Solo 401k Explained

Copyright (c) 2012 Mark Ryan Nolan

Solo 401k is a type of 401k plan but for the self-employed which allows the business owner to contribute high tax-deductible contribution amounts. For example, for tax year 2012 the business owner can contribute $50,000 plus an additional amount $5,500 if age 50 or older. The contribution limits for tax year 2013 increased by $500 due to inflation.

In order to contribute to Solo 401k earned income is required, a term used to define the compensation of a self-employed individual (i.e., a sole proprietor, a partner in a partnership or an owner of an entity that elects to be treated like a partnership for tax reasons, such as a limited liability company).

Computing Solo 401k Contribution

The starting point for determining the Solo 401k contribution is net earnings from self-employment as defined in IRC 1402(a) with the modifications described in IRC 401(c). For example, the starting point for determining net earnings from self employment will be Schedule C (line 31) or Schedule C-EZ (line 3) , in the case of most sole proprietors.

Annual Form 5500-EZ Reporting

The Form 5500-EZ is the Solo 401k plan's annual return that provides to the government with statistical information about the Solo 401k plan and the plan sponsor (the self-employed business), and serves to demonstrate compliance with various legal requirements. Form 5500-EZ is not required to be filed if the self-employed business has not leased employees and if the Solo 401k plan assets do not exceed $250,000 at the end of the plan year, usually December 31st.

Solo 401k Investments

Unlike most 401k plans that only afford participants some degree of investment control over the assets in their account, such as mutual funds, a Solo 401k is generally fully self-directed, hence why it's commonly referred to as self-directed Solo 401k. This means, that the Solo 401k plan trustee can direct the Solo 401k investments in virtually any investment type such as: real estate, tax liens, precious metals, promissory notes, private placements and any other investment that is not disallowed such as collectibles and works of art, to name a few.

Solo 401k Providers

However, in order to invest Solo 401k in alternative investments, the Solo 401k provider's Solo 401k plan document must allow for it. Therefore, because traditional Solo 401k providers such as banks, insurance companies and brokerage firms typically only offer Solo 401k plans that only permit investments such as stocks, mutual funds and bonds, to gain access to investments in alternative assets such as real estate and precious metals, the Solo 401k should be opened through a Solo 401k plan administrator whose plan documents allow for alternative investments.

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