401(k) Costs
Because Solo 401(k) plans have one participant, there are few administration requirements. Some providers will help you with the required compliance and associated paperwork for a fee. Note that some providers don’t offer full-service management and will only provide you with the information needed for your tax filing and regulatory reporting. Keep this in mind when you’re shopping around for a provider.
Most providers charge custody fees plus mutual fund expense ratios and commissions for trading individual stocks, bonds, or exchange-traded funds (ETFs). You may also pay fees per fund you use or other fees to an alternative provider if you invest in things like real estate.
Sample Solo 401(k) Costs
Type of Fee | Costs |
|---|---|
Custodian Fee | Up to $50 annually |
Trading Commissions | Up to $25 per trade |
Expense Ratios, Such as Mutual Funds & ETFs | 0.03% to 1.5% annually |
Administrative Charges, Such as Self-directed 401(k) | $200 to $2,500 annually |
Solo 401(k) Pros & Cons
| PROS | CONS |
|---|---|
| Easier to administer than other types of retirement plans | More compliance requirements than IRAs |
| Higher contribution limits than traditional IRA plans | Potentially higher administrative costs |
| Potential to borrow from 401(k) | Additional IRS filing requirements once you surpass $250,000 |
| Lower costs than traditional 401(k) | Must offer to newly hired employees and convert to traditional 401(k) |
Bottom Line
A solo 401(k) plan is an excellent choice for a retirement plan for solo business owners with no full-time employees. The plan can cover just the business owner or the owner and their spouse. You can get an easy-to-administer retirement plan with higher contribution limits and lower fees than traditional IRAs. Finding the best solo 401(k) providers and setting up the plan correctly can be just as crucial to the growth of a new business as finding the best small business checking account or getting a small business loan.
