The Solo 401k Strategy for Self Employed Owners and the New Tax Credit That Can Help Pay for It
The solo 401k has quietly become one of the most valuable financial tools available to self employed individuals. While most retirement conversations center on employer plans or traditional IRAs, the solo 401k offers a combination of flexibility, contribution power, and tax advantages that is difficult to match. Recent legislation also introduced a new tax credit that can reduce the cost of setting up or upgrading a solo 401k plan. For many business owners who operate without full time employees, this is an opportunity to strengthen retirement planning while capturing a meaningful tax benefit.
Watch the Webinar Recording
A full recording of the session can be viewed here and walks through each example in real time, including whiteboard illustrations, contribution calculations, and answers to live questions from business owners.
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Download the Slides
The visual references used during the presentation are available here for review.
Why the Solo 401k Continues To Stand Out
A solo 401k is designed for individuals who run a business with no full time employees other than a spouse or a business partner. That simple requirement opens the door to a retirement plan with much higher annual contribution room than a standard IRA and far more strategic flexibility than a SEP IRA, which is often the default recommendation for self employed people who are unfamiliar with the solo 401k option.
Partners Mat Sorensen and Mark J Kohler describe the solo 401k as the most useful retirement account available to individuals who work for themselves. They note that contribution ceilings regularly reach into the seventy thousand range for many participants, which is several times more than what a traditional or Roth IRA allows. Because the solo 401k includes both employee and employer contributions, the business owner controls multiple levers that can be adjusted for cash flow, tax planning, and long term compounding.
What sets the plan apart even further is the control provided to the account holder. Under a company like Directed IRA the account now has the ability to invest in real estate, private companies, lending arrangements, or standard public market investments.
The Solo 401k Within a Business Owner’s Structure
The solo 401k often sits inside a broader planning framework that many small business owners already use. A revocable living trust holds ownership of the operating company, the operating company adopts the solo 401k, and any separate entities such as real estate companies remain alongside it. This keeps the retirement plan tied directly to the business that generates the qualifying income.
A few key points about how the plan functions within this structure include:
- The owner participates in the plan as an employee of the operating company, which allows contributions to be based on a chosen W2 salary.
• Funding can take place in the following tax year as long as the plan was set up before year end, giving flexibility in managing cash flow.
• Existing retirement accounts can often be rolled into the solo 401k, creating one consolidated account with broader investment choices.
Eligibility and Requirements That Often Surprise New Owners
The most important requirement is the presence of self employment income that arises from the sale of goods or services. Passive income, such as rent from property held for investment, does not satisfy this requirement on its own. Many people new to the concept mistakenly assume that rental income qualifies them for a solo 401k, but the plan must be tied to operating income from an actual trade or business.
The other important condition is the absence of full time employees. A business that employs full time staff outside the owner and the spouse can no longer rely on a solo 401k and must consider a different retirement plan structure. Most self employed individuals who operate alone or with occasional contractors fit well within the solo 401k rules.
In addition, every solo 401k must be built on a properly drafted plan document. This document dictates what the plan is allowed to do, what types of contributions may be made, whether Roth contributions are available, whether alternative assets are permitted, and how rollovers and conversions are handled. This is why the presenters urge owners not to rely solely on generic custodial plans when they intend to self direct or use advanced features.
Adding a Spouse and Increasing Total Family Contributions
The structure is straightforward once the underlying rule is understood. A solo 401k remains eligible as long as the business has no full time employees outside the owner and the spouse. Because the spouse is treated as an employee of the business, that spouse can receive a salary and contribute to the same solo 401k plan.
In practice, this allows a family to double the number of contributions flowing into the plan. If the spouse already participates in a retirement plan at a day job, the overall deferral limit still applies across all plans, but the employer style contribution available inside the solo 401k often creates contribution room that would not be available through an outside employer. The strategy becomes especially useful for couples looking to accelerate retirement savings or to take advantage of Roth style contributions inside a self directed environment.
Understanding the New Tax Credit for Automatic Contribution Arrangements
Our large value add, the new tax credit that applies when a solo 401k adopts an automatic contribution arrangement. The law that introduced this provision was originally designed to encourage larger employers to automatically enroll their employees into retirement plans. However, the structure of the rule allows solo 401k owners to take advantage of the same credit as long as they follow the requirements.
The credit is worth up to fifteen hundred dollars over three tax years. Each year the owner can claim a five hundred dollar credit simply by adopting the automatic contribution arrangement and issuing the required notice. The plan participant which in most cases is the business owner receives a notice that states an automatic contribution rate will apply. The participant can then opt out of the arrangement. Once the notice is issued and the arrangement is adopted, the owner becomes eligible for the credit.
To claim the credit, the business files the appropriate tax form which is Form 8881. For S corporations and partnerships the credit flows through the entity and appears on the owners individual tax return. For sole proprietors the credit is claimed directly through the form that handles general business credits.
Why Many Business Owners Transition Away From SEP IRAs
SEP IRAs are familiar to many self employed individuals because they are easy to set up and simple to administer. However, the SEP structure limits contributions to a percentage of net earnings. The owners income must be quite high before the SEP contribution approaches the contribution potential of a solo 401k.
In an example shared, a business owner earning fifty thousand in net income would be able to contribute roughly twelve thousand through a SEP. A solo 401k under the same circumstances would allow the owner to combine an employee style deferral with an employer style contribution, reaching a total in the mid thirty thousand range. This dramatic difference leads many advisors to recommend the solo 401k rather than the SEP for individuals seeking meaningful retirement savings over time.
Bringing Legal Expertise and Custodial Administration Together
Highlighting the importance of using both a knowledgeable attorney for plan creation and a reliable custodian or administrator for ongoing compliance. The attorney ensures that the entity structure, plan features, contribution strategy, and tax planning are aligned. The custodian or administrator ensures that assets are handled correctly, transactions are recorded, conversions are issued on proper tax forms, and the annual filing obligations are satisfied when the plan passes two hundred fifty thousand in assets.
This relationship between legal planning and custodial support is what allows a solo 401k to function smoothly. Owners retain investment control but do not need to manage the technical reporting requirements.
Moving Forward with a Solo 401k and the New Credit
If you are considering a solo 401k for the first time, or you already have one and want to update it, the webinar provides a comprehensive foundation. The recording and slides on this page will help you step through each example and determine where your situation fits within the strategies presented.
The new tax credit makes this a particularly favorable moment to set up or enhance a plan. When structured correctly, the credit can offset the cost of establishing a compliant solo 401k and adopting the required arrangement. In many cases, owners find that the tax benefit effectively pays for the plan itself.
Owners who prefer guidance can schedule a consultation with an attorney who can review income levels, entity structure, contribution goals, existing retirement accounts, and the best approach for claiming the credit. Those who simply want to watch the webinar or refer back to the visual illustrations can explore the materials linked above.
If you are ready to establish a new solo 401k or want to explore how the plan can support your business and long term retirement goals, you can schedule a call with our team and receive personalized guidance on structure, contributions, and the new tax credit.
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For those who already have a solo 401k at Directed IRA and need their plan updated or need a copy of the required document for the tax credit, reach out directly and our team will assist you.
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