Solo 401K Retirement Program

If You Don't Know About This Retirement Program, You Need To

Mike Armour

A common challenge for all encore entrepreneurs is taking advantage of every opportunity to increase their retirement nest egg. Most choose to do so through some type of IRA instrument.

These include traditional IRAs. SEPs, SIMPLEs, and Roth IRAs. For most business startups, however, a far better instrument is one that relatively few people even know about. It's called a Solo 401K.

Don't confuse the Solo 401K with the more famliar 401K programs which businesses offer their employees. A Solo 401K is set up and administered in an entirely different way from a traditional 401K. And compared to traditional 401Ks, 503Bs, and the more familiar types of IRAs, a Solo 401K gives you much greater control of your retirement funds and increased flexibility as you invest them.

Ideally Suited for Startups and Small Businesses

Solo 401Ks have been around for decades, with a full body of IRS regulations governing them. Yet, for reasons which I'll touch on below, most people have never heard of this instrument.

Solo 401Ks were particularly designed to serve the needs of small businesses which employ only the owner or the owner and his or her spouse. Since the overwhelming majority of small businesses in the U.S. are in this category, most startups are ideal candidates for a Solo 401K.

As a business owner participating in a Solo 401K, you wear two hats. You function as both the employer and the employee. As with traditional 401Ks, both the employer and the employee make contributions to the Solo 401K.

For 2014 the employer and employee contributions together can be as high as $52,000, excluding any "make-up contributions" to which you are also entitled. As you can see, this allowable contribution is far higher than with SIMPLEs and traditional IRAs. And it's also higher than the maximum allowed with an SEP, which is often lauded for its generous limits.

As an employee, your contribution to a Solo 401K is in the form of a salary reduction. From a tax standpoint, as a result, the company benefits by reporting its contribution as a tax-deductible expense. And as the employee, you benefit because your salary, as reported to the IRS, is reduced by the amount of your contribution.

This is no different from the employer and employee tax benefits in a traditional 401K. But in this case, you get both sides of the benefit.

Establishing a Solo 401K

Because a Solo 401K is an employer-administered program, it must be set up by your business, not by you as an individual. This means that sole proprietorships do not qualify for a Solo 401K. But by simply structuring your business an LLC, S-Corp, C-Corp, or a husband-wife partnership, you make yourself eligible.

Moreover, if you happen to own multiple single-owner businesses (as I do), they can all participate in the same Solo 401K program. And the participation can be effected with a simple, single-page legal document.

Now to the really good part. What sets a Solo 401K apart from any other instrument like it is the absolute and total control that you have over your funds. Your company, through an affiliated trust fund which it creates, is the custodian of your Solo 401K funds. And you personally serve as the trustee. This means that you have neither the expense nor the cumbersome rules of a bank or brokerage house being the custodian of your funds.

You have complete control of where your money is invested and when it is invested. There are no outside approval loops to go through. And if you already have other retirement programs, you can roll them all over into your Solo 401K so that you have this level of freedom and control over all of your retirement funds.

Complete Investment Flexibility

When I sat up my own Solo 401K, I had funds in an existing SIMPLE, a SEP, and a traditional IRA, as well as a 503B account. I rolled all of these into my Solo 401K, combined their purchasing power for investments, and simultaneously gained management control over my retirement funds far beyond what these other programs had allowed me.

For example, most traditional retirement fund custodians do not allow you to purchase real estate or ownership in a business. With a Solo 401K, you alone make the decision as to where your funds are invested. So long as you are within IRS rules for IRA investments, you are free to invest however and whenever you wish.

After I combined my funds into a single 401K, I began buying homes as an investment. I could literally find a good deal in the morning, have a contract signed by noon, begin title transfer that afternoon, and wrap up the entire transaction in three or four days. You don't have this type of flexibility in any other type of tax-deductible retirement program.

And very non-traditional IRA investments are open to you. For instance, I have made real estate loans to individuals, taking a mortgage on the property as my security. I can purchase loans and liens at a discount. I can purchase raw land, commercial real estate, or multi-family housing units. And of course, I can have brokerage accounts through which I buy stocks, bonds, or mutual funds. This means that if one type of investment is under-performing, I'm perfectly free to move money out of that sector of the economy and into a completely different one.

And one benefit is especially noteworthy. With a Solo 401K, you can loan yourself up to $50,000 for any reason whatsoever. A handful of rules apply. You cannot have more than three loans at any given moment, and you must pay back the loan in regular installments, not to extend beyond five years. You must also pay an interest rate that's at least one percent above the prime rate at the time of the loan.

Why Solo 401Ks Are So Unknown

When I tell people about my Solo 401K and all of these things that I'm able to do with it, the frequent response is, "Why have I never heard of this before?" And there's a simple reason. Financial institutions and brokers never talk about them in their promotion of retirement options.

Remember, you are your own trustee. So you're not paying custodial fees to a bank or financial house. Other than needing a bank account to which you make deposits and through which you make investments, you don't need any financial institution involved in the administration of the program. It's therefore not in the self-interest of the financial community to advertise someting which does not bring them income.

Setup Considerations

There is an outlay of cash required, however, to set up a Solo 401K initially. Remember that the Solo 401K is housed inside a trust affiliated with your company. This means that you need someone with solid knowledge of Solo 401K regulations to set up the trust, to create a governing document (which may be quite extensive) describing how your retirement plan works and is administered, and to file any required paperwork with the government.

There are several companies around the country who will establish a turnkey program for you. My own Solo 401K cost me less than $2000 in setup fees with Safeguard Financial Services in Oregon. But because of the exceptional investment freedom with a Solo 401K, I quickly recouped my return on investment.

Then, because you are the custodian, you are required to file an annual report with the IRS showing the change in balances in the trust investments over the preceding 12 months. This is a simple form which normally requires fewer than 15 minutes to complete.

Strangely enough, one of the biggest challenges in this process is finding a bank that has a mechanism for setting up your checking account. Because your retirement funds are now going to be in a trust, banks who do not understand Solo 401Ks initially assume that they are to set up the account under the rules and regulations governing a trust. But that's not the case at all. A Solo 401K trust is not subject to the same regulations as most trusts.

When I was setting up my own trust, one of the biggest national banks tried for a week to figure out how to establish the account. They finally had to admit defeat. Fortunately, I found a regional bank with an officer who specialized in setting up these types of accounts. Usually the service provider who helps you set up your Solo 401K will be able to refer you to a bank with the proper know-how to open your account.

In the interest of keeping this article reasonably short, I've offered only a high-level look at Solo 401Ks. If the article has spurred your interest, I've developed a much longer tutorial on Solo 401Ks on the Startups After 50 website. It brings together everything that I've learned in having my own Solo 401K for years. And it offers more extensive details on establishing the trust, funding the program, making investments, and maintaining the documentation which the Federal government requires.

This article first appeared in Encore Entrepreneur inbox magazine on March 6, 2014.

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