What makes Solo 401Ks attractive is the flexibility that you have in managing your retirement savings and the range of investments that you can make with the money.
No other IRA-type program offers anything near the range of options that a Solo 401K affords you. And no other program allows you to be the legal custodian of your own retirement savings.
Author: Mike Armour
Even though the tutorial examines legal and tax issues faced by small business owners, it should not be construed as legal, accounting, or tax advice. Always seek competent professional counsel in addressing issues and questions raised in this tutorial.
A Guide to Solo 401Ks
Managing and Investing Solo 401K Funds
How Long Does It Take to Create a Solo 401k?
Because there is so much critical documentation which goes into structuring a Solo 401K properly, it normally takes two or three weeks for the process to be complete. Once the plan is established, its provisions are retroactive to the first of the year in which it is created. My company established its Solo 401K in September. But I was free to make contributions to the plan year as though it had been in effect from the first of January.
Also, before the Solo 401K is legally considered in effect, the company must take documented action to approve and implement the plan. This normally takes the form of a corporate resolution signed by the members of an LLC or (if your company is an S-Corp or a C-Corp) approved by the board of directors. The service provider who sets up your Solo 401K will probably provide the language that you need for this resolution.
If I have multiple businesses, can they all participate in a single Solo 401K plan?
The short answer is "yes." One business sets up the Solo 401K trust and the related documentation. Then by corporate resolution, any other company that you own can opt to participate in the program. These other companies make contribution deposits directly to the bank account for the trust.
This cooperative participation might be desirable in a situation where you have multiple businesses, none of which necessarily can predict their cash flow with assurance and accuracy. Or where no one business provides you enough salary to maximize your contribution to the Solo 401K. Just keep in mind that as other businesses become part of your Solo 401K program, you must provide plan coverage to any employees in those businesses.
The corporate resolution effecting participation can be a single-page document, but it should be drawn up properly. Again, the service provider who establishes your Solo 401K should be able to provide you the requisite language for this resolution.
How much flexibility do I have in making contributions to the Solo 401K?
One of the beauties of a Solo 401K is that you can adjust the level of your contributions yearly. And you can change your level of contributions for a given year within the year itself. Thus, when cash flow is strong you can increase your contributions, only to pull back a bit in years with weaker earnings.
This flexibility is particularly attractive if your business is a single-member LLC and you take your salary in the form of net profits. In many companies like this, it's hard to project your personal income for the year until you are well into the fourth quarter. You can therefore make fourth-quarter adjustments to allow for a year which proves more profitable than previously anticipated or which ends up making less money than you had originally projected.
What reports must I make to the government regarding the Solo 401K?
Because you are the custodian of the 401K trust, you must meet the fiduciary responsibilities of any trustee, which includes filing required reports. This primarily consists of completing an annual Form 5500-EZ for the IRS stating the change in fund balances over the preceding year.
You must also issue yourself, and any other employees, a W-2 which includes the amount of any contributions which the employee has made to the Solo 401K through a salary reduction.
Where can I invest 401K funds?
Because you act as the custodian for the 401K trust, you have absolute control over where funds from the trust are invested and when the investments are made. This is in total contrast to other IRA-type programs, where the custodian limits you to only certain types of investments. For instance, Fidelity or Schwab do not let you invest directly in real estate or make secured loans with your retirement funds. That's because these firms are primarily interested in selling stocks, bonds, mutual funds, and ETFs.
Once you are free of these institutional limitations, your range of investments is limited only by IRS regulations. For instance, the IRS does not allow you to invest in art and other collectibles such as stamps, rugs, and antiques. Nor does it permit investments in life insurance or in alcoholic beverages. And with certain exceptions, you are not allowed to invest in precious metals and coins.
Otherwise your investment options are rather unfettered. You can buy houses, multi-family complexes, commercial real estate, or raw land. You can invest in businesses. You can make real estate loans, securing them with the underlying real estate. You can purchase loans and liens at a discount. And of course, you are free to pursue more traditional retirement investments such as stocks, bonds, CDs, etc.
Incidentally, if you open a brokerage account to buy securities which are traded on exchanges, the account must be in the name of the Solo 401K trust, not in your name or the name of your company. In fact, no transaction which you enter on behalf of the trust should ever be in your name or the company name. And any documents which you sign for the trust, including checks and receipts, should clearly indicate that you are signing as the trustee.
You can accomplish this on checks by having the word "Trustee" printed just above the signature line. On other documents you may need to follow your signature with a comma and the printed word "Trustee."
While there are relatively few limitations on where you can invest, there are stringent requirements on who can benefit from your investments. Basically you cannot undertake any investment which directly or indirectly benefits what IRS calls "disqualified persons." Nor can the trust sell any of its assets to these parties. The IRS identifies "disqualified persons" as you and your spouse, your lineal ancestry and their spouses, and your lineal descendents and their spouses. There are severe and costly penalties if IRS determines that you have violated this provision.
To cite a few examples of what the IRS precludes, you can't make a loan to your parents or your children. You can't buy an investment home in a resort community and let family members use it for vacation. And you can't invest in a business owned by a disqualified person.
Interestingly, siblings are not considered disqualified persons. Neither are uncles, aunts, cousins, nephews, and nieces. So you could invest in your brother's business or make a mortgage loan to your sister or to a cousin.