Choosing the Best Solo 401k

What’s a Solo 401k?

A Solo 401k, officially known as an Individual 401k, is a 401k retirement account available to businesses with no employees (other than the owner or the owner’s spouse). It is the most common retirement used by the self-employed. Of note for someone like me, who runs a very small writing and self-publishing enterprise, you can have more than one 401k account even if you still only have one personal contribution limit. So even though I also have a work-sponsored account with my employer as a radiologist, I finally got around to opening up an individual 401k last year.

Why a Solo 401k?

For someone like my wife, who runs an independent psychiatry private practice, it’s the best/easiest way to fund a retirement account.

But even if you maximize the personal contribution limit (currently $19.5k in 2021) with your work account, having a solo 401k for your side hustle still gives you extra tax-advantaged space by allowing you to contribute ~20% of profits from your business up until the $58k per account annual contribution maximum (in 2021).

So it’s a great option if you’d like more tax-advantaged retirement space for contributions if you make any money outside of an employed position (like any of those places that send you 1099 forms at tax time). Physician surveys, moonlighting, consulting, writing, etc are all common sources.

A solo 401k can also give you a place to roll over old accounts from previous jobs to a new account, making everything easier: fewer accounts to manage, less difficulty rebalancing, and the ability to choose a no-cost provider with access to excellent low-fee funds.

Why not a SEP IRA?

The short answer is that the individual 401k is a newer and better option in almost every way:

Many people are able to put more into the 401k account every year (because the IRA only allows for the employer/profit sharing contribution and not an employee contribution), and the i401k also allows access to the features we’ll talk about below like Roth contributions, 401k loans, and catch-up contributions for those above the age of 50.

The 401k is also often the better choice because it allows you to also take advantage of the Backdoor Roth IRA (see the detailed post on WCI if you need some background). Pre-tax money in another IRA runs afoul of the pro-rata rule, which means using a Simple IRA or SEP IRA prevents you from truly maximizing your tax-advantaged retirement space.

The main benefit of the SEP-IRA is that it can be expanded to make retirement accounts for employees should your business grow in the future.

For someone like me, choosing the Individual 401k is a no-brainer.

Main Individual 401k Providers

There are comparison tables out there that may or may not be up to date, but while all companies get the main task of giving you a place for your money, the main difference between the various companies is in the details of what their plans allow. Things on the table:

  • Roth contributions. All companies allow for traditional pre-tax contributions, but only some permit Roth contributions
  • Rollovers. Some accounts won’t let you roll over old accounts or only permit rollovers from certain account types (like 401ks but not IRAs)
  • 401k loans. You can actually borrow against your own retirement savings. Not something I intend on using but nice to know it’s there.
  • Fees. Most are free to open and maintain and only charge fees for trades (typically $0 for mutual funds and ETFs, meaning that these accounts are essentially free for the passive investor).

So here are the main companies and the relevant information for our purposes. Spoiler alert, I chose E*TRADE and have been pleased so far (no affiliate relationship).

  • Vanguard (Allows Roth contributions but no rollovers or 401k loans. $20 annual fee for each different Vanguard fund in the account until you hold more than $50k with Vanguard, very limited investment offerings; Vanguard is a wonderful company for just about everything except their i401k offering)
  • Fidelity (No Roth. No electronic deposits, must send a paper check–are you kidding me?)
  • TD Ameritrade (Irrelevant, will be merged into Schwab shortly)
  • Charles Schwab (No Roth or 401k loans)
  • E*TRADE (Permits Roth and Traditional pre-tax, accepts rollovers from everywhere, and allows 401k loans)

So after comparing all the plan documents from the major players, only E*TRADE has all of the features that one can ask for from a straight vanilla plan.

My particular needs: I wanted both pre-tax and Roth options, particularly because I wanted an easy way to roll over a combination of after-tax Roth 403(b) accounts and pre-tax employer matches from my internship and residency as well as a random IRA from my residency position (created by the county hospital that had me contributing to a pension that I would ultimately never qualify for). Consolidating accounts from my old employers into a single place where I had full control was something I considered mission-critical to simplify my finances.

The one nice thing that’s missing but isn’t currently relevant to me at this point is the lack of nondeductible after-tax contributions and in-service withdrawals, the combination required to utilize what’s called the Mega Backdoor Roth IRA. Unfortunately, no company lets you do that with a cookie-cutter plan. You would need to get a bespoke plan with a company like mysolo401k in order to enable the mega backdoor.

Also, none of the main free players give you checkbook control, which would allow you to basically use your solo 401k to invest in all sorts of weird one-offs like angel investing or buying real property. I’m pretty firmly in the set-it-and-forget-it passive investment camp when it comes to my retirement savings, so that’s also a nonissue for me (as it is for almost everyone). The most common choice for those who want checkbook control is probably Rocket Dollar (that’s an affiliate link), but that flexibility isn’t free. If one is looking for some extra cash for an investment property down-payment, for example, taking out a 401k loan is probably an easier option.

