November 28, 2022

Today we're going to be talking about retirement accounts. There's plenty of them out there. From traditional Roth, 401(k) IRA, SEP IRAs, SIMPLE IRAs, and so forth, all these different types of retirement accounts that the government allows investors to save for the future.

There's so many accounts out there and I think this is by design. It's hard enough to get most Americans to invest or provide a vehicle to invest in. However, the best account out there by far is the Solo 401(k) due to its substantial benefits for self-employed individuals.

In this article, we’ll take a look at who qualifies for Solo 401(k), understanding employee:business contributions, and the many perks of this great retirement vehicle.

Who Qualifies?

To start, self-employed people who run a business that has a net profit qualify for a Solo 401(k). You can also have a spouse be a part of your 401(k) if they work in the business and you can actually have part-time employees, but they cannot work more than 1,000 hours a year (Shout out to Mat Sorenson and Ignatius L Jackson for letting me know this!). 

You're also able to roll all 401(k) plans into your Solo 401(k). So let's say you had a previous employer that had a 401(k). Once you have your Solo 401(k) set up you're able to roll your funds into that account. You can still be working at a company, but as long as you have a side hustle, you're going to be able to contribute to this account. 

Business Owner Contribution and Employee Contribution

Keep in mind the total employee contribution. As an employee across all our retirement accounts and companies that we might work for in one given year, we’re only allowed a max employee contribution. In 2022, it's $20,500. In 2023, you'll be able to contribute up to $22,500 into your employee side of your contributions for your 401(k). 

Now, this is important because let's say we quit our W-2 job halfway through the year and then open up our own business, that employee portion can only be $20,500. 

What I like about the Solo 401(k) the most is because you are the best employee in your business. Not only can we make the same contribution that every other person that works at a W-2, but we can also get a business deduction for the business contribution.  

Example: Let’s say I set aside $20,500 as an employee. As a business, I can contribute 25% of my W-2 wages. If I pay myself $50,000 as a W-2 working in my company, I'd be able to pay myself 25% of the $50,000 which comes out to be about $12,500 in a business contribution in addition to the $20,000 that I'm able to do as an employee. 

This is super powerful because not only can you get the employee limit, but you can also take advantage of getting the business contribution. This business portion is actually a tax deduction from your business income because you're contributing to retirement accounts of your employees. 

Perks/Benefits of the Solo 401(k)

One of the perks and the benefits of this Solo 401(k) is we can actually borrow against it. And so we’re able to take up to $50,000 from it at a time and you pay it back at a prime rate plus 1% or 2% 

The strategy here is to contribute when you're at a 35% or 37% tax bracket, get your tax deduction, and borrow against the value of the account. Then we’re able to use that money in your personal name, whether it's for your business, rental properties, etc. 

Also, if you were ever to self-direct your Solo 401(k), it's not subject to UBIT or UDFI tax which most of all your self-directed IRAs or other types of retirement investing in real estate are going to be subject to.

You can generally administrate your account and you get to pick what investments are in the account. So I'm able to invest in the same things that my Roth IRA or my taxable brokerage is invested in inside of my Solo 401(k). 

The cherry on top is the employee contribution can also be a Roth contribution. So you can do Roth employee contributions, and then your business deduction is going to always be traditional.

So this is the most supercharged retirement account for people who are self-employed and I recommend this over a SEP IRA, a simple IRA and even some of the other retirement accounts. 

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As we saw, the Solo 401(k) is a great retirement account for those who qualify for it. By taking advantage of the Solo 401(k)’s strategies, you can avoid significant tax liabilities, borrow against it, and roll all of your 401(k) accounts into one account.

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