Start a business just so I can have a Solo 401(k)?

[email protected]608-524-4899

Not sure how MANY people do it, but I can share my knowledge about it.

I own rentals with two partners and we all use a combination of SDIRA, SOLO401K and cash. When we started, we were using funds saved up in our fairly sizeable IRAs and paying cash for properties. When I learned about SDIRAs, I was not yet aware of SOLO401s. If I had, and understood the benefits of the SOLO, there is NO way I would have done the SDIRA, since I qualified for SOLO.

Two of us are 'full time' self employed and make enough to make large contributions. The third partner has a W2 job and ALSO is a partner in their spouse's business on a part time basis, which qualifies them for a SOLO too.

I have a friend who is interested in owning more rentals (he has some he financed conventionally now). He is a carpenter by trade working for a large builder. He is starting to do 'side jobs' which can easily bring $40 - $50+ per hour in our area. He figures working one Saturday a month should bring in 5K per year. Not a lot for a contribution, but he has sizeable IRAs to roll over too that will enable him to buy several more rentals with 40% down and earn in the neigborhood of 16-20% a year.

I am not sure how many poeple go from say full time W2 accountant (or whatever) to full time self employed accountant, but I think MANY jobs or non job skill sets lend themselves to part time self employment that would qualify them for a SOLO.

Dan Dietz

Daria B.

Rental Property Investor · Gainesville, FL · Member since 2015 · 1k+ posts · 432 votes

9y

That's an interesting bit of research you found. I have never looked into the qualifications of the Solo 401k but I too wondered if it would be something I could utilize and at what level of "self-employment" I could do to qualify.

Following this to see what other experiences there are on this topic.

John Dombrowski

RE Investor · San Diego, CA · Member since 2015 · 119 posts · 18 votes

9y

@Paul B.,

I just signed up to drive for Uber. I figure I will just do one quick fare every week or 2 just so I get a 1099 at the end of the year. And I can network a little bit that way..... :-)

Brian EastmanPro Member

Self Directed IRA & 401k Advisor · Wenatchee, WA · Member since 2014 · 2k+ posts · 2k+ votes

9y

We would generally not recommend that someone who does not currently or who cannot easily and permanently qualify for a Solo 401(k) "create" self-employment simply to qualify for a plan.

A Solo 401(k) is an employer sponsored retirement plan, designed for owner-only businesses with no full time employees other than the business owner. Self-employment is earned income such as from providing a service or selling a product. Passive income such as that from rentals does not qualify.

The bar is rather low to be self-employed, but you not only have to be self-employed to establish the plan, you need to remain self-employed to continue to maintain the plan. One can have a sole proprietorship, LLC, corporation, etc. That business activity will need to operate properly including any licensing at the state or local level, tax filings, etc. There is a cost of doing that.

Many investors, especially on a web forum, over promote the Solo 401(k) and I very frequently see folks with or looking to setup such plans that do not belong in the plan. There are several advantages to the Solo 401(k) for those who do qualify, but maintaining qualification and compliance is important. It is not just an "account" that you setup and forget. If you find yourself in a situation where you are no longer self-employed, then the plan may need to be terminated and rolled over to an IRA.

The avoidance of UDFI taxation on debt-financed real estate is a nice feature of the Solo 401(k). Most folks think that paying taxes in an IRA is a bad thing, and want to avoid that at all costs. When you run the numbers, however, you will see that UDFI is not generally a huge factor, and that the IRA is still receiving the significant benefits of using leverage and a higher cash-on-cash return as a result.

Without taking the time for a full example, consider this. A $100K property where 60% is borrowed and income is 10% will pay about $175-200 in UDFI taxation for a year. How much work do you need to go through to avoid that small tax?

There are several qualified professionals here on BP who can help you evaluate your specific situation and determine if a Solo 401(k) is a good long term fit. If not, the IRA LLC is an excellent tool and a potential means to get much better results for your retirement savings through investments such as real estate.

6 Reply

Mike ReynoldsPro Member

construction · Nacogdoches, TX · Member since 2011 · 2k+ posts · 1k+ votes

9y

Originally posted by @Brian Eastman:

We would generally not recommend that someone who does not currently or who cannot easily and permanently qualify for a Solo 401(k) "create" self-employment simply to qualify for a plan.

A Solo 401(k) is an employer sponsored retirement plan, designed for owner-only businesses with no full time employees other than the business owner. Self-employment is earned income such as from providing a service or selling a product. Passive income such as that from rentals does not qualify.

