Solo 401(k): What To Know About Your Eligibility, Rules & Regulations

The solo 401(k) or self-directed 401(k)—or what the IRS calls a one-participant 401(k)—is an increasingly popular way to save for retirement, diversify retirement assets, and protect them from creditors. Fortunately for us savvy savers, the rules about eligibility and what you can do with your account are right there in black in white. Back in 1978 when the IRS under the Carter administration amended the Tax Code to allow for Solo 401(k)s, the eligibility criteria and defining features of the structure was set in ink and have changed little since. 

Are You Eligible For a Solo 401(k)? Find Out Now

The Solo 401(k) has clear eligibility criteria. You must have two things:

  1. “The presence of self-employment activity.” Our friendly Legalese Translator wants everyone to take note of the wording here because it’s about to become important. Note that it doesn’t say “100% of income derived from self-employment.” But people make these assumptions. 
  2. “The absence of full-time employees.” Again, the wording matters. You, of course, may work for yourself. You can even have independent contractors.

Partners, fortunately, may be included in your plan as well, but typically, the Solo-K is just that: a one-person affair. Fortunately, 

The Solo 401(k) Rules Every Saver Should Know: The Real Deal on Prohibited Transactions

Although we’ve taken a deep dive into prohibited transactions before, questions about this issue are perennial. Although the reality is there are many possible iterations of what a prohibited transaction could look like, there are some general guidelines you can use to help you remember the basics. Broadly speaking, these are the kinds of transactions a Solo 401(k) can never engage in without running the risk of penalties:

  • Self-dealing transactions. Your Solo-K can’t do business with you or any businesses you own. Doing so, or attempting to, is called “self-dealing.” It’s against the rules because of the many obvious opportunities one would have for corruption if doing business with yourself weren’t prohibited. Investors especially are already known for bending the rules, and prohibited transaction principles against self-dealing prevent plenty of scandalous possibilities. 
  • Transactions with disqualified persons. Disqualified persons is a term coined by the Department of Labor, which makes these rules. They have a lengthy list, but the idea is people particularly close to you transacting with the plan are also against the rules. Your Solo-K or Self-Directed IRA can’t do business with, say, your spouse, children, other relatives, and even certain business partners. If you’re unsure if someone or their business is disqualified, talk to an attorney or CPA before making the transaction.

In fact, as a general rule, it’s better to be safe than sorry when it comes to prohibited transactions. Because you can’t just be granted absolution: usually prohibited transaction penalties are unavoidable after the fact. The best thing to do if you have any doubt in your mind about whether a transaction is against the rules is to ask an expert, or at the very least, someone more familiar with the subject than yourself. Prohibited transactions are best when avoided altogether.

How to Keep Your Solo 401(k) Compliant

Anyone with a Solo 401(k) should be aware of compliance requirements. You have to keep your plan compliant and avoid making transactions you’re not allowed to (known as prohibited transactions) if you want to avoid costly penalties. It’s yet another responsibility that comes with the freedom you get to enjoy with a Solo-K. Self-directed investing can make your retirement dollars work far harder for you, but only to the degree, you manage it properly. 

A professional can be helpful here, but some of the basic things to concern yourself with about 401(k) compliance are things you can learn and do now. Here are just a few of the issues you need to be aware of:

  • Make sure you keep Uncle Sam in the loop. The IRS requires you to update your plan formally every six years.
  • Keep excellent books so all income is reported correctly.
  • Avoid prohibited transactions at all costs.
  • Keep up with your paperwork, which includes filing a 5500 or 5500-EZ with the Department of Labor. Fun fact: the DOL is the agency that also gifted us the prohibited transaction rules.
  • Separate 401(k) funds from other plans and participants in your life. For optimal asset protection, keep things compartmentalized.

There are other considerations, and remember, since you’re flying custodian-free, it’s all on you. For this reason, many investors choose to get professional help with 401(k) compliance, and you can find full-service law firms and 401(k) specialists. Be sure to vet the credentials of anyone you entrust with your retirement finances. You want someone with real experience or easily verified licensing (lawyers and CPAs, for example, are easy to check up on).

Bottom Line: Knowledge is Power with the Solo 401(k)

The more you know about your Solo K responsibilities and obligations, the more likely you are to leverage this vehicle successfully. Enjoy harnessing the unique benefits, and don’t be afraid to call upon your investing network or a pro if you’re lost. It’s okay to not know everything. Fortunately for us all, these rules and laws are well documented and easy to access on the Department of Labor and IRS websites. Now that you know what to watch out for and how to comply, you can start developing a wealth-building strategy to diversify your retirement dollars and maximize them into your golden years. Happy saving.

Last Updated: 
August 20, 2019

Scott Royal Smith is an asset protection attorney and long-time real estate investor. He's on a mission to help fellow investors free their time, protect their assets, and create lasting wealth.

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