One of the great perks of being a full-time employee of a company is that you may have access to a 401k plan to help prepare for retirement. These plans allow you to contribute money to an account and invest to build wealth.
Meanwhile, all the money you put in is deducted from your taxable income. Plus, in many cases, employers will match contributions up to a certain percentage.
If you are self-employed, you may believe you don’t have access to a 401k. But that’s not true! To explain, many discount brokerages offer special “Solo 401k” plans for small business owners and their family members.
These are often also called “one participant” 401k plans or “individual” 401k plans. A Solo 401k plan could supplement or replace other retirement saving options, such as a SEP IRA.
Let’s examine the details of a Solo 401k, as well as many of the companies that offer them so that you can decide if one of these plans makes sense for you.
Table of Contents
- What is a Solo 401k?
- Contribution Limits
- Differences from a SEP IRA
- What Happens if You Hire Employees?
- Major Brokerage Solo 401ks
- Self-Directed Options
- Other Things to Know
- Summary and Conclusion
What is a Solo 401k?
A solo 401k (also referred to as an individual 401k) is a retirement plan designed for people who work for themselves. If you run a small business and are the lone employee, you and your spouse can qualify for a solo 401k.
A solo 401k can be a powerful tool in your efforts to save for retirement. It allows you to invest in just about everything from stocks, to mutual funds, to bonds and exchange-traded funds, even if you don’t work for a large company.
All contributions to a solo 401k are deducted from your taxable income so that you can save considerable money in taxes over time.
Just like traditional 401k plans, you typically can’t withdraw money in a solo 401k until age 59 ½. If you withdraw money before then, you’ll be forced to pay taxes on those funds as well as a 10% penalty.
There are limits to the amount of money you can contribute to your solo 401k on an annual basis. In 2019, an individual can put aside a maximum of $56,000, or $62,000 if they are over age 50.
What’s interesting is that when you make these contributions, you make them as both an employee and an employer.
“The business owner wears two hats in a 401(k) plan: employee and employer,” the Internal Revenue Service notes. Contributions can be made to the plan in both capacities. The owner can contribute both.”
If you have a solo 401k plan, you can contribute up to $19,000 in “employee deferrals” and $56,000 in profit-sharing contributions. But the entire amount can’t top $56,000.
Thus, if you contribute the maximum in employee deferrals, you can contribute no more than $37,000 in profit-sharing. Got it?
It’s also worth noting that the profit-sharing contributions can’t exceed more than 25% of your income. So your maximum allowable contribution may be less, depending on your earnings.
Your contributions may also be limited by the broker with which you obtain your 401k plan. We’ll offer some detail on those possible restrictions later.
Like traditional 401k plans, a solo 401k plan allows you to pay less in income taxes because all contributions are deducted from your taxable income. For example, if you earn $100,000 in 2019 but contribute $19,000 to your 401k, only $81,000 of your income is taxable.
In some cases, this may result in you moving to a lower tax bracket, so there’s great incentive to contribute as much as possible.
With a traditional solo 401k, you will be required to pay tax on any investment gains once you withdraw money at retirement age.
There is another kind of 401k plan, known as a Roth 401k, that offers different tax advantages. With a Roth, your contributions are taxed up front, but the earnings can grow tax-free. Some brokerages offer a Roth option for solo plans.
The choice on whether to open a traditional or Roth 401k depends on many factors, including your current and projected tax bracket and income. So it may be worth talking to a financial advisor to determine the best plan for you.
Loans from a Solo 401k
One potential advantage of a solo 401k is that they often allow you to borrow from the account. This can be a helpful feature in the event of an emergency or large, unexpected cost.
You are permitted to borrow up to $50,000 from a 401k or 50% of your balance, whichever is less. You are required to pay back the loan within five years with interest.
Interest rates can vary depending on the administrator but are usually a percentage point or two higher than the prime rate, currently at about 5%.
As we note below, not all brokers allow for solo 401k loans, so be sure to check the fine print when researching plans.
Moreover, taking out a loan from your 401k should only be done when you think it’s absolutely necessary. Any time you take money from an account (even if you pay it back) you are potentially reducing the amount you will accumulate over time.
Generally speaking, you’ll earn more in the long run if you leave the funds alone.
Differences from a SEP IRA
If you work for yourself, you may already have opened a Simplified Employee Pension Individual Retirement Plan.
The two plans are very similar, in that they both allow contributions of up to $56,000 and usually allow you to invest in a wide range of products. But in some cases, a solo 401k may be a better option for you.
Here are a few of the key differences to be aware of:
- A SEP IRA can have more than one participant. If you are a small business owner with up to five employees, it might make sense to have a SEP IRA. A solo 401k only works if you are genuinely a one-person shop.
- The IRA pegs solo 401k contribution limit at $56,000, regardless of income. With a SEP IRA, in theory, you can contribute that much but must keep contributions to less than 25% of your income.
What Happens if You Hire Employees?
A solo 401k is an appropriate plan for a person who works for himself. It is not suitable for a company with employees.