The bar is rather low to be self-employed, but you not only have to be self-employed to establish the plan, you need to remain self-employed to continue to maintain the plan. One can have a sole proprietorship, LLC, corporation, etc. That business activity will need to operate properly including any licensing at the state or local level, tax filings, etc. There is a cost of doing that.

Many investors, especially on a web forum, over promote the Solo 401(k) and I very frequently see folks with or looking to setup such plans that do not belong in the plan. There are several advantages to the Solo 401(k) for those who do qualify, but maintaining qualification and compliance is important. It is not just an "account" that you setup and forget. If you find yourself in a situation where you are no longer self-employed, then the plan may need to be terminated and rolled over to an IRA.

The avoidance of UDFI taxation on debt-financed real estate is a nice feature of the Solo 401(k). Most folks think that paying taxes in an IRA is a bad thing, and want to avoid that at all costs. When you run the numbers, however, you will see that UDFI is not generally a huge factor, and that the IRA is still receiving the significant benefits of using leverage and a higher cash-on-cash return as a result.

Without taking the time for a full example, consider this. A $100K property where 60% is borrowed and income is 10% will pay about $175-200 in UDFI taxation for a year. How much work do you need to go through to avoid that small tax?

There are several qualified professionals here on BP who can help you evaluate your specific situation and determine if a Solo 401(k) is a good long term fit. If not, the IRA LLC is an excellent tool and a potential means to get much better results for your retirement savings through investments such as real estate.

Good post but one thing that has always stuck in my mind is this. If a company has no employees other than the owner, how big could it really get anyway?

Another thing that I have wondered about also is what happens if the company does grow and there is a need to hire someone? Would you have to create a different entity and do away with the solo k?

Brian EastmanPro Member

Self Directed IRA & 401k Advisor · Wenatchee, WA · Member since 2014 · 2k+ posts · 2k+ votes

9y

@Mike Reynolds

We have many self-employed clients with significant earnings such as $250K to $400K per year. No the business is not that "big", but the income is. Being able to put up to $60K of that aside tax-deferred into a retirement plan like the Solo 401(k) is nice.

If you find yourself out of qualification for a Solo 401(k) on the low end (out of business), then you terminate the plan and rollover to an IRA.

If you find yourself out of qualification through adding employees, then you have the option of providing a full-blown "ERISA" 401(k) through the business and offering a retirement plan to the employees. Making such a plan self-directed is possible, but becomes very complex administratively and could expose you to liability as plan trustee if your employees make poor self-directed investment choices. So, most folks choose not to go that route unless the "employees" are a handful of sophisticated business people/investors. They may continue with a generic Wall St 401k in the business (or not) and rollover the Solo 401k and any non-traditional assets to an IRA at that point.

A point to keep in mind is that if you have multiple businesses, they are looked at as one by the IRS and Department of Labor when considering retirement plan benefits. As such, you generally cannot be self-employed with a Solo 401(k) in business A with no employees and also have business B with employees an no 401(k) plan.

Solo 401k Expert · Anaheim Hills, CA · Member since 2012 · 18k+ posts · 6k+ votes

9y

The self-employment activity or business that is required to establish a Solo 401k plan has to be legitimate and when I speak with people occasionally who want to setup some self-employment activity just to qualify for a Solo 401k what they are proposing in most cases is not a legitimate self-employment activity or it does not have the longevity that is needed to maintain the plan.

The bottom line is that if the fact that Solo 401k plan is superior to an IRA prompts you to start a legitimate business that you perhaps were considering in the past but never done it is a good thing. But unless you have a solid business plan and expectations to maintain the business for years to come and making profits from this business I would not recommend going this route.

3 Reply

Colleen F.Pro Member

Investor · Narragansett, RI · Member since 2013 · 8k+ posts · 4k+ votes

9y

So if you start a solo 401 k and then you stop being self employed you cant just leave it There? What is supposed to happen if you do? I know you can't contribute but you have to Convert?

Solo 401k Expert · Anaheim Hills, CA · Member since 2012 · 18k+ posts · 6k+ votes

9y

if your self-employment activity stops the Solo 401k plan have to be terminated.

Brian EastmanPro Member

Self Directed IRA & 401k Advisor · Wenatchee, WA · Member since 2014 · 2k+ posts · 2k+ votes

9y

Unlike a larger employer 401k where you can leave your funds in place after you terminate employment, a Solo 401k does not allow for that. If you "terminate", you are also shutting down the employer that is the sponsor for the plan. A 401k cannot exist without a sponsor.

