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.

The Solo 401(k) can certainly stir up some confusion. In fact, the whole world of self-directed investing can. So in the interest of saving your precious time, and helping you maximize every single one of your retirement dollars, we’re collecting our FAQs about the plan to answer more of your questions in one place. Let’s look at some of our most common ones.

FAQ #1: Why Is The Solo 401(k) Better Than a Normal Traditional 401(k)?

First of all, it isn’t always. The Solo 401(k) is only better for some people, namely the people that qualify because of self-employment income. So if that doesn’t apply to you at all even through your investments, you’re both ineligible for the Solo 401(k) and unlikely to benefit. But because you’re here reading through the Royal Legal Library (Thanks, by the way! Stay as long as you like and learn all you want for free here!), we’ll assume you’re either an ass-kicking entrepreneur or real estate investor like our clients, or someone who got here because you need this info. Or maybe you just want to be the smartest investor at the room at your next meet-up or have a pal who could use this down the line. So here’s why the Solo 401(k) is better for some investors.

Note From Your Friendly Legalese Translator: We’ve actually got a hack real estate investors can use to structure REI income for a Solo 401(k) eligibility. FAQ #5 below spells out details. But for now, understand that us asset protection pros create structures and help you understand the legal narrative around your plan. The legal narrative matters for you and explaining your structure to someone like, say, Uncle Sam. That’s the only person, other than your own paid helpers, you EVER should have to explain to other than a Judge. If you (against sane legal advice) volunteer info to others, you at least want to tell the same story that you tell the Taxman. Your legal structures do most of the work, but understanding the legal narrative, or the story we tell about these structures in simple terms helps you really understand and exploit them. Knowing the story matters for your Solo-K or any legal tool.

The solo 401 (k) certainly is better for self-employed people and many investors. If you’re among them, you can confirm personal suitability with your attorney, CPA, or other financial advisor. But the most basic reason it’s “better” for these folks is it gives them an option at all. In the bad old days, there wasn’t a good vehicle for stashing retirement savings.

But things got really awesome for investors when some regulations relaxed in the 2000s, even though the Solo 401(k) was created under the Carter Administration. You know, the one you may remember from not remembering much of if you’re a Millennial, or if you’re more experienced, you may think of him as that unfortunate peanut farmer from Georgia who was trying to hammer out the Iranian Hostage Crisis while you were getting your ass-kicking real estate business going. You can thank that Southern-accented, now nearly 100-year-old peanut farmer’s staff for the Solo-K, no matter what you think of the man himself. Carter’s people made this kind of investing a possibility, and one of his Presidential predecessors even the Millennials like our Legalese Translator remember allowed regulations to loosen further. Between them both, and just for the record, each was of a different party, all of us can now enjoy Solo-K’s with Checkbook Control based just on having a real estate portfolio and appropriately arranged structure.

FAQ #2: What’s Checkbook Control?

You’ll see mention of Checkbook Control neatly scattered throughout virtually anything you read about the Solo 401(k). Of course, not everyone neatly explains the details as we do here in Royal Legal Land. Checkbook control isn’t just an ad keyword or some kind of marketing term, it’s actually the feature linked to the account’s most obvious benefit: the ability to go beyond the world of traditional financial products.

Checkbook control is the feature that enables you to enjoy the full liberties of a self-directed account. These words can be confusing, because they evoke the image of an actual checkbook, so think of “checkbook” as shorthand for “your entire account.” Checkbook control actually refers to the power you get to make nontraditional investments restricted only by Tax or Labor Code law. So you may find it easier to remember like this: it’s called checkbook control because you get to control your investments yourself. Self-directed 401(k)s come with Checkbook Control usually, but you want to be sure. A plan without checkbook control would be extremely limited. Note that you can also get this feature on other types of accounts like the self-directed IRA and its Roth version.

FAQ #3: How Do I Use My Real Estate Business for Solo 401(k) Eligibility?

Here’s the hack we’ve been teasing. You really can structure your real estate business accounts to justify Solo 401(k) eligibility. Remember, the accounts for businesses with sole owners. If that’s not how your REI assets are currently structured, it’s surprisingly easy to do. Most investors with LLCs or unused Series are able to tweak these structures, or you can create an entirely new business with an attorney’s help to ensure you’re complying with the requirements.

But yes, it’s possible to arrange your REI assets and flow of income from these investments to qualify for a Solo-K. And we haven’t even gotten into the details of how you make even more money for your portfolio by using your Solo 401(k) to make real estate investments, but this dream’s real too.

Now, this trick won’t work if, say, you need to own a corporation for your business or MUST have full-time employees (see our piece on eligibility if you’re unclear why: it’s one of the two main criteria). But for those without such complications, the Solo-K can be the easiest qualified retirement plan to form as well as one with the most perks just for REIs.

FAQ #4: How Much Can I Contribute to My Solo 401(k), and Can I Exceed These Limits?

As of 2019, the time of this writing, contribution maxes are higher than ever. Savers under 50 years old can contribute $56,000 for the year. Those above 50 may make an additional $6,000 in catch-up contributions or a total of $62,000 for Tax Year 2019.

You generally can’t go beyond the limits because there are provisions for catch-ups, which the Taxman sees as a “good reason” to let someone stash an extra 6k (for now). That person 51 or older is nearing the end of their career and gets to squirrel away some more. The spirit of the catchup contribution is also to help those folks who didn’t start saving early enough: they may be earning more and can “catch up” at the end of their working lives. We encourage everyone to start saving as young as possible and make sure our top ten retirement savings tips for any age are free to you.

