Kitces: Establishing Solo 401(k) Plans For Self-Employed Workers: Options, Contribution Limits, Deadlines, And More! (November 23, 2022)

Kitces has made available for download their article, “Establishing Solo 401(k) Plans For Self-Employed Workers: Options, Contribution Limits, Deadlines, And More!”, published in Kitces. The Executive Summary is as follows:

Among the several different types of retirement plans that are available to self-employed workers, solo 401(k) plans can offer the most flexibility and the ability to contribute the highest amount of tax-advantaged savings. But alongside those advantages, there are some specific rules and regulations that are unique to solo 401(k) plans, which can add to the complexity of setting up and maintaining a plan. And for advisors who serve self-employed clients, managing a solo 401(k) plan is often a different process than managing other types of investments.

However, the advantages of solo 401(k) plans – which include higher contribution limits for individuals with moderate incomes as well as the ability to make Roth contributions to the plan (plus additional nondeductible contributions which can be converted into even more Roth dollars) – mean they can often be worth the added complexity, particularly for individuals who want to save a high percentage of their income and/or build tax-free Roth savings. They can also permit participants to take loans from the plan, creating a source of emergency funds without the need to make a (potentially taxable) distribution.

Setting up and maintaining a solo 401(k) plan involves creating plan paperwork (including a written plan document and adoption agreement), keeping records of contributions and withdrawals, and for plans with more than $250,000 in assets, filing Form 5500-EZ annually with the IRS. Business owners typically outsource some or all of these tasks, and they can do so in one of two ways: by choosing a pre-approved, ‘off-the-shelf’ plan with a broker-dealer firm (who then serves as custodian for plan assets), or by hiring a third-party plan provider to create a ‘self-directed’ plan, which can invest in a wider range of assets.

Although both types of solo 401(k) plans come with particular benefits, there are also tradeoffs to each approach. Off-the-shelf plans can be easier to administer, since the broker-dealer handles most of the plan paperwork and holds the plan assets often for little to no cost. However, off-the-shelf plans also tend to offer fewer options; for example, TD Ameritrade’s merger with Charles Schwab resulted in the elimination of Roth features from their off-the-shelf solo 401(k) plan.

Self-directed plans, meanwhile, offer more ability to tailor a plan’s features to an individual’s needs. These features can include the ability to make Roth or nondeductible contributions, to take loans from plan assets, and to invest in non-traditional assets such as real estate, crypto assets, and precious metals – many of which are not allowed by most off-the-shelf solo 401(k) plans. But self-directed plans can be complex to manage, with the possibility of assets being held in multiple locations (as well as the responsibility of the plan participant to avoid investing in prohibited assets or making prohibited transactions), and costs that typically include startup fees of several hundred dollars, along with additional fees for ongoing maintenance.

The key point is that advisors can offer a valuable service by guiding their self-employed clients to the right solo 401(k) plan option, and by filling in the gaps between whatever services the plan provider performs and what the client is responsible for (such as opening accounts, keeping track of contributions and distributions, or preparing Form 5500-EZ). Ultimately, with the potential for added wealth that solo 401(k) plans can create, making the process of managing the plan a little easier for clients is a great opportunity to provide value that the client can see from year to year.

To read the full report, click “Establishing Solo 401(k) Plans For Self-Employed Workers: Options, Contribution Limits, Deadlines, And More!” 

Posted by Melissa Zheng, Associate Editor, Wealth Strategies Journal.

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