The option is to rollover the 401k assets to an IRA at that point.

Justin WindhamPro Member

Banker · Nationwide · Member since 2015 · 4k+ posts · 1k+ votes

9y

@Colleen F. @Paul B.

I will echo the sentiments of other providers who have posted here. If you are creating self-employment activity with the intent to create a Solo 401k, you want to make sure the SE activity is legitimate and ongoing. Your SE activity and plan could technically start at roughly the same time. Doing this isn't necessarily prohibited, it's just that too often when someone creates a side business mainly to become Solo 401k eligible, the side business isn't quite what it should be when it comes to legitimacy. You should really intend to make a profit, that activity and profit generation (even if small) should be ongoing for the foreseeable future, and you should have the intention to make contributions to the plan from that earned income.

@Mike Reynolds

I know what you mean in wondering how big a company could get with no employees and it does depend on your definition of "big" here. An owner-only company is going to be small by any measurement of employee count, but the income can be significant as @Brian Eastman pointed out. Sometimes you have high earning individuals in sales or other lucrative freelance and consulting gigs. Some owners actually have a business model that allows for contractors to generate significant income for them. There is no limit on income, just W2 employees working more than 1,000 hours per year. While some solo businesses will not ever get to the level it takes to maximize participant contributions, others do quite easily with money to spare.

John Dombrowski

RE Investor · San Diego, CA · Member since 2015 · 119 posts · 18 votes

9y

Even though I won't make that much driving for Uber, can I just put whatever I make directly into my solo401k as a contribution?

Justin WindhamPro Member

Banker · Nationwide · Member since 2015 · 4k+ posts · 1k+ votes

9y

@John Dombrowski

Most likely. You can put 100% of your net earnings from self-employment into your plan up to $18,000 ($24,000 if age 50 or over).

Paul B.

OP

Rental Property Investor · Dallas, TX · Member since 2015 · 501 posts · 504 votes

9y

Originally posted by @John Dombrowski:

@Paul B.,

I just signed up to drive for Uber. I figure I will just do one quick fare every week or 2 just so I get a 1099 at the end of the year. And I can network a little bit that way..... :-)

Since you won't be making a lot of money there, how will you have any significant funds in the Solo 401(k)? Did you roll over an old 401(k) or IRA into it?

@Brian Eastman,@Justin Windham

Dan P.

Investor · Salem, OR · Member since 2012 · 16 posts · 0 votes

9y

I have the same question as @Paul B. but for different reasons. I am not self-employed and my w-2 wage is too high to make IRA contributions but I max out my 401(k) contributions. So I am interested in backdoor Roth contributions. The problem is that I have a large rollover IRA that is several years old. So if I tried to do a backdoor Roth strategy I will run into the pro-rata rule. So I believe I can convert those traditional IRA funds back into a 401(k) however my current employer has very poor 401(k) options and it would destroy my asset allocation.

So what I have been considering, and which led me to this post, is doing some self-employment to qualify for a solo 401(k) that I can roll my traditional IRAs into with better investment options and then allow me to start doing a backdoor Roth.

Overall that's probably a lot of work to add the Roth amounts to my overall retirement contributions but I am interested in whether it would even work and what the drawbacks would be other than the amount of work.

Thanks

Michael Lee

Investor · Coppell, TX · Member since 2008 · 2k+ posts · 646 votes

9y

Hello and welcome to BP and asking a good question! If you keep that a secret but you will probably get anyway and have that shut down for personally benefiting. I have been looking into various tax-free or tax free investing. I have been looking into those for several months and have not made a decision yet. Have you ever heard or looked into a QRP (Qualified Reirement Plan). I just read a book on them and it is a checkbook account, there is no administrator and you can be in charge.

They compared with a SDIRA and the QRP was better at most points, including yearly donations of $54,000, $108,000 for a married couple. You might want check out tax state to make sure you recalled and it is my remembrance that any income must be put back in that account and the taxes owed are deferred, not due unless you pull any of it out.

I think about any deferred income tax and free from the IRS taking anything from it were my favorite reasons while I was searching. I still have not done anything really of what they did. If you opened up a ROTH retirement fund and you are young enough to justify that. That ROTH QRP does not even pay tax on the income reported.. I am 60 years old now and I am a little concerned that most on-the-side vehicles were thoroughly researched by a lawyer.

