Opening a solo 401k for your small business can make a lot of sense financially. When you’re self employed, the solo 401k allows you to save the most money versus all of the other self employed retirement plans (SEP-IRA, SIMPLE IRA, Keogh Plan). It is even better if you and your spouse run your business together, because you can save even more with your spouse.
But setting up and opening your solo 401k plan can be confusing. There are a lot of options to consider, and you want to select a plan that offers flexibility for the future. Unlike a SEP-IRA, there is a lot more paperwork to fill out, and there are more potential fees to consider.
Things To Consider When Opening A Solo 401k
If you’re considering opening a solo 401k, there are a few things to consider when it comes to plan features.
There are five key areas that you need to decide before you open your solo 401k:
- Will you have both Traditional and Roth Solo 401k contributions?
- Will you allow loans from your solo 401k plan?
- Can you do rollovers into the plan?
- What are the fees for maintaining the plan?
- Do you want to invest in alternative investments, like real estate?
Everyone who opens a solo 401k will have different requirements. However, I would recommend you open a solo 401k plan with the most options and flexibility. While you can always amend your plan documents, it can be a hassle and can cost you money (potentially). As such, it makes sense to create a solo 401k plan with the most options up front.
Prototype Plan Vs. Custom Plan
Once you understand what options you want for your solo 401k plan, it’s time to discuss plan documents.
See, your solo 401k really has two parts:
- The Solo 401k Plan Documents (also called an Adoption Agreement) – this is what spells out what options your solo 401k offers
- The brokerage documents/application – this is what your brokerage firm needs to open accounts in the name of the 401k
When it comes to the solo 401k plan documents, you can either use a prototype plan, or create your own custom plan.
A prototype plan is typically offered by the brokerage firms that offer free solo 401k plans. They are called prototype plans because they are very generic plans that were created by a lawyer, and anyone can use them. However, because these are generic plans, they might not offer all of the options you’re looking for in a solo 401k.
For example, Fidelity’s solo 401k plan doesn’t offer a Roth solo 401k option. Vanguard’s solo 401k plan doesn’t offer loans from your 401k. As such, you need to carefully consider the options available in a prototype solo 401k. E*Trade offers the most robust prototype solo 401k plan.
On the other hand, you can create a custom solo 401k plan. This is where you pay a company to draft you plan documents that are custom to your needs. The reason you create this is because you want to invest in alternative assets like real estate.
The most popular company that does this currently is MySolo401k.net. This company will create a solo 401k document that you can then use to administer your plan. It allows for much more flexibility, but you will pay a fee upwards of $900.
Another popular one is RocketDollar. They are quicker and easier to work with, with slightly lower fees.
Should You Do A Roth Solo 401k?
One of the options that’s become important is allowing for a Roth solo 401k. Surprisingly, many brokerage firms currently don’t allow a Roth solo 401k, but it can be a valuable option.
When it comes to your solo 401k, it’s important to remember that you have two aspects of contributions to your plan:
- You have your elective deferrals, which can either be Roth or Traditional
- You have your profit sharing contribution, with can only be Traditional
Where a Roth option comes in handy is if you’re looking for tax diversification. With Roth contributions, you are using post-tax money. So, you will pay more in taxes today, but you will pay less in the future. However, if you’re putting in large profit sharing contributions into your solo 401k, then it might make sense to make Roth contributions.
The reason? It will give you tax diversification in retirement. You can choose whether you use taxable or tax free money in the future – and options are always great.
The important thing to remember here is options. You just want the options to be able to invest how you choose.
Selecting A Brokerage Firm For Your Solo 401k
When selecting a brokerage firm for your solo 401k, you want to select the firm that offers the most options.
If you’re okay with a prototype plan, you can use our Solo 401k Brokerage Comparison to see which major firms offer the options you’re looking for.
If you’re using a custom solo 401k plan, you need to take your solo 401k documents to the brokerage of your choice and they will open a custodial account on your 401k’s behalf. Some firms offer this service, and others don’t. For example, Fidelity and Charles Schwab are two brokerage firms that allow for customers to use third-party 401k plans with their brokerage services.
However, when using a third party plan, it adds to the complexity of using a solo 401k. For instance, as a custodial account, the firm will not keep track of your trades and investments – that’s your responsibility. If you need to fill out tax forms, such as a 1099-R, these firms will not help you. You either have to do it yourself, or pay someone to do it for you.
We decided to go with ETrade for our Solo 401k because they had the most robust free plan.
What Paperwork You Need To Fill Out To Open Your Account
I was surprised at how much paperwork is required to open a solo 401k account. You’d think it would be simple, with very common forms to fill out. However, it’s completely the opposite. It becomes even more challenging if you add a Roth solo 401k, and you have to do double the paperwork if you’re adding a spouse to your plan.
When opening your solo 401k plan, you will need to create the following documents. You will need to create separate plan documents for both your Traditional and Roth Solo 401ks. They are both considered separate plans for tax purposes.
Plan Documents For Traditional Solo 401k
- 401k Plan Adoption Agreement
- Designation of Successor Plan Administrator (notary or witness required for this form)
Plan Documents For Roth Solo 401k
- 401k Plan Adoption Agreement (make sure you include a section about taxable movement of funds from Traditional to Roth 401k if desired)
- Designation of Successor Plan Administrator (notary or witness required for this form)
Required Documents For Individual
- Brokerage Account Application for 401k Account
- Brokerage Account Application for Roth 401k Account
- Designation of Beneficiary Form for Account (for both accounts)
- Power of Attorney (if desired, for both accounts)
Required Documents For Spouse
- Brokerage Account Application for 401k Account
- Brokerage Account Application for Roth 401k Account
- Designation of Beneficiary Form for Account (for both accounts)
- Power of Attorney (if desired, for both accounts)
When you’re done with all these documents, you’ll have two solo 401k plans, and 4 accounts (a traditional and Roth solo 401k account for each spouse).