If you have a solo 401k and hire workers, you will be required to switch your solo 401k to a traditional 401k plan. And that can come with some hefty administrative costs and rules to follow.
So if you think you’ll hire workers in the future, you may want to explore a SEP-IRA instead. A SIMPLE IRA, which allows for employee contributions, is also another option.
Major Brokerage Solo 401ks
Many major online brokerage firms offer a 401k option for self-employed people. Most plans are similar but may have different costs, options or features. It’s worth researching all of these companies to see if one offers a solo 401k that is a good fit for you.
Most major discount brokerage firms will set up a solo 401k at little to no cost. However, they do charge commissions each time you trade a bond, stock, mutual fund or other investment.
Therefore, it would be wise to avoid making frequent small, purchases and instead make larger trades spread out over an extended period.
1. Fidelity Solo 401k
Fidelity is one of the world’s largest discount brokerage firms, with nearly $2.5 billion assets under management. Its Self-Employed 401k offers access to a wide range of investment options, has no minimum balance requirements and no fees except for a $4.95 per trade commission.
You can get free one-on-one investment advice in person at one of its many investment centers, or by phone.
You’re able to contribute the maximum of $19,000 annually into a Fidelity Self-Employed 401k as the employee. And when contributing as the employer, you can contribute up to 25% of compensation (up to $56,000.)
However, Fidelity does not offer a Roth 401k option that would allow contributions to grow tax-free.
One commenter on Fidelity’s website noted this lack of a Roth option as a major drawback.
“I’m strongly considering switching if Fidelity doesn’t roll out the Roth feature soon,” they wrote.
“I’ve been otherwise very pleased with Fidelity’s offerings and services.”
Pros: Large investment selection, low fees
Cons: No Roth option.
2. TD Ameritrade Solo 401k
TD Ameritrade is another prominent discount broker offering a solo 401k with a broad universe of investment options from which to choose.
Employee contributions top out at $19,000, with employer contributions up to $56,000 or 25% of compensation.
There are no maintenance fees on the TD Ameritrade Solo 401k account, though you will be charged $6.95 per trade.
TD Ameritrade allows you to make loans from your Solo 401k account, and there is a Roth option.
Pros: No maintenance fee, many investment options, Roth option available.
Cons: $6.95 per trade commission is higher than some brokerages.
3. Charles Schwab Individual 401k
Schwab is one of the oldest discount brokerages with some of the lowest costs. The company offers an Individual 401k for self-employed people with no maintenance fees. And you can trade with commissions of just $4.95.
It provides a wide range of stocks, bonds, mutual funds and ETFs in which to invest. All Schwab ETFs, as well as more than 500 others, trade with no commission at all.
Schwab will let you contribute up to 20% of profit sharing on top of the $19,000 salary deferral max. All total contributions can’t top more than $56,000, per the IRS limit.
You may not take loans from a Schwab Individual 401k, and Schwab does not offer a Roth 401k option.
Pros: Large selection of investments, and Schwab ETFs and more than 500 others trade with no commission. Schwab also offers one-on-one investment help at no charge.
Cons: Loans are not permitted. No Roth 401k option.
4. E-Trade Individual 401k
E-Trade is synonymous with online investing and has about 5 million brokerage accounts. The company offers a 401k for self-employed people with access to a wide universe of investments.
The brokerage firm has a traditional and Roth solo 401k option and allows you to split contributions between the two. You can trade stocks and ETFs for $6.95 per trade. Plus, E-Trade also offers many ETFs mutual funds with no commission. But mutual funds with a transaction fee are $19.99 per trade.
You can also hand over management of your solo 401k to E-Trade Capital Management. (This requires at least a $5,000 minimum investment and a 0.3% annual fee.)
E-Trade allows contributions of up to 100% of compensation or $56,000 annually, whichever is less.
Unlike some brokerages, you are permitted to make loans from an E-Trade solo 401k plan.
Pros: Large investment selection. Roth 401k option available. Ability to make loans.
Cons: $6.95 per trade for stocks and ETFs is higher than some brokers (though it drops to $4.95 if you trade more than 30 times in a month). High cost of $19.99 to trade mutual funds, unless you purchase fee-free funds.
5. Capital One Spark Solo 401k
The Spark Solo 401k fund is administered through Capital One Advisors and offers access to preset managed portfolios and some low-cost ETFs.
Capital One charges a $150 setup fee and $25 per month maintenance fee. You can make loans from the solo 401k account, and there is a Roth option.
If you pick Spark, you can select from five managed portfolios. Or choose to customize a portfolio with exchange-traded funds from Vanguard, PowerShares, iShares and State Street.
Pros: Roth option and loans available
Cons: Limited investment choices, higher costs.
6. Vanguard Solo 401k
Vanguard is a pioneer in low-cost investing and offers an individual 401k option for small business owners and their spouses. Its investment choices are limited to about 100 Vanguard mutual funds, including 38 index funds with very low expense ratios.
Vanguard charges $20 per year for each account but no commissions on each investment purchase.
Vanguard does not allow loans from an individual 401k but does offer a Roth option.