Typically, when a lawyer is involved something it is probably wrong with that investment as a vehicle. Just go with something that has been around for a while and do not invest where you do not feel too good about it. Too many people want to get away with things that are not right and try figure out an obstacle instead of doing something that is practicle.

I do not know for sure that everything I said is right so you need to do your own research and even talk to a tax consultant that has experience in that matter. You have gotten many remarks from people and some of them are salespeople that are trying to make money from you. A majority of them are speaking down on that change. You should go with something that is simple and easy and proven and does not have so many questions about it.

Good luck to you!

Solo 401k Expert · Anaheim Hills, CA · Member since 2012 · 18k+ posts · 6k+ votes

9y

@Michael Lee

The Solo 401k plan that is being discussed in this forum is a QRP. It allows large contributions (not donations, donations are made to church and other non-profit) up to $60K/yr per participant, post-tax contributions up to $24K into Roth account of the Solo 401k plan and more...

Solo 401k Expert · Anaheim Hills, CA · Member since 2012 · 18k+ posts · 6k+ votes

9y

@Dan P.

If your income does not allow you to contribute into Roth, you can do the backdoor Roth IRA. You will have to make non-deductible contribution to a Traditional IRA and then convert that into Roth. If you have legitimate self-employment you can also utilize Solo 401k.

Dan P.

Investor · Salem, OR · Member since 2012 · 16 posts · 0 votes

9y

@Dmitriy Fomichenko. Right, so I guess my simplified question is if there is any drawback to doing some self-employment in order to open a solo 401(k) in order to convert my traditional IRAs into the solo 401(k)? Once that's done I can then do the backdoor Roth without worrying about pro-rata.

Solo 401k Expert · Anaheim Hills, CA · Member since 2012 · 18k+ posts · 6k+ votes

9y

Dan, you should consult with your CPA or tax advisor about specifics of your situation.

Colleen F.Pro Member

Investor · Narragansett, RI · Member since 2013 · 8k+ posts · 4k+ votes

9y

@Brian Eastman The business I started for the SOLO 401K was for legitimate income from consulting. I didn't terminate the consulting it just isn't happening right now. For the SOLO There were operating documents but until you reach some amount it is pretty minimal documentation. Since it is the kind of income that is sporadic what is the definition of terminating the activity? If you think about the original poster scenario, if he stops driving for 6 months is that no longer an ongoing business?

Another type of activity would need another TIN and thus a different SOLO 401k correct?

(I will ask more specifically to an personal advisor just asking in principle).

Brian EastmanPro Member

Self Directed IRA & 401k Advisor · Wenatchee, WA · Member since 2014 · 2k+ posts · 2k+ votes

9y

A business activity can be minimal or sporadic and still qualify for a Solo 401(k). If a business goes away - i.e. does not generate any taxable income for a particular tax year, for example - then the Solo 401(k) has no sponsor. What that really means will differ based on the type of entity (sole proprietor vs corp) and nature of the business. In some trades you can very much be "in-business" and not have revenue in a specific year. In other cases such as driving for Uber or Lyft, that would not be the reality.

My point is that a lot of folks are over-promoted on the benefits and persuaded to setup a Solo 401(k) plan when they really do not have a legitimate ongoing business activity. I see it all the time. I wanted investors here on the forum to really understand that a Solo 401(k) is an Employer Sponsored Retirement Plan, and to consider that and ask questions specific to their situation before opening such a plan.

Mikey Phillips

Rental Property Investor · Federalsburg, MD · Member since 2017 · 1 post · 0 votes

8y

so can I open a solo Roth 401k if I have an LLC? or it makes no difference if its an LLC or sole proprietorship?

Justin WindhamPro Member

Banker · Nationwide · Member since 2015 · 4k+ posts · 1k+ votes

8y

@Mikey Phillips

A Solo 401k can be adopted by an LLC or a sole proprietorship. What matters as far as eligibility is concerned is that you have self-employment activity and no employees.

https://www.irs.gov/businesses/small-businesses-self-employed/self-employed-individuals-tax-center

George Blower

Retirement Accounts Attorney · Southfield, MI · Member since 2017 · 3k+ posts · 1k+ votes

8y

@Mikey Phillips

To learn more about self-employed business entity types and self-employment rules, see the following. Also, you can have part-time W-2 employees (work less than 1,000 hours).