The Solo 401(k) is unique because it only covers the business owner(s) and their spouse(s), thus, not subjecting the 401(k) plan to the complex ERISA (Employee Retirement Income Security Act of 1974) rules, which sets minimum standards for employer pension plans with non-owner employees.
Self-employed workers who qualify for the Solo 401(k) can receive the same tax benefits as in a general 401(k) plan, but without the employer being subject to the complexities of ERISA.
Congress remedied this situation in 2001 with the passing of the Economic Growth and Tax Relief Reconciliation Act (EGTRRA).
[3] A Solo 401(k) Plan can be adopted by any self-employed business, including a sole proprietorship, limited liability company, partnership, C-Corporation, S-Corporation, etc.
[4] Certain employees may be excluded from plan eligibility, such as those under age 21,[5] non-resident aliens, and union members for which retirement benefits were the subject of a collective bargaining agreement.
Brokerage-based plan documents usually limit the available investment options and offer market-based assets, such as stocks and mutual funds, while self-directed plan documents generally offer more investment options and often allow for alternative assets, such as real estate and private business, as well as include a loan feature and Roth deferrals.
Investors typically choose between the two plans based on their investment goals, asset preference, fee schedules, and desired level of control.
[10] However, due to the fact that in a Solo 401(k) the plan holder is acting both as employer and employee, the actual percentages assume a more meaningful role.
If the plan holder is filing as a Sole Proprietor or Single Member LLC (which is true in most cases), then the limit is capped at 20% of the self-employed income plus $19,000 for 2019, a $500 increase from 2018.
Internal Revenue Code Section 401(a)(3) states that the amount of employer contributions is limited to 25 percent of the entity's income subject to self-employment tax.
Calculating one's maximum annual solo 401(k) contribution limitation, including employee deferrals and profit sharing contributions, is based on self-employment income or W-2 income earned by the plan participant and the adopting employer's established legal entity (sole proprietorship vs. "C" corporation).
In other words, in the case of a "C" or "S" corporation, the employee deferral and profit sharing contribution is based on the individual plan participant's W-2 amount.
"[13] The employee deferral contribution can be made in both pre-tax, after-tax or Roth, so long as the plan documents allow for it.
[11] The Solo 401(k) is an IRS Qualified Retirement Plan which means that it shares the same tax benefits as other QRPs.
Tax deferred investments though a self-directed IRA LLC generally help investors generate higher returns.
Tax responsibility doesn't start until retirement age as the plan holder begins to take out Required Minimum Distributions (RMDs).
For a distribution to be qualified, it must occur at least five years after the Roth Solo 401(k) Plan participant established and funded his/her first Roth 401(k) plan account, and the distribution must occur under at least one of the following conditions: If a plan holder is using his/her Solo 401(k) funds to invest in an active business held through a passthrough entity, such as a limited liability company or partnership, then there is the possibility of Unrelated Business Income Tax (UBIT or UBTI).