Setting Up a Solo 401(k)

Let's face it: Taxes are boring. I once counseled an IRS employee with romantic troubles to talk to his dates about something else, anything else. (That advice did seem to improve his romantic prospects, by the way.) Nonetheless, my husband and I hired our CPA to consider the boring stuff very carefully and then to -- egads -- discuss it with us.

His latest recommendation: "You must open a solo 401(k) this year to save on taxes."

The solo 401(k), it turns out, isn't boring at all. Why? Because it will save our family money, and in the long haul, it could help my husband and me retire to a cabin in the woods with one of those soaring great rooms that shows off the earth and sky. Interested in saving for your own retirement love nest? Then consider these aspects of the solo 401(k):

What is a solo 401k?
A solo 401(k) -- also sometimes referred to as an individual 401(k) or a self-employed 401(k) -- is a retirement savings vehicle for the self-employed. But don't let a narrow definition of self-employed limit your possibilities. Even if you work for The Man from 9 to 5 but have a side business for which you earn separate income, you may qualify.

Why should I be interested?
The solo 401(k) offers a number of perks:

  • It offers the chance for more tax-sheltered retirement money than other types of plans for self-employed folks. Currently, you can set aside up to $15,500 in contributions plus 25% of your yearly business revenue if you're incorporated (20% if you're a sole proprietor), with the cap set at $45,000 in 2007.
  • If you're age 50 or older, you can add $5,000 in "catch-up" funds.
  • If you're an employee and contribute to your employer's 401(k) plan but have a sideline business, you may still be eligible.
  • If your plan administrator allows it, you may borrow up to 50% of the money in the account as long as it's paid back within five years with interest.

What should I consider before taking action?

  • All plans are not created equal. You'll want to compare retirement plan provider fees, administrative costs, and investment choices to ensure you get the best deal.
  • The money is tax-deferred, so when you retire and start withdrawing the funds, you'll need to pony up to the IRS. The good news? During retirement, you may be in a lower tax-bracket.
  • If you foresee the need to add more employees in the future, the solo 401(k) may not be the best option for you. Once your employment roster includes more than you and your spouse, you'll have to transfer the money into an account that covers all of your employees, likely incurring more administrative costs and hassle.
  • If your self-employed income is in the hundreds of thousands, you should consult a CPA to determine if there are other plans that will better shelter your income.

Where should I go for more information?
Take a look at Calling itself an unbiased provider of information for "401(k) plan sponsors, small businesses, and plan participants," the site offers a solo 401(k) calculator, a directory of providers, and a host of other tools to get you off to a good start.

This article is adapted from theMotley Fool Green Light Money Answers archive, which features more than 100 articles on personal-finance topics such as taxes, credit, and beginning investing, organized by subject and life stage. For access to this content -- plus the current newsletter, back issues, members-only discussion boards, and advisor blogs -- take a free 30-day trial today!  

Fool contributor Elizabeth Brokamp is a licensed professional counselor who regularly talks money with her honey, Robert Brokamp, editor of The Motley Fool'sRule Your Retirement newsletter and co-advisor of Motley Fool Green Light. The Fool has a disclosure policy.

Read/Post Comments (3) | Recommend This Article (21)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On February 10, 2011, at 2:50 PM, wadams92101 wrote:

    Well written and organized article. One additional point in which readers may be interested is that Solo-Ks also offer many advantages for investing in real estate and related assets. This requires either a custodian allowing for such investments (brokerages houses generally limit investors to their products) or the owner of the Solo-K can serve as the trustee/custodian. A competent and qualified professional is recommended for <a href="">Solo... advise and set up</a>

  • Report this Comment On August 22, 2012, at 10:40 AM, msimpson626 wrote:

    Contact a reputable firm that specialized in retirement plans for small businesses. There are too many rules and regulations (and they change too often) to keep up with it and run your own business at the same time. I was referred to Steidle Pension Solutions by a friend of mine and couldn't be happier with the advice, guidance and cost of the service that they provide.

  • Report this Comment On September 07, 2013, at 11:49 PM, JohnTrs wrote:

    Thank you article was a good starting place for my firm's research. We researched long and hard at my for a small business 401k plan that was cheap and we decided to go with They had the cheapest options including lots of low expense ratio Vanguard funds and the ability to self manage for those who wanted it and a small management fee for those that wanted it on autopilot.

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