The Mega Backdoor Roth

I spent a lot of time confirming none of the big players would help you achieve the Mega Backdoor Roth IRA. I even tried to see if I could customize the E*TRADE plan document myself to permit it but no dice.

Ultimately, no current vanilla plan allows for all the factors needed to utilize the Mega Backdoor Roth. In the context of a solo 401k, this only comes into play when the profits of your business aren’t enough to get you to the $58k annual account limit via profit-sharing BUT you do have enough income and extra cash on hand to want to make up the difference (you can only contribute up to the $58k max or 100% of net compensation, whichever is lower). If you’re running an independent private practice or a big business, your profits may be enough to make this moot.

To enable the MBR you’ll need customized plan documents such as what you can get at mysolo401k or Rocket Dollar (the former is cheaper, the latter would earn me some money). Expect to spends hundreds but not thousands per year to have this kind of account.

Perhaps some competition in this space will eventually result in this filtering down to common providers.




Robert 02.15.21 Reply

Since you mentioned you had done some legwork to check in with these “main/large brokerage” solo 401k providers about their ability to do a Mega Backdoor Roth IRA, are you referring specifically to the ability to do it through a solo 401k (via an after-tax, non-Roth contribution with immediate in-plan conversion into a Roth contribution)? Or do you know if your research showed that all of these providers are unable to do it for ANY 401k/403b plan, including employer-sponsored (specifically, the automatic/next day in-plan conversion from an “after-tax non-Roth” account to a “Roth” account)?

From what I’ve been reading, you should be allowed to make up to ~$19k in elective contributions from your paycheck to a Roth 401k/403b, along with up ~$39k (minus any matching contributions) to an after-tax, non-Roth portion of that account. I believe this should be allowed at most providers and with most employers (though I’m sure there are exceptions). The part of the process I think is harder to find is the ability to do automatic or next day in-plan conversions on these contributions, though I have heard that Fidelity does offer to do these automatic conversions as the administrator for at least one employer’s 401k. Thanks for any additional info you have!

Ben 02.15.21 Reply

I’m specifically discussing this with regards to a solo 401k.

Employer-sponsored plans vary in their abilities because each employer will have its own plan documents, but the individual 401k options use standard plan documents that do not allow for voluntary after-tax contributions, which is the first requirement for a Mega Backdoor Roth. They allow only for employee and profit-sharing contributions. So you’ll need a third-party plan to enable it (note that a third-party plan from a service like mysolo401k will amend plan documents from a big provider like Vanguard or E*TRADE, changing the capabilities of said plan).

That said, even most employer plans that allow for after-tax contributions tend not to permit in-plan conversions or in-service distributions, which means that you cannot do a rollover until you leave that job. Because the gains of those after-tax contributions are taxable, the considerable delay results in a significant taxable event. This is still not a bad idea compared to a regular taxable account but doesn’t achieve a functional equivalent to a regular Roth contribution the way the Mega Backdoor does. But this varies by the employer plan documents, not so much the plan provider itself.

Robert 02.15.21

I appreciate the clarification! I wonder if there is a particular reason that employers and their plan documents prohibit voluntary after-tax contributions up to the current $58k? And why they would prohibit in-service distributions to a Roth IRA?

When you mentioned the third party plan from mysolo401k in your comment above, at what point in the process would they amend the plan documents from a big provider (to allow for in-plan conversions)? If you were changing jobs and were trying to roll your old company’s 401k into a solo 401k, or some other situation? I know that you were specifically discussing solo 401ks, but if you are working with mysolo401k, what is the situation where you would have old plan documents from a “big provider” in the first place, if not for rolling over your old employer 401k?

Ben 02.15.21

The simplest answer is that the more things a plan permits the more complex and therefore the more it costs. With regards to the MBR, it’s a relatively recent phenomenon.

When you purchase a plan from a third-party provider, you purchase it right and it happens right then (allowing some time for processing). If you’re trying to simply roll over an old employer account, an out-of-the-box plan like the one I have at the moment would be fine. You wouldn’t need a customized plan.

The situation arises when someone like me who already has an individual 401k at some point down the road decides they want to do an MBR, and in order to do that, they’ll need a plan that permits it.

There are plenty of people who do not make enough money to where they have a meaningful amount extra to contribute to their i401k outside of the employee contribution and profit-sharing. If you earn $30k, for example, then you can contribute ~$25,500 normally. The most you could then contribute via the MBR is $4.5k–which may not be worth it for the hassle even if you didn’t need the cash to actually live on, especially when you consider adding on a regular or backdoor Roth.

The average American is unable or unwilling to maximize their tax-advantaged retirement space, so these techniques to stretch them further like the MBR are for a small minority of enterprising folks.

Steven B 07.06.22 Reply

FYI: Confirmed w/Fidelity that they now *DO ALLOW WIRES* into a Self-Employed 401(k). One wire for employer contribution and another for the employee. There’s some trickery re coding the wires, but it is possible.

PYP contribution for prior year
CYP current year employee
KCT current year for employer

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