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.