What is a Solo 401k and How to Easily Set One Up

Being self-employed has many benefits, but there are also some pretty important drawbacks. One of them is the lack of a retirement plan sponsored by an employer, such as a 401(k).


If you are self-employed and this is the case for you: do not despair. You can set up a solo 401(k), also known as an individual 401(k), a self-employed 401(k), or a one-participant 401(k). The 401(k) is an investment account for self-employed workers that has many of the features you can find in an employer-sponsored plan.

What Is a Solo 401(k)?

A solo 401(k) is a way for a self-employed individual to invest for their retirement. A business owner with no employees can set up an account of this kind as long as they meet certain requirements.

One of the main benefits of this account over other retirement plans is that the solo 401(k) has higher contribution limits, and that means that you can invest more into your retirement plan.

However, there are some requisites that need to be met in order to be eligible for a 401(k) account. Here are a few solo 401(k) rules.

Requirements for Setting Up a Solo 401(k) Account

In order to be eligible for investing in a 401(k) account there are two requisites that must be met.

First of all, you should be self-employed. This means that you are the one responsible for your own income, and not an employer.

Individuals who fit this requirement are freelancers, sole proprietors, independent contractors, and small business owners with no employees.

An exception is made for spouses of small business owners who do work for the business, as they can contribute.

The second condition that must be met in order to invest in this kind of account is that you have an earned income. For the self-employed, this can be proven with tax records.

And that’s it! Those are the only two conditions that must be met in order to be eligible for a 401(k) account. If you meet both of these requirements, here’s how you can set up your 401(k).

How to Set Up a Solo 401(k)?

The Internal Revenue Service (IRS) has established the need to follow certain steps in order to open a solo 401(k) retirement plan.

According to the IRS, the first step is adopting a plan in writing. That is to say, you need to present a written declaration in which you specify the type of plan you mean to adopt.

As with employer-sponsored retirement plans, there are two types of retirement plans you can choose from: a traditional 401(k) or a Roth 401(k).

Each of them has their own benefits and drawbacks, and which one you choose will mostly depend on the kind of tax benefit that will fit you best.

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Once you have decided which plan is the best for you, need to set up a trust for holding the money until you need it or until you reach the age of retirement.

What is a Solo 401k and The Requirements

What Is a Traditional Solo 401(k) Plan?

A traditional solo 401(k) plan means that you investment will be made with pre-tax dollars. This means that your taxable income will be reduced during your working years.

You can deducts the contributions to the traditional solo 401(k) in your income tax return.

You will be taxed when you withdraw funds from the plan once you’ve reached retirement age. Remember that the gains that your investment has accrued over the years will also be taxed.

The risk with this kind of investment plan is that the tax rate could be higher by the time you need to start making withdrawals from your fund than it was at the time of the initial investment.

Should this happen, the benefit you received by deducting your contributions in your income tax returns can be erased by the later tax burden.

However, you should also consider that most people are in a lower tax bracket when they retire, so you could end up paying less taxes later on.

What Is a Roth 401(k) Plan?

The main difference between a traditional plan and a Roth plan is that, in the latter, the investment will be made with after-tax dollars.

This means that you’ve already paid taxes on your income, so you don’t have to pay taxes when you withdraw money from your investment fund.

You will not pay any taxes on the gains from the money you invested, either, as long as you withdraw those gains once you’ve reached your retirement age.

What Are the Benefits of a Solo 401(k) Plan?

One of the main benefits of a solo 401(k) account is that you can choose the kind of tax break that fits you best by going for either a traditional 401(k) or a Roth 401(k) investment plan.

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The other big advantage is that the 401(k) typically has the highest contribution limits compared to other retirement plans.

Solo 401(k) Contribution Limits

The solo 401(k) works like an employee-sponsored retirement plan in that contributions can be made by both the employer and the employee. In this case, since you are a self-employed individual, these contributions are both made by you.

In 2020, the maximum amount you can contribute as an employee is $19,500. Once you are 50 years old or older, you can make catch-up contributions of up to $6,500.

As an employer, on the other hand, you are able to contribute up to 25% of your net income.

In 2020, the solo 401(k) maximum contribution total is $57,000, which includes both your contributions as an employer and as an employee, but does not include the $6,500 catch-up contribution.

The solo 401(k) contribution deadline will depend on your business type and your self-employed tax return due date. You should know that contributions must be made before your business tax return due date.

The last big advantage of the solo 401(k) plan over plans like the SEP IRA, is that you can take loans from the solo 401(k). This is not usually recommended, but you have the option if you ever need it.

Solo 401(k) vs. SEP IRA

A SEP IRA is another type of retirement account that is usually recommended to small business owners.

SEP IRAs work a lot like traditional IRAs, they are treated in the same way for tax purposes and have the same options for investments.

However, a SEP IRA is an attractive investment plan for small business owners because it doesn’t have many of the operating costs of other conventional retirement plans that are employer-sponsored.

Other requirements that make SEP IRA ideal small businesses are the requirements for being eligible for this plan.

Among others, contributors must be at least 21 years old, have been employed for at least three years, and a compensation minimum of $600.

Moreover, this investment plan allows for contributions to be interrupted in years when the business is not doing as well.

The main difference between a solo 401(k) vs a SEP IRA is that the SEP IRA does not allow to take a loan from your SEP IRA investment plan.

If you are not sure how to set up your solo 401(k) account and would like some assistance, you can do it through intermediaries like Rocket Dollar.

Here’s how to set up Rocket Dollar for solo 401(k) investing.

Setting Rocket Dollar for Solo 401(k) Investing

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If you are unfamiliar with it, Rocket Dollar is a platform through which you can invest in any asset category allowed by the IRS.

However, the platform specializes in investments in unconventional assets, such as real estate, loan investments, cryptocurrencies, and precious metals.

If you decide to invest through Rocket Dollar, you’ll find that the process is very easy. The platform itself will guide you through the setting up of a solo 401(k) account.

Setting up the solo 401(k) account will include the opening of a bank account for that purpose.

Once you’ve set it up, you can invest in any asset you want that is allowed by the IRS, including unconventional assets.

You will be able to track your investments through the platform very easily with the investment tracker.

In order to invest in a solo 401(k) account, you’ll need a trust account, which will be taken care of when you are setting up your solo 401(k) with Rocket Dollar.

You will be provided with all the needed documents to set up your plan, as well as an Employee Identification Number (EIN).

As you can see, a solo 401(k) investment plan is a great alternative for self-employed individuals.

Setting it up can seem daunting at first, but it is not that difficult, and you can always go through an intermediary if you are in need of some help.

The solo 401(k) is a great way of saving up towards retirement when employer-sponsored retirement plans are not within your possibilities.

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