Starting a Solo 401(k): The Solo(K) Series Continues

This is part 2 of The Solo 401(k) mini-series. In Part 1, I discussed the many benefits of a solo 401(k) and the necessary conditions for opening one. So now you’re convinced you need to open one. Here are answers to some common questions you might have about starting a solo 401(k).

What about the SEP-IRA?

Before you decide on starting a solo 401(K), let’s discuss another retirement account.

You may have heard about the SEP-IRA (or just SEP) as another retirement account option for the very small business. The SEP-IRA has the same contribution limits as the solo-K, but contributions are made by the employER only. Additionally, SEP-IRAs do not allow for Roth contributions.

While you can contribute the same amount to a SEP as you can to a solo-K, having a SEP-IRA (since it is a pre-tax IRA) will prevent you from contributing, tax free, to a backdoor Roth IRA.

So, why would you open a SEP-IRA instead of a solo-K?

The main reason is that a SEP can be opened after the calendar year for which it applies. You can wait until your tax due date, including extensions (around October 15th), to open and fund a SEP-IRA.

For example, you have until 10/15/19 (with an extension!) to open and fund a SEP for 2018. (Even if you have already filed your 2017 return and didn’t know this rule, you still have time to amend your return and open a SEP for 2017!)

By contrast, you must open a solo-k by the end of the calendar year it is for. A very minor reason to open a SEP over a solo-K is that the paperwork to open a SEP is simpler. But don’t do it just because you’re lazy!

Contributions to either a Solo-K or a SEP are based on net profits adjusted by FICA taxes (Social Security + Medicare taxes). The contributions to a Solo-K and a SEP are the same if you have already made your $19k employee contribution at work. Otherwise, you can add what remains of your employee contribution, up to $19k/$25k to the maximum Solo-K contribution.

What should I consider before starting a solo 401(k)?

There are a few good solo 401(k) choices with low to no fee plan options. They differ mainly in:

  • Fees: Some are free, some are not.
  • Traditional vs. Roth employee contributions: Not all will offer the Roth option.
  • Rollovers: Not all will accept rollovers from old IRAs, 403(b)s, 401(k)s. This is a deal breaker, in my opinion, since the ability to do this is one of the great reasons to have one.

Thankfully, someone else already did a great and thorough review on the most popular solo-K options.

Where should I open my solo-K?

Here are my top 3 picks:

  • TD Ameritrade: Offers a Roth option. Has a good list of commission-free ETFs including many Vanguard ones. M has his solo-K here and I plan to open one here too.
  • E-trade: Offers a Roth option. Lots of free funds.
  • Fidelity: No Roth option. Lots of free funds and ETFs.

All of these accept rollovers of old IRAs, 401(k)s. Some offer loans (which I don’t recommend ever doing), too.

At this time, I do not recommend opening a solo-K at Vanguard for two main reasons: they do not accept rollovers (deal breaker) and you can only invest in their investor share class funds. These funds have a higher expense ratio than their admiral class fund or ETF equivalents. They also charge a $20 fee per fund in the account annually until you reach a balance of $50K.

Final Thoughts on Starting a Solo 401(k)

For many of us, starting a solo 401(k) is the right money move.

If you’re still not sure, review the impressive benefits of a solo 401(K) and determine if you qualify. But maybe you’re already wanting to get started. Today is the perfect day to create that investment account.

Follow the steps outlined above and then drop us a note below to let us know how the process went. Your future self will thank you for not putting this off any longer!

Do you have a SEP or a solo-K? Are you planning on starting a solo 401(k)? Comment below!]]>

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