Ongoing Considerations For Your Solo 401k
One of the great things about a solo 401k is that they are relatively easy to maintain, for the most part. Since you are technically the administrator of your own plan, you are personally required to submit required filings for the plan.
There are two ongoing paperwork requirements that you will need to stay on top of. First, if your plan has over $250,000 in assets on the last day of the plan year, you have to file a form 5500. This can be a bit complicated, but if you can fill out all of that paperwork above, you can likely handle it yourself.
You can submit the IRS Form 5500 for free, electronically here: EFAST2 Filing From The IRS.
If you don’t want to do it yourself, you’ll need your CPA to handle this for you, and they’ll likely charge a fee to do it.
The second form you need to keep in mind is a 1099-R, but that form is only required if you take distributions from your 401k plan or if you roll it over, withdraw money of any kind, or change providers. This form is also relatively easy to fill out, but there is no free electronic filing for this form. You either have to pay a service to file it, or mail it in yourself.
Conclusion
A solo 401k can be a great way to save for retirement if you’re self employed. A Roth solo 401k adds even more flexibility to your potential retirement savings. But filling out the paperwork to open a solo 401k can be tedious and time consuming.
If you’re considering a solo 401k plan, make sure that you setup a plan that offers flexibility for your needs over time.
Robert Farrington is America’s Millennial Money Expert® and America’s Student Loan Debt Expert™, and the founder of The College Investor, a personal finance site dedicated to helping millennials escape student loan debt to start investing and building wealth for the future. You can learn more about him here and here.
He regularly writes about investing, student loan debt, and general personal finance topics geared towards anyone wanting to earn more, get out of debt, and start building wealth for the future.
He has been quoted in major publications including the New York Times, Washington Post, Fox, ABC, NBC, and more. He is also a regular contributor to Forbes.
Are employers allowed to have multiple 401K plans? I have never seen pre-tax and roth 401K options offered as separate plans? They have always been offered as options within a single plan.
If you did have multiple 401K plans for a single employer entity wouldn’t this trigger a need to file a form 5500 for each 401K and then designate these as a “control group”?
They are technically two separate plans anyways, but most employers bundle them into one form/benefit enrollment. If you were to do as solo 401k (like in the article), you have to open a separate account for both the traditional and Roth version of your 401k.
As for the Form 5500, typically it only needs to be filed if the plan value exceeds $250,000. However, I’m not a CPA or tax expert in that regard, so you’d likely want to consult one.
Hi
I still have a problem understanding how the solo 401k works. I have the adoption documents. I also have a sep Ira with Fidelity. When I asked Fidelity if I can have a Roth inside of the solo 401 k I was told is not possible. They do not have such flexibility. Do I need to have a Roth inside of the 401 k ? Does it make a difference if it’s within the 401k solo or is a separate account ? The intent is to shelter more than just the $6500 after tax $. In essence I would like not to be taxed when I start pulling RMD. Thank you.
The reason Fidelity told you this is that Fidelity doesn’t offer a Roth Solo 401k option, other providers do.
Do you need to have a Roth option? That’s up to you and how you want to handle your taxes.
With a solo 401k, your elective contribution (up to the 401k contribution limits of $18,500 in 2018) can be either pre-tax or Roth. However, your profit sharing contribution (what your business contributes) is always pre-tax.
If you really want the Roth, then you would need to go to another brokerage. TD Ameritrade and E*Trade are considered the best free solo 401k providers. We break down the full comparison here: Best Solo 401k Providers.
Could I open my own Roth Solo 401(k) because I’m looking at moving and will have to change employers. Since I’ll change employers and may have my own company in the next year or so working on the side I’m not sure if I can just set up my own Roth Solo 401(k) or if that’s even possible. I’d much prefer that to some of the terrible retirement options I keep seeing and I also have a Roth IRA that I fund as well.
You need to have your own business already setup to open a solo 401k.
You can easily roll over your existing 401k into a Rollover IRA though – and you should. Read this: https://thecollegeinvestor.com/13782/rollover-401k-change-jobs/
Can I self administer a Roth Solo 401k in similar way as my Solo 401k
Thx
Yes, you definitely can. In fact, you’ll be opening said Roth S401k at the same place you open the regular one, and they work exactly the same.
It seems all brokerages require an Employer Identification Number established at the IRS to open an Individual (Solo) 401K. Is the EIN only for the 401K or does the EIN also need to be on all tax forms e.g. 1099-Misc when receiving payment as a self-employed? Currently my spouse is a real estate agent but has her personal SSN on her 1099-Misc.
Thanks.
The EIN is created just for the Solo401k. It’s used for Solo401k reporting – or even assets you buy for the solo 401k. It is separate from your business’ EIN.
I would like to do in-service distributions (rollover) to avoid having to file or forgetting to file form 5500 which can cause issues later on with the IRS by keeping the balance below $250k. I see your other article mentioned E-Trade offers in-service distribution as an option. How do I make sure this is setup by E-Trade? Do I also need to specify it in their plan provisions? If so, how should I word it to make it legally binding?
Thanks.
You need to make sure it hasn’t changed – speak to an advisor to setup your plan. We’ve seen some mixed comments since this article was first written.
Second, most people prefer to keep money in their 401ks, versus an IRA – makes doing a mega-backdoor cleaner. The 5500 is super easy, takes 5 minutes to fill out, and once you do it once, you’re likely always going to do it. Just food for thought.