When to Open Your Solo 401(k) to Maximize Tax Benefits
A self-directed Solo 401(k) is one of the best retirement plan options for independent entrepreneurs.
With a self-directed Solo 401(k), you can invest in anything the IRS rules allow for, including real estate, venture capital, cryptocurrency and more. Being able to invest in what you know is a game changer when it comes to protecting and growing your nest egg.
But where a Solo 401(k) really stands out is when it comes to contributing to your plan. A Solo 401(k) allows you to supercharge your retirement savings by setting aside up to $61,000 per year if you are under age 50, and $67,000 if you are age 50 or older (as of 2022).
If you are considering establishing a new Solo 401(k) plan for your business, paying attention to the calendar can be important. For some investors, there is a big benefit to having a plan setup sooner rather than later.
How are you Compensated?
All 401(k) contributions must come from compensation received from the employer. There are two types of compensation, depending on the business format.
In a sole proprietorship, LLC, or partnership, it is most common for income from the business to be classified as “pass through” to the owner. This means that all net income from the business is considered income to the owner(s) of the business.
In a S-Corporation, C-Corporation, or an LLC that has taken a “corporate tax” election, all income does not pass through to the owner as compensation. As an employee of your own business in this scenario, you will receive W-2 wages. Some income can be classified as shareholder distributions and therefore not subject to payroll taxes for Social Security and Medicare. Only the W-2 wages are considered compensation for purposes of 401(k) contributions.
The formulas for determining your potential 401(k) contributions depend on how your compensation is defined.
Two Types of Contributions
Solo 401(k) plans allow for contributions from the employee and the employer. If you have an owner-only business, you are considered the employee of your business for purposes of 401(k) contributions.
Employee Contributions
As the employee, you can contribute up to the individual limit based on your compensation from your business. As of 2022, the limit is $20,500 for individuals under age 50. Savers who are age 50 or older can add a “catch up” contribution of $6,500, bringing the total to $27,000.
For a business owner in a pass-through entity, compensation is the net income of the business. For someone with a corporate tax structure W-2 wages are the compensation that can be used.
You can contribute 100% of compensation up to the individual limit.
Employer Contributions
Your business can also make a profit-sharing contribution to the plan.
In a W-2 compensation environment, an employer contribution of up to 25% of wages is allowed.
In a pass-through environment, the calculation is more complex. The maximum allowed is 20% of allowable compensation, which is net business income less 50% of your self-employment taxes.
Solo 401(k) Plan Establishment Deadline
Prior to passage of the SECURE Act in 2019, a Solo 401(k) had to be adopted on or before December 31st to be able to accept contributions for that year.
The SECURE Act extended this deadline to the tax-filing date of the business, including extensions.
But here is the big caveat. A plan established in the year after the taxable year can only accept employer contributions for the prior year.
If you establish a new Solo 401(k) between January 1st and your tax filing date, you cannot make employee contributions for the prior year. That can dramatically reduce the amount you are able to set aside into your plan.
Eligible Compensation
Even if you setup your plan before December 31st, your ability to make contributions may be limited depending on your business’s tax structure.
Employer profit sharing contributions can look to all income received since the beginning of the plan year. So, even if you setup your plan in December, you can make an employer contribution based on all your income for the year.
That is not the case with all employee contributions, however.
In a sole proprietorship / pass-through environment, you do not have “payroll”, per se. You get paid when you file your tax return and determine your income for the year. As such, you can look at the entire tax year back to January 1st when calculating your compensation for purposes of employee contributions.
If you pay yourself a W-2, timing matters. Employee contributions are linked to payroll processing and must be made within about 7 days from the end of a pay period. As such, you can only contribute based on wages received after your plan is setup, and must make your final year-end payroll contribution by about January 7th.
If you setup your plan on December 1st, you can only make employee contributions based on your wages received after that date. Some people setting up a plan late in the year may choose to pay themselves a year-end bonus to allow for a larger plan contribution.
The Bottom Line
If you are a sole proprietor, there are advantages to having your plan setup by December 31st. You can make full employee and employer contributions for the year of plan establishment and can do so up until your business tax filing date, including extensions.
If you have a corporation and pay yourself a W-2 wage, timing is more critical.
You can make a full employer profit sharing contribution for the year, whether you setup your plan in the current year or by your business tax filing date.
Employee contributions can only be made based on wages received after the plan is established, and must be made by about January 7th. Establishing your plan in advance of year end will give you more of an opportunity to contribute for the current year.
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Quick answers to common questions
We’ll take you through a simple, step by step process designed to put your investment future into your own hands…immediately. Everything is handled on a turn-key basis. You take 100% control of your Retirement funds legally and without a taxable distribution.
YES! In 1974, Congress passed the Employee Retirement Income Security Act (ERISA) making IRA, 401(k) and other retirement plans possible. Only two types of investments are excluded under ERISA and IRS Codes: Life Insurance Contracts and Collectibles (art, jewelry, etc.). Everything else is fair game. IRS CodeSec. 401 IRC 408(a) (3)
It’s actually pretty simple. Early on, regulators let the securities industry take the lead in educating the public about retirement accounts. Naturally, brokers and banks promoted stocks, bonds, and mutual funds—giving the impression that those were the only allowed investments. That was never true... and still isn’t. You can probably guess why they kept the rest under wraps.
It is possible to use funds from most types of retirement accounts:
- Traditional IRA
- Roth IRA
- SEP IRA
- SIMPLE IRA
- Keogh
- 401(k)
- 403(b)
- Profit Sharing Plans
- Qualified Annuities
- Money Purchase Plans
- and many more.
