Designed for sole proprietors, freelancers, and contractors, the Solo 401(k) helps self-employed people maximize their retirement benefits.
Whether you freelance as an independent contractor or receive income from a side hustle, you’ll want to jump on the opportunity to leverage wealth through a Solo 401(k). This plan is also known as an Owner Only 401(k) Plan or Individual 401(k).
First, let’s go through an overview of what exactly is a Solo 401(k), who's eligible, your options, and how to open one.
What Is a Solo 401(k)?
A Solo 401(k) recognizes independent contractors as a business wearing the hat of both employer and employee. As such, you would be able to make contributions according to each title.
As an employer, you can contribute up to 25% of your compensation in 2022. As an employee, you can contribute up to a limit of $20,500. An additional catch-up contribution of $6,500 is available to those who are above 50. The limit will increase to $22,500 and $7,500, respectively in 2023.
In total, depending on your income in 2022, you can contribute $20,500 as an employee plus up to $40,500 as an employer equaling $61,000 (total contribution in 2023 will be $66,000). If you are age 50 or older, remember to factor in the catch-up contribution. This contribution can exceed the annual limits of $61,000 and $66,000 for 2022 and 2023 respectively.
Solo 401(k)s also don’t come with typical cumbersome compliance requirements since there are no other employees. They were designed with simplicity in mind for use by sole proprietors, freelancers, and contractors. Much of the paperwork and bureaucracy that comes with setting up and managing a 401(k) in a corporation has been greatly simplified.
You also have the opportunity as an investor to direct your funds into a variety of assets. The only limits on what you can invest in depends on your recordkeeping. Investing in a self-directed Solo 401(k) allows many types of alternative investment options. These include stocks, bonds, mutual funds, exchange-traded funds, crypto currencies, and real estate.
Eligibility Requirements
First and foremost, to open a Solo 401(k) you need to generate income from your own business. This income can be verified through tax records.
The second factor to consider is that only you and a spouse can operate or be employed by your business. This means you cannot have any other employees working for you to qualify to open a Solo 401(k). However, you can have other owners in the plan and their spouses if they all work for the business.
How to Apply for a Solo 401(k)
When opening a Solo 401(k) there are steps the IRS list on what is needed to establish a plan. The first step is to find an IRS approved document provider like IRAR Trust.
The document you will need to complete, date and sign to establish the plan is called an Adoption Agreement. You must state what features are available under your plan in this document. Additionally, you must state the name of the plan. As an example, ABC company 401(k) plan.
You will also decide which features to allow. Should you allow loans? Should you allow Roth contributions?
Establishing a Solo 401(k) plan requires you to get a separate Employer Identification Number (EIN). This is because your solo 401(k) plan is separate from your business dealings.
You will also need to decide on certain features. Will your plan allow for alternative assets such as real estate and private equity? Remember, to have a fully diversified retirement portfolio you should consider tangible assets. You don't want to put all of your eggs in one basket.
Next, you will have to establish a bank checking account. This is where you will deposit your contributions and income generated from investments. Also, this is the account that you will use to make investments and pay investment expenses.
The intention of this account is to save for retirement. Funds should be kept separate from personal and business accounts. This ensures that the account is not used for personal gains.
Then, there is the accurate recordkeeping once you start investing. A good Solo 401(k) company can provide a record-keeping system to account for the different types of contributions you will be making along with the investments made from those contributions.
Keeping good records now, will help you track and allocate funds correctly. Good recordkeeping is also extremely important for retirement withdrawals. You will want to know what sources are available to you during your working years, when you retire, or if you face difficult circumstances or hardship.
The tax benefits can also be maintained with a good record keeping system, tracking Roth contributions and its earnings as an example.
Solo 401k Options
There are a couple of options for opening your Solo 401(k). With a regular 401(k) deferral, the benefit comes from reducing your taxable income for year since your income is deferred into the plan. As an investor, you can get an immediate tax deduction on your contributions.
You’ll pay income taxes on those contributions in your later years as you start making withdrawals in your retirement. This tax-deferred plan may benefit those who will most likely anticipate falling into a lower tax bracket during their retirement years.
For those who anticipate being in a higher retirement tax bracket, the Roth 401(k) provides an alternative tax advantage. To avoid hefty taxes down the road, the Roth 401(k) is funded using after-tax dollars. This means you’ll pay income taxes on the contributions made to the plan, and your withdrawals may be tax-free upon retirement.
What other Retirement Plans are Available to Independent Contractors?
Self-employed contractors or small businesses can take advantage of some individual retirement plans (IRAs) as well; Traditional IRA and Roth IRA. Contributions to these individual accounts do not affect the amount you can contribute to your Solo 401(k) plan aka Solo 401k for Independent Contractors.
The Solo(k) offers the largest contribution amounts of any small business plan. This includes the Simplified Employee Pension Plan (SEP IRA) and Savings Incentive Match Plans (SIMPLE IRA).
Why Choose IRAR?
When choosing a trusted custodian for your Solo 401(k), IRAR has you covered. We provide comprehensive support to investors saving for retirement. We help you understand the investment process and rules governing retirement accounts.
We also offer low fees and a customer-focused experience. Our Solo 401(k) platform is state of the art and user friendly. It provides accurate recordkeeping, compliant processes, and reporting. We also have a team of self-directed retirement specialists who are knowledgeable.
Are you interested in our white-glove services for your Solo 401(k)? Sign up here. You'll receive an invitation to check out our revolutionary platform before the launch of our platform.
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