Pros: Low costs. Roth option available.
Cons: Investment choices limited to Vanguard funds. No loans allowed.
7. Merrill Edge Individual 401k
Merrill Edge is a Bank of America subsidiary offering an individual 401k with a $100 setup fee and a monthly fee of $20.
Merrill Edge allows for loans and has a Roth 401k option. The plan provider allows you to invest in mutual funds or model portfolios selected by Morningstar Investment Management.
|Broker||Commission/Fee||Loans Allowed?||Roth Option?|
|Fidelity||$4.95 per trade||No||No|
|TD Ameritrade||$6.95 per trade||Yes||Yes|
|Charles Schwab||$4.95 per trade||No||No|
|E-Trade||$6.95, lowered to $4.95 after 30 trades per month.||Yes||Yes|
|Capital One Spark||$150 setup fee, $20 per month maintenance||Yes||Yes|
|Vanguard||$0 to $20 per trade, depending on investment. $20 per year account fee.||No||Yes|
|Merrill Edge||$100 setup fee, $20 per month maintenance. ($25 per month if your business earns more than $250,000 annually.)||Yes||Yes|
If you want to set up a solo 401k but prefer not to use a major discount brokerage firm, you can go through a company offering a self-directed plan. These companies essentially allow you to serve as the custodian of the 401k plan as well as the recipient.
These may be worth exploring if you are interested in getting access to some non-traditional investments, such as private debt and equity, early-stage venture capital or precious metals. Here are a few of the more prominent options in this space:
Rocketdollar allows you to have a self-directed solo 401k plan with the ability to invest in almost anything permitted by the IRS. The company was founded in 2018 and charges a $360 upfront account setup fee and then $15 per month.
Rocketdollar offers access to a wide range of asset classes through a variety of partnerships with investment groups. They include:
Real estate (including office buildings, self-storage facilities, and rental properties)
- The DeRosa Group, Quinlan MacKay, Aerial Investment Management, Pinnacle Storage Properties, SDIRA Wealth, Rich Uncles, BCP Services.
Early stage investing
- WealthBlock, Dealbox, Honeycomb Credit, Mr. Crowd, KingsCrowd, 1000 Angels
Physical assets ( including raw land, gold, and agriculture)
- Energy Funders, Harvest Returns, US Gold Bureau
Private Equity and Debt
- Cadence, Carofin, DarcMatter
Accuplan Benefit Services offers a self-directed solo 401k plan with access to real estate investments. Through the ONE-K plan, you can purchase real estate directly, purchase options on properties and even flip properties.
To allow this, Accuplan will set up LLCs or C-Corps for you, then set up the 401k plans for those companies. Under this setup, you direct the company’s investments as a trustee.
MySolo401k offers self-directed plans for small business owners and allows you to invest in real estate, precious metals, tax liens, promissory notes and private equity. You can even invest in Bitcoin through MySolo401k.
MySolo401k will also let you invest in stocks and mutual funds, as it will facilitate you setting up a brokerage account through one of the discount brokerages above.
MySolo401k has a $550 initial setup fee, then a $125 annual fee after 12 months.
With MySolo401k, a solo Roth 401k option is available, and you can also take out loans on the account.
Other Things to Know
Here’s a few other things to keep in mind.
If your solo 401k account reaches more than $250,000 in value, you will be required by the IRS to fill out a 5500-EZ form on an annual basis. The form asks for basic plan information, as well as your contributions for the year and total assets.
As a small business owner, you may need to do more than determine your income and profits to determine how much you can contribute to a solo 401k. This is especially true when trying to calculate the profit sharing portion of your income.
While the IRS states that you can contribute up to 25% of profit sharing income, it is specifically referring to only the portion of your income that is subject to the self-employment tax. Thus, in practice, that percentage ends up being closer to 20%.
But calculating this can be complex. The IRS has a calculator to help you determine how much you can contribute.
Summary and Conclusion
If you are a small business owner and the lone full-time employee, it’s good to know you can take advantage of a 401k plan just like many people in the workforce. In fact, the high contribution limits on solo 401k plans make it a potentially lucrative option for you as you plan for retirement.
Most major brokerage firms offer individual 401k plans, and none of them are bad choices. Other third-party services such as Accuplan and Rocketdollar are intriguing options that offer access to different kinds of investments.
However, most investors will be better off going with a well-known broker. (This is especially true if you ever want to roll over a solo 401k to an IRA or another kind of retirement account.)
It’s hard to recommend any single broker because all have some pros and cons. Some offer low costs but more limited investment options. Some are more flexible but have higher fees.
The key to selecting a solo 401k provider is to determine your needs. Then go with the broker that offers the best fit for your situation.
The good news is that in most cases if you are unhappy with one solo 401k provider, you are welcome to roll the account over to a different company.
If you are considering opening a solo 401k, it may be worth speaking to a financial advisor. They can give you guidance on which provider to select, how much to contribute to a plan, and what investment choices to make.
Do you work for yourself? Have you considered opening a solo 401k plan? If so, which company did you sign on with? Let us know in the comments.