Solo 401K: Pros & Cons Fully Explained (2021)

Alright, so what is the Solo 401K?

The Solo 401K is just a one-participant 401K plan. Traditionally, 401K plans are offered by an employer to its employees to help them save for retirement. But a Solo 401K plan just applies to one person who typically wears both hats, the business owner.

If you are self-employed with no employees, then the Solo 401K was designed for you.

Because you are the Employer and the Employee in your business, you get to reap the tax benefits of both sides.

As of 2021, you can contribute up to $58,000 in a Solo 401K account.

For comparison, that’s $52,000 more than you can in a traditional IRA or retirement account. Normally, you can only contribute up to $6,000 per year in a traditional IRA.

To make this even better, you can deduct your contributions from your tax return

With that being said, I want to fully review Pros and Cons and walk through an in-depth Solo 401K explained.

Outline for Solo 401k:

Solo 401k intro: (0:00)
What is a Solo 401k?: (1:09)
Tax Benefits of Solo 401k: (3:30)
Solo 401k loans: (3:45)
Solo 401k and Roth IRA: (4:13)
Problems & Cons of a 401k: (4:56)
Eligibility Requirements of 401k: (5:57)
How do you contribute to a Solo 401k: (7:19)
Solo 401k vs SEP IRA: (8:41)

[flamingspinach]

At 7:48 you say that you can contribute up to 25% of your total compensation as an employer contribution. But it's important to note that if your business is a sole proprietorship or partnership (or LLC taxed as such), the tax deduction generated by the employer contribution also affects your total compensation when wearing the employee hat. That is, the deduction resulting from the employer contribution also lowers your total compensation, which in turn lowers the limit for the employer contribution.

In your example at 8:00 you say that if someone has $100, 000 in earned income they'll be able to make a $25, 000 employer contribution, but it won't work that way - in practice, if you've made $100, 000 from your business before taxes, the maximum employer contribution you can make will be $18, 470. You can compute it as follows. First, half of the self-employment tax of 15.3% is deductible, so subtract $7, 650 to get $92, 350. Then, you can take at most 20% of $92, 350 as an employer contribution deduction, since 25% of the remaining 80% after the deduction will be equal to 20% of the original amount before the deduction (0.25 * 0.8 = 0.2). And 20% of $92, 350 is $18, 470.

For more information see IRS Publication 560, specifically:
- the definition of "net earnings from self-employment" in Chapter 1 ("You take into account the income tax deduction for the deductible part of self-employment tax and the deduction for contributions to the plan made on your behalf when figuring net earnings")
- the information about employer deduction limits for defined contribution plans in Chapter 4 ("If you are self-employed, you must reduce this limit in figuring the deduction for contributions you make for your own account."
- the section on the Deduction Limit for Self-Employed Individuals in Chapter 4 ("The deduction for your own contributions and your net earnings depend on each other. For this reason, you determine the deduction for your own contributions indirectly by reducing the contribution rate called for in your plan.")
- the Rate Table for Self-Employed in Chapter 6, where it shows how a 25% contribution is reduced to a multiplier for the calculation of the deduction limit

The above is about the case when your business is a sole proprietorship / partnership, but AFAIUI if your business is taxed as a corporation, you'll still need to set aside some money on the business side in order to pay for the employer contribution, which will reduce your W-2 wages as the employee, resulting in a similarly reduced contribution limit, so there's no getting around this.

Also, by the way, at 7:00 you say, "if your spouse works with you in the business, she is not considered a full-time employee for purposes of the Solo 401K plan", but the law actually doesn't care about whether your spouse is male or female here :)

[jasongoodman]

Damn. I just opened up a SEP IRA, now I'm going back to my Bank and redoing for the Solo. Thank you for the save brother. Wakanda Foreva. ✊

[michellebowers]

The only bummer I have about opening a solo 401k is that I didn’t know about it 5 years sooner.

[rtanaka]

Fantastic video. Exactly the info I was looking for

[kellithomas]

This is an excellent explanation about the solo 401k and now I am confident about opening up my retirement account. Thank you so much!

[ube-s]

Hi, I like your slow and clear explanation. Thank you.

[thecognateconnnection]

WOW! thank you for creating this video. Some of us need to think about this like yesterday.

These videos are awesome! I had no idea about SEP IRAs or Solo 401Ks. I'll be moving some of my Traditional IRA funds soon. Thanks a lot!

[ezeamadirealtor]

Awesome video, I like the added benefits of the Solo 401k vs the SEP, thinking of joining the great resignation movement and branching out on my own. The Solo 401k will help stack some $$ away. Thanks for the breakdown

[ngalawena]

- You can potentially get up to $57, 000 in a Roth component Solo 401k!!!!
- Up to $57, 000 can be entirely tax deductible if you choose to!
- Roth component of 401(k) can be compounded (no MAGI — or back door Roth)
- Can avoid UBIT on leveraged real estate
- Cons: must be “substantial and recurring”
- Cons: when you hit $250k in 401(k) you need to file a form 5500 each year
- Pro: the $37, 500 employee deferral can be an “In plan conversion” wherein it becomes ROTH. So the entire $57k is ROTH

[tarzanjammyy]

Great video. Question: 1. From which account should the employee contribution go from? Directly from business checking account or from the personal salary account?

[CianTv]

Can income from my holding company’s subsidiary count as income from for my holding company if my holding company creates and contributes to a solo 401(k)?

If not, would u recommend that the holding company charges a management fee every month to count that as “income” for contributions?

[LIVINGINBALTIMOREMARYLAND]

Great job. Appreciate the advice before the end of the tax year!

[naomicoutinho]

Hello there! Thank you for the great information you provided for Solo 401K. Some important aspects that would be very helpful would be things like contribution deadlines also the respective IRS regulation number / form number where one can go read in case there are different categories and therefore different rates for how the rule applies

[nicktrimmer]

Thanks Sherman!

Super helpful. How would the taxation work if I loaned someone money for a real estate deal and participated in the deal, as either a debt or equity investor?

Thanks so much!

[elsamorales]

How does loans from the solo 401 work? Time frame, interest, and payback options… thank you

[kelseycaballero]

Which would make more sense for a lower income earner? (50k or less per year)

[angle]

Great explanation. But how do you setup one?

[miguelducasse]

hmmmm question? if you wanted to purchase real estate through your current roth IRA plan which one would you choose from out of the options you have out of all the retirement accounts i know you would have to transfer from a roth to a different account but what are the best retirements accounts that are fitted for purchasing realestate

[charliegruberrealtor]

Great video, thanks. Can you confirm or add details about income caps for ability to write off contribution amounts?