A solo 401(k) is a specialized qualified retirement plan allowing business owners and their spouses to shelter up to $57,000 to $63,500 of income from taxes each year. Solo 401(k)s are attractive because they function like any other 401(k) except at lower cost and are an option for business owners with no full-time employees.
ShareBuilder 401k is an experienced 401(k) provider that allows solopreneurs to maximize their retirement savings at an affordable price. Clients get access to a low-expense, diverse, high-quality fund lineup and an easy to use online portal. Opening a solo 401(k) with ShareBuilder 401k has a one-time setup fee of $150 and ongoing administration costs start at $25 per month.
How a Solo 401(k) Plan Works
The solo 401(k), also called an individual 401(k), works similarly to a regular 401(k) plan with a couple of key differences. Plan participants can contribute up to $19,500 of their earned income into the plan and increase this with employer contributions via profit sharing up to $57,000. Participants age 50 and older are allowed catch up contributions, increasing the total amount to $63,500.
The critical difference between a solo 401(k) and a traditional 401(k) is that, as the name suggests, the solo 401(k) is for one participant—the owner—and his spouse. Both have early withdrawal penalties as well as identical contribution limits and distribution rules.
Having one participant makes a solo 401(k) cheaper and easier to administer while providing the same tax benefits and general investment options. For this reason, a solo 401(k) is a great retirement savings plan for solopreneurs or those who earn 1099 income and are looking to shelter income or profits from their business.
Who a Solo 401(k) Plan Is Right For
The types of individuals who find a solo 401(k) plan appropriate include:
- Solopreneurs and their spouses
- Businesses that rely on independent contractors instead of full-time employees
- Freelancers and independent consultants
- Self-employed business owners who think they’ll eventually hire employees
To add a spouse to the plan, the spouse must work in the business at least part-time.
The solo 401(k) allows you to contribute much more than a traditional individual retirement account (IRA), getting the tax benefits of reducing your income several times more than the $6,000 cap on a traditional IRA. While the solo 401(k) and a simplified employee pension (SEP) IRA have the same contribution limits once you reach a threshold income of $74,000 annually, it allows for easier expansion for businesses that may be growing in the future.
Solo 401(k) Plan Contribution Limits 2019
Individual 401(k) plans have two contribution limits. The first is deferrals up to the lesser of 100% of an individual’s wages or $19,500. The second comes in the form of discretionary profit-sharing for additional contributions up to either $37,500 or 25% of the participant’s income, whichever is lower. Supplemental catch-up contributions are also allowed for participants age 50 and older.
The two types of contributions to Solo 401(k) plans and their respective 2020 limits are:
- Employee deferrals: The maximum total employee deferrals for 2020 is $19,500 or 100% of income.
- Profit-sharing component (discretionary): Employers can elect to make additional profit-sharing contributions above the $19,500 threshold to a Solo 401(k) plan but are limited to an additional $37,500 or 25% of income.
Traditionally employee deferrals come from wages—they are elected by an employee each pay cycle—while profit-sharing contributions in a 401(k) come from the employer. However, in single-employee businesses, employers and employees are the same people, and deferrals vs profit-sharing are much the same.
Because solo 401(k)s are 401(k) plans with a single participant, the IRS governs them the same as any other plan. This includes dividing contributions into two different types, each with their own limits. The reality of a solo 401(k) is that it doesn’t matter how the contributions are made, so long as account holders follow the rules and limits.
As a type of 401(k), individual 401(k)s do come with costs that aren’t always found in IRA alternatives.
Solo 401(k) Plan Costs
Costs for 401(k) plans are paid directly by company owners, from plan assets, or from mutual fund fees within the plan. Fees can range from 0.25% or less for large plans to more than 4% for smaller plans that aren’t careful. Total costs between 1.25% to 2% of plan assets is usually a good target.
Expected Annual Fee
Up to 1%
Up to 0.25%
0.5% to 2%
Up to 0.6%
Up to 0.5%
Not every solo 401(k) plan has every fee associated with the account. It is important to read the fine print of all custodial documents and investment profiles to see what the total fees are on your account.
Solo 401(k) Plan Rules
Most 401(k)s and other employer-sponsored retirement plans are governed by the United States Department of Labor under the Employee Retirement Income Security Act of 1974 (ERISA). These regulations can restrict the contributions of employers and highly compensated employees. Because solo 401(k)s are only for single-employee companies, they are exempt from ERISA. This provides owners more flexibility in how they use their plan.
To set up and use a solo 401(k), business owners are still required to follow certain rules established by the IRS and Department of Labor for any 401(k) plan. These regulations govern the adoption and administration of all 401(k) plans, and failing to comply can lead to plan disqualification and penalties for plan sponsors.
The four primary plan rules include to provide disclosures to all eligible employees, submit plan and filings before deadlines, follow contribution guidelines in plan document, and vest employer contributions immediately.
1. Provide Disclosures to All Eligible Employees
When a plan becomes active, disclosures must be provided to all employees eligible to participate. Even though a solo 401(k) is only for a self-employed individual and possibly their spouse, disclosures must be prepared that contain certain information about the plan, including employer contribution guidelines and deadlines.
2. Submit Plan and Filings Before Deadlines
The IRS provides detailed deadlines for preparation and adoption of plan documents, annual filings, including Form 5500 and employee disclosures. These filings need to be prepared and submitted on time. Form 5500 typically is due the last day of the seventh month after the plan year ends, such as July 31 for a calendar year plan.
