Ready to get a Solo 401(k) Started or Need to Find out if This Strategy is Right for You? Book a free 15-minute call with one of our client advisors and start preparing with confidence.
The Power of a Solo 401(k): Top 5 Reasons You Should Have One
A Solo 401(k) is a powerful tool for multiple reasons. It’s more than just an account to save for the future to sit in the stock market. If you can qualify, it is a crucial part of building wealth. Here are the top five reasons you should consider a Solo 401(k):
1: “Mega” Roth
You are probably familiar with a Roth IRA. You can contribute up to $7,000 every year ($8,000 if you are age 50 or older) The income made on those contributions are tax-free. With a 401(k) you can ALSO make an employee ROTH deferral contribution of $23,500 every
year ($31,000 if age 50 or older). If you want to contribute MORE than $23,500/$30,000 into a Roth 401(k) every year, you need to make additional certain types of 401(k) Contributions. This is called an After-Tax Employee Contribution. With a Solo 401k, you can make this additional contribution up to the OVERALL 401k contribution annual limit of $70,000 ($77,500 if age 50+; amounts are adjusted for inflation). It is critical that once the After-Tax Employee Contribution is made that it be immediately moved to your Solo 401k Roth account, or rolled out to your Roth IRA. Also, in order to contribute $70,000, your W2 (the one you need to give yourself from your S-corp) needs to be at LEAST greater than that, not including payroll taxes, etc. Technically, you could include a Roth Employer Contribution as well, but you still can’t exceed the overall 401k contribution limit ($70,000). For example, Your S-corp makes $200,000 this year. You give yourself a reasonable W2 of $80,000. Your S-corp adopts a Solo 401k with KKOS Lawyers and we help you implement the “mega” Roth. You end up with $7,000 in your Roth IRA, and $70,000 in your Roth Solo 401k. And it all grows Tax-Free! And you can do this every year! This “Mega” Roth strategy is powerful, and you can only do it with a Solo 401k (or if you’re a rank and file employee and your workplace employer 401k allows it). Remember, in order to qualify to have a Solo 401k, you must have self-employment income, and no disqualifying employees. In other words, you must be a business owner without employees (other than yourself, other owner(s), and certain family members who work in the business).
Get personalized help from our team at KKOS Lawyers!
2: Self-Direct
A Solo 401k is like an IRA in the sense that the law allows you to have a ‘regular’ Solo 401k meaning it’s opened at a traditional financial institution and you invest in stocks, bonds, and mutual funds. Or you can have a ‘self-directed’ Solo 401k meaning it’s opened at a self-directed custodian that allows you to invest in alternative assets like real estate, private equities, lending, crypto, etc. The type of Solo 401k that we setup here at KKOS Lawyers is a self-directed Solo 401k meaning your custodian (our sister company Directed IRA/Trust Company) will allow you to invest your Solo 401k funds into alternative assets. For example, your Solo 401k has $70,000. You are an expert at crypto investing. Rather than forming a ‘typical’ Solo 401k with your funds sitting in the stock market at a financial institution, you form a self-directed Solo 401k with KKOS Lawyers, and you’re able to invest it into your favorite cryptocurrency, and if it’s Roth, the gains are tax-free. The ability to invest in what you know is critical to building wealth!
3: Avoid UDFI Tax
One of the ways you can use a self-directed IRA is to invest in real estate. Typically it is wise to use leverage/financing to invest in real estate. When using leverage/financing to invest in real estate with an IRA (any IRA whether it’s Roth, Traditional, SEP, etc.), there is the risk of having to pay Unrelated Debt Financed Income Tax (UDFI). However, when you use a 401k to invest in leveraged/financed real estate, you completely avoid UDFI Tax. For example, your Solo 401k has $200,000 to invest. You find a property to buy that’s $500,000. Your Solo 401k gets a non-recourse loan (this is typically the required type of loan) for the other $300,000. The property generates income for your Solo 401k and NO UDFI Tax. This is a HUGE benefit and which is why the Solo 401k is the best way to make leveraged/financed real estate investments.
4: Tax Deduction
I am sure you are familiar with how a typical 401k works. The money you contribute is typically tax-deductible. With a 401k you can make an employee deferral contribution of $23,500 every year ($31,000 if age 50 or older). You can also make a tax deductible employer contribution up to 25% of your W2 (the one you need to give yourself from your S-corp). But remember that any tax deductible contribution you make to your Solo 401k reduces how much you can contribute to Roth via the “Mega” Roth strategy above. For example, Your S-corp makes $200,000 this year. You give yourself a reasonable W2 of $80,000. Your S-corp adopts a Solo 401k and you make a traditional/tax-deductible employee deferral contribution of $23,500. Plus an employer contribution of $20,000 (25% of your W2). Your taxable income just went down by $43,000 ($23,500 + $20,000). Rather than paying income tax on the full $200,000, your taxable income is now only $157,000. This is arguably the best tax deduction there is because unlike most tax deductions you have to buy something or spend money and your funds are gone, with this, your money is stills yours for the future. That money is now growing tax-deferred for your future/retirement.
5: Borrow It, Tax Free
If you are a business owner, you know how difficult managing cash flow can be. The thought of putting money into a 401k and not being able to touch those funds for decades can be difficult. Fortunately, that is simply not true. You can borrow from your 401k tax-free, penalty-free, any time! For example, You have $80,000 in your Solo 401k. You can borrow 50% or $50,000 whichever is less. Here, you can borrow up to $40,000 tax-free, penalty free. You can use these funds however you like, no restrictions. You just need to pay it back within 5 years and make sure you make quarterly payments of principal and interest. You would need to work with your 401k custodian (in our case, Directed IRA/Trust Company) to initiate the loan and the necessary documentation.
Take Action
Whether it’s to do the “Mega” Roth, or to self-direct, or to invest in leverage real estate to avoid UDFI Tax, or to make tax deductible contributions, or to borrow from it tax-free, the Solo 401k is a powerful tool to build wealth! Let us help you get this important tool setup correctly so you can start using it to your advantage! Click here to learn more about our upcoming Solo 401k special:
Book a Call or Learn More About Our Solo 401(k) Special