Solo 401k Plans For Dummies

The Solo 401k was created by the 2001 Economic Growth And Tax Reconciliation Act and works much as you would expect.  Instead of being sponsored by a corporation for the benefit of its employees, however, solo 401k plans were established for the benefit of self-employed individuals without access to a traditional corporate 401k plan.

Rules And Requirements Of Solo 401k Plans

Solo 401k Eligibility

Access to solo 401k plans are restricted to individual small business owners and their spouses with no full-time employees.  If your business has full-time employees, you should consider another self-employed retirement plan such as a SEP IRA or Simple IRA.

Contribution Limits

Solo 401k plans share their contribution limits with corporate 401k plans for the most part.  That means in 2009 you can contribute up to $16,500 of your income plus a $5,500 catch-up contribution if over age 50 for a grand total of $22,000.

Additionally, business owners are allowed to make a “matching contribution” up to 25% of your total pay, up to a maximum total contribution of $49,000 in 2009.  The matching contribution can’t be more than 20% of your business’s total net income, though.

Administrative Requirements

You are required to file an annual form (form 5500) when your plan reaches $250,000 in assets.  Other than that, there are few administrative requirements aside from the usual accounting issues.

Benefits Of Solo 401k Plans

• Low Administrative Overhead – Paper-keeping requirements for solo 401k plans are lax compared to other self-employed retirement plan options
• Fixed Contribution Rates – Solo 401k plan contribution rates mirror those of their corporate cousins, meaning they rise with inflation over the years and are fixed regardless of your business’s income.  SEP IRA contributions, on the other hand, are capped at 20% of your business’s net income.  So if your business earned $50,000 last year, you would be limited to a $10,000 SEP IRA contribution ($50,000 x 20%); however, with a solo 401k you can contribute the full $16,500 regardless of how much your business earns (provided it earns at least the amount you contribute, of course).
• Roth or Traditional Versions – Solo 401k plans come in both Traditional and Roth versions, allowing you more control over your taxes, both present and future, than other self-employed retirement plans.