The Solo 401(k) Plan, also known as the Individual 401(k) or Self-Directed 401(k) Plan, is an IRS approved type of qualified retirement plan which is suited for business owners who do not have any employees, other than themselves and perhaps their spouse. A Solo 401k plan offers the same advantages as a Self-Directed IRA LLC, but without having to hire a custodian or create an LLC.
The setup structure is as easy to implement as the IRA LLC and cost only marginally more when considering you avoid the costs of having to use a custodian.
Below are listed the distinct advantages of a Solo 401(k):
- High Contribution Limits: While an IRA only allows a $5,500 contribution limit (with a $1,000 additional “catch up” contribution for those over age 50), the Solo 401(k) annual contribution limit is $53,000 for 2016 with an additional $6,000 catch-up contribution for those over age 50. In addition, if your spouse generates compensation from the business, he or she can also make high contributions to the Plan.Under the 2016 Solo 401(k) contribution rules, a plan participant under the age of 50 can make a maximum employee deferral contribution in the amount of $18,000. That amount can be made in pre-tax or after-tax (Roth). On the profit sharing side, the business can make a 25% (20% in the case of a sole proprietorship or single member LLC) profit sharing contribution up to a combined maximum, including the employee deferral, of $53,000.For plan participants over the age of 50, an individual can make a maximum employee deferral contribution in the amount of $24,000. That amount can be made in pre-tax or after-tax (Roth). On the profit sharing side, the business can make a 25% (20% in the case of a sole proprietorship or single member LLC) profit sharing contribution up to a combined maximum, including the employee deferral, of $59,000. Loan Feature: While an IRA offers no participant loan feature, the Solo 401k allows participants to borrow up to $50,000 or 50% of their account value (whichever is less) for any purpose at a low interest rate (the lowest interest rate is Prime which is 3.50% as of 12/21/15). This offers a Solo 401(k) Plan participant the ability to access up to $50,000 for use for any purpose, including paying personal debt or funding a business.
- “Checkbook Control” and No Custodian Fees: With a Solo 401(k) Plan, you can serve as trustee of the Plan giving you “checkbook control” over the Plan’s funds. To this end, making an investment with your Solo 401(k) Plan is as easy as writing a check. Another significant benefit of the Solo 401(k) plan is that it does not require the participant to hire a bank or trust company to serve as trustee. This flexibility allows the participant to serve in the trustee role. This means that all assets of the 401(k) trust are under the sole authority of the Solo 401k participant.
- Tax-Free Loan: With a Self-Directed 401K Plan, a plan participant is eligible to borrow up to $50,000 or 50% of their account value (whichever is less) for any purpose, including paying personal expenses such as credit card bills, mortgage payments, personal or business investments, a car, vacation, or anything else. The loan has to be paid back over a five-year period at least quarterly at a minimum prime interest rate (you have the option of selecting a higher interest rate). There is no pre-payment penalty.
- Roth Type Contributions: With IRAs, those who earn high incomes are disallowed from contributing to a Roth IRA or converting their IRA to a Roth IRA. The Solo 401(k) plan contains a built-in Roth sub-account which can be contributed to without any income restrictions. With a Roth Solo 401(k) sub-account, you can make Roth type contributions while having the ability to make significantly greater contributions than with an IRA.
- Cost Effective Administration: In general, the solo 401(k) plan is easy to operate. There is generally no annual filing requirement unless your solo 401(k) plan exceeds $250,000 in assets, in which case you will need to file a short information return with the IRS (Form 5500-EZ).
- Exemption from UDFI: When an IRA buys real estate that is leveraged with mortgage financing, it creates Unrelated Debt Financed Income (“UDFI”) – a type of Unrelated Business Taxable Income (also known as “UBTI or UBIT”) on which taxes must be paid. The UBTI tax is approximately 40% for 2016. But, with a Solo 401(k) plan, you can use leverage without being subject to the UDFI rules and UBTI tax. This exemption provides significant tax advantages for using a Solo 401(k) Plan versus an IRA to purchase real estate.
Our attorneys can work with you to implement and administer the solo 401k plan and ensure ongoing compliance.