A Self-Directed Solo 401(k) plan is a fantastic way to save for your retirement future.  With a self-directed plan you can protect and grow your nest egg with a wide variety of investment types like real estate, venture capital, and cryptocurrency.  You also can build your tax-sheltered retirement savings more quickly than with an IRA thanks to the generous contribution limits that 401(k) plans offer.

Many investors qualify for this powerful tool, but do not realize that they do.

A common misconception is that you can only participate in one 401(k) plan.  Well, that just is not true.

If you have more than one job with different employers, then you can participate in the 401(k) – or similar employer retirement plan – offered by each employer.

That means that if you are an employee of a company that offers a retirement plan, and you are also separately self-employed with your own business, you can setup a Solo 401(k).

Solo 401(k) Qualification

In order to operate a Solo 401(k) plan, you need to have some kind of qualifying self-employment.  You can be a sole proprietor or setup a business like a LLC or corporation.  The format does not matter.  Having a for-profit enterprise that generates earned income is the basic requirement.

Your business also needs to be an owner-only operation.  If you have any full-time employees working more than 1,000 hours per year, then your business cannot sponsor a Solo 401(k).

Some examples of self-employed activities that could potentially sponsor a Solo 401(k) include:

• Real estate agent
• Freelance writer, designer, or technical specialist
• Artist or craftsperson
• Coach or physical trainer
• Consultant
• Umpire or referee
• Contract medical professional
• Independent sales representative
• Driving or delivery

Employee Contribution Limit

401(k) plans allow for generous contributions from both the employee and employer.

While you can potentially participate in more than one 401(k) plan, you can only contribute up to your individual limit.

As of 2022, that means $20,500 for those under age 50 and $27,000 for those age 50 or older.

Your contributions can be to one plan or both.

Employer Contributions are Independent

While your maximum overall contribution is limited across the plans your participate in, the same is not true of employer contributions.

Your business can make the maximum profit-sharing contribution available based on your business income, regardless of whether your other employer may also be making profit-sharing or matching contributions.

Source of Contributions

Contributions to your own Solo 401(k) must come from your business that sponsors the plan.

If you make $15,000 per year with your side gig and $150,000 in your day job, you can only look to the $15,000 of self-employment earnings to source contributions to your Solo 401(k).

Where to Contribute?

Where to put your contributions merits consideration.

If your employer makes matching contributions, you probably want to contribute at least to the matching threshold.  Having someone else contribute to your plan is basically 100% free ROI on every dollar they add.

On the other hand, if investment flexibility is more important to you than the matching amount, you may want to shift more of your contributions to your own self-directed plan.

Future Rollovers

If you ever change your primary job, the 401(k) associated with that employer becomes available for rollover.  That means you can then move some or all of that money to your Solo 401(k).

When Having your Own Solo 401(k) Makes Sense

If your main goal is simply to diversify a portion of your existing retirement savings and you have a high contribution 401(k) with your primary employer, then a self-directed IRA is a perfectly good solution.

Following are a few cases where a Solo 401(k) may provide an advantage.

Boost Your Savings Level

Maybe you are early in your career and want to get a jump start on building tax-sheltered savings.  Perhaps you need to rebound from a less than optimal start or a hiccup along the way.

If you can put an extra $10,000, $20,000, or more into your Solo 401(k) while also contributing to an employer plan, that can make a big difference.

Tax Reduction

Tax-deferred contributions to your Solo 401(k) reduce your tax burden.  If you would rather use your side income to grow your savings than pay more taxes, the Solo 401(k) is the right tool for the job.

Avoid UDFI on Leveraged Real Estate Investments

If one of your investment goals is debt-financed real estate, then the Solo 401(k) has a distinct advantage over a self-directed IRA.

An IRA is taxed on the portion of the gains that it receives based on the borrowed money in a mortgaged rental property or leveraged multifamily syndication.

While the tax an IRA will pay is generally not too bad, paying no tax is always better.

A Solo 401(k) is exempt from taxation on Unrelated Debt-Financed Income when the debt is used for the acquisition of real property.

Don’t Force It

While a Solo 401(k) can have many advantages, there are situations where it may not be the best choice.

If you cease being self-employed, then you no longer have an employer capable of sponsoring your Solo 401(k).  That usually means rolling over your Solo 401(k) and any investments in the plan to a self-directed IRA.

If you have a legitimate side business that is something you intend to do for many years, then a Solo 401(k) can work very well for you.

If you are creating some form of self-employment just because you really want to have the Solo 401(k), you may regret that decision a few years down the road.

What that means is don’t setup a side gig just so you can avoid UDFI taxation on a single syndication deal.  You’ll probably spend more time, energy, and money maintaining the business than your plan will save in taxes as compared to making that same investment with an IRA.