Just to compare the Solo-K to its more common employer-sponsored sister, the Solo-K tops the Traditional in terms of your contribution abilities. For Tax Year 2019, a Traditional 401(k) account’s contribution limits sit firmly at $19,000 for savers under fifty. Those 51 and over get the wiggle room for catch-ups just like the Solo-K holder. That’s nearly ⅓ of the Solo-K’s capacity, and remember that’s an annual figure. A Solo-K alone can hold enough for most of us to retire with everything we need if not in style.

You may have noticed we’re hung up on the year, but that isn’t because maximums go up automatically or anything. They may not change at all, but if they’re going to, it will be for the new tax year. Maximum contributions for the 401(k) tend to rise over time in fairly small increments of $5,000-$6,500 (though that’s still way higher than limits for IRAs or their increased amounts). All retirement savers can remember these rules update annually and make a habit of checking for the “new” numbers around the first of the year. That way, you can save all year long, squeezing every ounce of power out of that Solo-K.

FAQ #5: Should I Max Out Solo 401(k) Contributions? Can I Max Out More Than One Retirement Plan?

We encourage retirement planners to max out their plans when possible. Whether it’s possible for you depends on your other expenses and personal details. Maxing out isn’t necessarily in everyone’s best interest, but it is best to max out contributions to any accounts you can afford to. A retirement penny saved can turn into a retirement dollar earned when you fully leverage every fraction of that cent with a Solo 401(k).

And if you have multiple accounts? You may indeed max them all out. We have some investors who just pick the order of importance in case they ever need to scale back savings, too. For example “If there’s an emergency, I’ll prioritize my Solo-K, then my self-directed Roth IRA, than my Traditional IRA, then my spouse’s plans.” We do recommend coming up with emergency plans of this kind just in case.

Heck, even if you need to scale savings down for a month or two because of a real deal crisis, at least you’ll know your plan and not compromise the diversified portfolio if you know which accounts are most beneficial. In the example, the accounts were prioritized in order of freedom and max contribution amounts, so feel free to borrow that template for your own use.

The self-directed, or solo 401(k)—or what the IRS calls a one-participant 401(k)—isn’t all that different from a "regular" 401(k) on paper.

Its name actually derives from the fact that it is a “one participant" retirement plan. But solo 401(k)s offer a whole new level of freedom as far as investing your retirement dollars goes. The seasoned investor can use their knowledge to get an edge. He or she may develop a diverse retirement portfolio that includes nontraditional assets, including real estate.

Our clients love the solo 401(k) for many reasons, but these are some of our favorites.

Sweet Freedom: Invest Where Your Expertise Lies

The solo 401(k) with checkbook control has the ability to break free of the world of traditional investing. You can diversify your retirement dollars across almost anything when you use this type of account. In fact, the IRS only prohibits three specific types of investments:

1. S-Corporation Stock
2. Collectibles
3. Life insurance policies

Beyond these three things, the sky’s the limit. So you’ll have to find another place to stash your classic cars (may we recommend an asset-holding structure such as the series LLC?). But aside from these three off-limits categories, that leaves literally everything else on the planet that one can invest in.

So if you’re a commodities or crypto genius, maybe this is the plan for you. You can invest in these nontraditional assets only with self-directed accounts. The checkbook control feature of such plans gives you this liberty.

The fact that you can invest in real estate with a solo 401(k) is a major draw of this self-directed account for our real estate investor clients. Whether you’re just starting out or have been in the game for a long time, many investors and entrepreneurs who are solo 401(k) eligible use the plan to make real estate investments.

Here’s an educational resource you can use to learn more about the benefit of buying real estate with a self-directed 401(k).

The Solo 401(k)’s Tax Benefits: Just The Highlights

There are a host of benefits exclusive to the 401(k), and tax perks make up the bulk of them. Savvy investors can use their knowledge of the plans tax benefits to purchase tax-advantaged real estate, defer income.

• Deferred income benefits. Your solo 401(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. 
• Access for self-employed people. Prior to one-participant accounts, self-employed people didn’t have many options for retirement savings at all.
• Viable for real estate business profit savings
• Capital gains deferrals. Prohibited transaction penalties are something to look out for. 
• Tax benefits for contributions. There are many possible ways the solo 401k can reduce your taxable income, but you’re also eligible for other perks like the easy Savers Credit. Learn more about how you can save on your self-directed 401(k) come Tax Season.

Savings Benefits: Sky High Contribution Limits

Unlike the self-directed IRA, the solo 401(k) has remarkably high contribution limits. While at the time of this writing IRA contributions max out at $5,500 (or $6,500 for workers at the eligible age for catch-up contributions), you can contribute up $60,000 to your solo 401(k) if you’re under fifty. If you’re over, you get an extra $6,000 allowance for catch-up contributions.

Flexible Lending Options

While 401(k) and asset protection experts may debate the wisdom of taking advantage of this feature, you can indeed borrow up to 50% of your 401(k) for essentially any reason. Many real estate investors use this perk as a way to finance their investments.

The reason actually borrowing from your 401(k) is a dice-roll is if you do make a bad deal, your retirement account is what really suffers. Recovering isn’t always easy, and real estate investors can mismanage funds by say, over-investing in a single property, neglecting due diligence with their 401(k) investments, or failing to request the proper professional help before making moves with their plans. Don’t be one of them.

The smart investor, on the other hand, can use this feature for a tax-friendly, easy loan: the self-directed 401(k) loan. Applied wisely, it can multiply your funds. The outcome really depends on your investing ability, which is both a blessing and a curse with self-directed investing. But hey, that’s the price of freedom.