How To Set Up a Solo 401(k) in 5 Steps
Tom has 15 years of experience helping small businesses evaluate financing and banking options. He shares this expertise in Fit Small Business’s financing and banking content.
A Solo 401(k) is an employer-sponsored retirement plan that allows self-employed individuals to contribute up to $58,000 per year before taxes, including $19,500 of employee contributions. Setting up a Solo 401(k) requires five steps that range from understanding how a Solo 401(k) works to funding the account.
Should you need a Solo 401(k) provider, ShareBuilder 401k allows entrepreneurs to maximize their retirement savings at an affordable price for both setup and administration of their plan. Clients get access to a low-expense, diverse, high-quality fund lineup and an easy-to-use online portal.
To set up your own Solo 401(k), here are the steps to follow:
1. Understand the Eligibility Requirements for a Solo 401(k)
Because IRS regulations say Solo 401(k) plans can only have one participant, these plans are only appropriate for self-employed individuals and small business owners who have no full-time employees. Solo 401(k) plans will require a plan administrator, also known as an investment provider, who’ll help ensure regulatory paperwork is completed. If you plan to hire full-time employees in the future, a Solo 401(k) plan can convert easily to accommodate additional full-time employees within the company’s 401(k) plan.
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 $58,000 each year, the SEP-IRA only allows you to contribute up to 25% of your income or $58,000, whichever is less. Also, if you have a SEP-IRA and hire additional full-time staff, you are required to make contributions for those employees whenever you make contributions for yourself. That said, a SEP-IRA can be rolled over to a new 401(k) plan, whether it be solo or traditional, should you unexpectedly need to hire staff.
2. Find a Solo 401(k) Provider
Finding a provider to administer your Solo 401(k) is arguably the most important step in the process. Most people who want to set up a Solo 401(k) look for a simple, straightforward, and affordable plan. However, remember that these plans are all about your future individual goals and business plans—you want to ensure that your provider can help you with those.
When you start looking for a Solo 401(k) provider, it’s important to consider these three things:
- Costs: Many Solo 401(k) plans charge manageable and competitive fees
- Level of management: Not all providers will actively administer Solo 401(k) plans from the standpoint of annual regulatory and compliance filings; some will provide you with the information that’s needed to report at no cost but leave the responsibility for filing to you while other providers will offer more hands-on management for a monthly or annual fee
- Investment flexibility: Be sure to choose a provider that’ll give you access to the investment options you want, in alignment with your financial needs
If you already have an investment account or IRA plan, you can ask your current advisor if they also offer a Solo 401(k). If your advisor is unable to help, make sure you shop around and choose a reputable company. We’ve researched the best Solo 401(k) providers to help you in that process. These providers will offer a mix of quality services at affordable costs.
3. Create Plan Documents and Disclosures
After you select a provider, you’ll receive a package of documents referred to as an “employer kit” or “employer application” to set up your plan. You can expect the package to contain several documents and disclosures, and most of the forms are self-explanatory.
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
You’ll need to make initial elections on your investment choices during this phase of the process, but they can be changed at any point in the future. Go through the disclosures to make sure you understand how the plan works and what you need to do to remain compliant, and then sign the appropriate paperwork.
From a regulatory perspective, a Solo 401(k) is like a traditional 401(k), but with only one participant. Even though you don’t have employees who can participate in your Solo 401(k), your plan administrator will need to provide disclosures that contain information on the plan and the benefits of tax-free savings.
In addition to requesting information on you and your business, this paperwork may include items that would go on IRS Form 5500 if you have over $250,000 in your account or have additional plan participants. Should you later convert your Solo 401(k) to a traditional 401(k) with more participants, you or your plan administrator will need to give each eligible employee the same set of disclosures in an enrollment package.
The primary disclosures for a Solo 401(k) plan include:
- General 401(k) disclosure: The IRS wants to make sure employees understand 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
4. Open an Account With Your Provider
Now that you’ve chosen your provider and obtained all required documents and disclosures, it’s time to open the Solo 401(k). This account should be formed any time prior to your tax-filing deadline and needs to be formed in accordance with any 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 in a way that’s similar to how you fund an IRA, it’s typically a best practice to set up a new account in the year that it’ll be effective and make your first contributions in the same year.
5. Make Contributions to Your Solo 401(k)
Once all the paperwork is completed and the disclosures are reviewed, it’s time to fund your account. Most providers will accept a check, wire transfer, or automated clearing house (ACH) payment to fund the Solo 401(k). It’s up to you to decide whether you want to make monthly installments or fully fund the account in one lump-sum payment.
There are two pieces to the contribution strategy with a Solo 401(k). First, you are allowed to contribute up to $19,500 from your salary. If you are over 50 years old, you can contribute an additional $6,500. The second piece comes from the employer as a profit-sharing contribution of up to 25% of your net self-employment income. This earned income is your net profit minus your plan contribution to the Solo 401(k) and one-half of your self-employment tax.
The limit on compensation that can be used to determine your contribution is $290,000 in 2021. 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 important to get your contribution correct.
Once your account reaches $250,000 in assets, you’ll have new requirements, including filing Form 5500 with the IRS. 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. For a fee, some providers will help you with the required compliance and associated paperwork. Note that some providers don’t offer full-service management and will only provide you the information needed for your tax filing and regulatory reporting. Keep this in mind when you are 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 | Cost |
|---|---|
Custodian Fee | Up to $50 annually |
Trading Commissions | Up to $25 per trade |
Expense Ratios Like Mutual Funds & ETFs | .03% to 1.5% annually |
Administrative Charges Like Self-directed 401 (k) | $200 to $2,500 annually |
Solo 401(k) Pros and Cons
| PROS | CONS |
|---|---|
| Easy to administer | 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) |
| Spousal participation | |
Bottom Line
A Solo 401(k) plan is an excellent option for small business owners with no other full-time employees. These plans offer higher contribution limits than traditional IRAs as well as a variety of investment options. With the right provider, the Solo 401(k) is easy to set up and maintain.