3. Follow Contribution Guidelines in Plan Document
While a solo 401(k) does not provide for employer matching contributions, other contribution guidelines outlined in plan documents need to be followed. Failure to follow with plan documents can lead to stiff penalties and/or corrective actions. For example, any excess contributions will be taxed for the year it was contributed and again when it is withdrawn from the account. You may also lose qualified retirement account status for not taking out excess contributions.
4. Vest Employer Contributions Immediately
In all 401(k) plans, employee deferrals always vest immediately, but employers sometimes establish schedules for vesting employer contributions with employees. In solo 401(k) plans, vesting schedules are not used. All contributions vest immediately.
Unlike IRA alternatives, solo 401(k) plans allow for borrowing against retirement funds—a service offered by some providers. Although most people choose not to use this option, about 19% of Americans able to borrow against their 401(k) assets do so.
Where to Get a Solo 401(k)
Though there are many types of 401(k) providers, it’s helpful to consider firms that specialize in solo 401(k)s as niche products. A provider can help employers through the process of designing, adopting, and administering a plan specifically structured as a solo 401(k). Providers also update plans and submit proper filings as necessary.
Five of the top solo 401(k) plan providers include ShareBuilder 401k, Rocket Dollar, Human Interest, Vanguard, and Fidelity.
ShareBuilder 401k specializes in bringing 401(k) plans to the masses with special emphasis on sole proprietors. The low-cost fee structure is transparent: pay a one-time setup fee of $150 and a monthly maintenance fee of $25 per owner. Plan participants have plenty of investment options in the index exchange-traded funds (ETFs) and model portfolios. Employers can add employees to the plan later if they end up hiring eligible participants.
For the business owner who wants a partner in his 401(k) plan, ShareBuilder 401k is a terrific option. It makes things simple for the sole proprietor to administrate the entire plan seamlessly.
Founded in 2018, Rocket Dollar brings a self-directed solo 401(k) to business owners. Self-directed means there is a checkbook associated with the account allowing for other types of IRS approved investments like gold, real estate, and even cryptocurrency. A self-directed retirement plan can be tricky, and business owners should familiarize themselves not just with the allowed investments but how the transactions and holdings must be applied to be compliant with IRS rules.
Rocket Dollar is a great option for savvy business owners seeking retirement investments outside of traditional mutual funds and ETFs. The flexibility Rocket Dollar offers is a major advantage.
Human Interest is a younger company that is already disrupting the retirement plan industry. Unlike some more established providers, Human Interest makes fee transparency one of its primary goals with a $399 setup fee and $99 annual fee. It aims to provide cost savings to business owners on all kinds of retirement plans, including solo 401(k)s.
Some business owners are more comfortable than others with online products and newer providers. Human Interest is a great option for those who are willing to use technology for cost savings.
With more than $4.5 trillion under management, Vanguard is the largest mutual fund company in the world and a very well-established money manager. The fund company provides custodian services for IRAs and a host of retirement plan solutions. Vanguard’s pricing structure for solo 401(k)s is very economical, but investments generally are limited to Vanguard mutual funds.
Most small business owners only need a simple, straightforward, cost-effective plan to help them save and invest. With Vanguard, business owners get exactly that.
Fidelity is widely known as one of the largest diversified financial services companies in the world. They provide brokerage and investment advisory services to companies―both large and small―as well as a wide array of retirement plan solutions—including solo 401(k) plans.
Providers like Fidelity, who offer an array of other services outside solo 401(k)s, are great for business owners who may want more investment options than just mutual funds but don’t need to pay the added cost of checkbook control. They may also need guidance in other areas of their business or personal finances.
Alternatives to a Solo 401(k)
A solo 401(k) isn’t always the best option for someone who’s self-employed. Sometimes, people can’t afford to contribute a high enough percentage of their income for the fees of a 401(k) to make sense. For many reasons, it’s important to consider other options.
Valid alternatives for single-member businesses include ShareBuilder 401k, Rocket Dollar, Human Interest, Vanguard, and Fidelity.
1. Traditional IRA
A traditional IRA is an account where you deduct your contributions that then grow tax-deferred. You can’t pull money out of the account until at least age 59 1/2, or you will have to pay a 10% IRS penalty. Any funds that come out of the account are also added to your income for the year of the distribution. In this respect, they are the same as a solo 401(k).
Where they differ is in how much you can contribute. Someone who doesn’t have an employer-sponsored plan, such as a 401(k), is allowed to contribute $6,000 in 2020—$7,000 if you are age 50 or older. Think of an IRA like a box where you can have many investment options such as a savings account, certificate of deposit (CD), mutual fund, stock, bond, gold, or real estate. Your investment options are usually dictated by where you open the custodial account.
The SEP-IRA is an employer-sponsored plan where a business owner’s company makes tax-deductible contributions on behalf of any eligible employee. Just like a traditional IRA and a solo 401(k), those with a SEP-IRA must keep funds in the account until age 59 1/2 or older or face the 10% early withdrawal penalty. Money taken out of the account is treated as income in the year it was distributed. Also like the 401(k), the maximum contribution for 2020 is $57,000.
Where it can get expensive to have a SEP-IRA vs a solo 401(k) is the cost of contributions. For an employer to qualify for a SEP-IRA, they must fund contributions for all employee accounts that are proportional to contributions in their own accounts based on individual compensation. Employees do not contribute to SEPs.
If a business owner thinks they may eventually grow beyond five to eight employees, a SEP can quickly become expensive.
A solo 401(k) is a great opportunity for sole proprietors to save large amounts of money in a tax-deferred account. Those seeking to open a solo 401(k) should first consider the types of investments they want to purchase in the account and what the fees are with various providers.