It must be noted that most employer sponsored plans such as a 401(k) will not allow you to roll youraccount into a new Self-Directed IRA plan while you are still employed. However, some employers will allow you to roll a portion of your funds. The only way to be completely sure whether your funds are eligible for a rollover is by contacting your current 401(k) provider.
A Solo 401(k) requires a sponsoring employer in the format of an owner-only business. If you have a for-profit business activity – whether as your main income or as a side venture – and have no full-time employees other than potentially your spouse, your business may qualify. The business may be a sole-proprietorship, LLC, corporation or other entity type.
A self-directed retirement plan is a type of IRA or 401(k) that gives you greater control over how your retirement funds are invested. Unlike traditional accounts held at banks or brokerage firms that limit you to stocks, bonds, and mutual funds, self-directed plans allow you to invest in a wide range of alternative assets including real estate, private businesses, precious metals, cryptocurrency, and more.
These plans still follow the same IRS rules and maintain the same tax-deferred or tax-free benefits as conventional retirement accounts. The difference is simply in how and where you choose to invest.
No. Moving to a self-directed IRA or Solo 401(k) does not trigger any taxes, as long as your funds are eligible for rollover.
Self-directed retirement plans maintain the same tax-advantaged status as traditional plans offered by banks or brokerage firms. The key difference is flexibility—our plans are designed to give you greater control and allow for a wider range of alternative investments beyond stocks, bonds, and mutual funds.
A prohibited transaction is any action between your retirement plan and a disqualified person that violates IRS rules and can lead to serious tax consequences. Under IRS Code 4975(c)(1), prohibited transactions include:
- Selling or leasing property between your plan and a disqualified person Example: Your IRA cannot purchase a property you already own.
- Lending money or extending credit between the plan and a disqualified person Example: You cannot personally guarantee a loan your IRA uses to buy real estate.
- Providing goods or services between your plan and a disqualified person Example: You can’t use your personal furniture to furnish a rental property owned by your IRA.
- Using plan income or assets for the benefit of a disqualified person Example: Your IRA cannot buy a vacation home that you or your family use.
- Self-dealing by a fiduciary (using plan assets for their own benefit) Example: Your CPA shouldn't loan your IRA money if they’re advising the plan.
- Receiving personal benefit from a deal involving your IRA's assets Example: You can’t pay yourself from profits your IRA earns on a rental.
If a transaction doesn’t clearly fall within the allowed guidelines, the IRS or Department of Labor may review the situation to determine if it qualifies as a prohibited transaction.
Disqualified persons are individuals or entities that are prohibited from engaging in certain transactions with your IRA or 401(k). Doing so could trigger a prohibited transaction, which may result in taxes and penalties.
Here’s who is considered a disqualified person:
- You (the account holder)
- Your spouse
- Your parents, grandparents, and other ancestors
- Your children, grandchildren, and their spouses
- Any advisor or fiduciary to the plan
- Any business or entity owned 50% or more by you or another disqualified person, or where you have decision-making authority
These rules exist to prevent self-dealing and ensure your retirement plan remains in compliance with IRS regulations.
(Reference: IRC 4975)
Understanding and following these rules can be tricky, but it’s very doable. The best way to stay compliant is to work with professionals who specialize in self-directed retirement plans. They can help you navigate IRS guidelines and avoid prohibited transactions.
If an IRA holder is found to have engaged in a prohibited transaction with IRA funds, it will result in a distribution of the IRA. The taxes and penalties are severe and are applicable to all of the IRA’s assets on the first day of the year in which the prohibited transaction occurred.
Yes. While self-directed retirement plans allow for a wide range of investments, there are a few important restrictions.
You cannot invest in collectibles or life insurance contracts, and you must avoid prohibited transactions—activities that benefit you personally rather than the retirement plan. These include things like buying or selling property to yourself or family members, using plan assets for personal gain, or self-dealing in any way.
Violating these rules could cause your entire IRA to lose its tax-advantaged status. To protect your account, it’s essential to work with professionals who understand IRS regulations and can help you stay compliant.
This is a common misconception. In many cases, professionals may simply be unfamiliar with self-directed retirement plans, as they fall outside their usual scope of work. CPAs and tax preparers are trained to file taxes, not necessarily to advise on alternative retirement strategies. Financial advisors and brokers often work for firms that focus on traditional investments like stocks and mutual funds—and may not benefit from or support alternative options like real estate or private lending.
Self-directed retirement investing is legal under IRS rules—but like any specialized area, it requires working with professionals who understand how it works.
The IRS has rules in place to make sure your IRA is used only for the exclusive benefit of the retirement account—not for personal gain or to help family members. These rules can get complicated because there are many ways a conflict of interest can occur, even unintentionally.
For example, if your IRA buys a house and rents it to your mother, you might be reluctant to evict her if she stops paying rent. That emotional connection creates a conflict between what’s best for your IRA and your personal relationships, something the IRS aims to prevent.
These rules help ensure your retirement account stays compliant and protected. (See IRC 408)
Yes. Most tax-deferred retirement accounts—such as Traditional IRAs, old 401(k)s, 403(b)s, and TSPs—can be rolled over into a self-directed IRA or Solo 401(k), depending on your eligibility. Roth IRAs cannot be rolled into these accounts.
You can contribute directly from earned income, subject to annual IRS contribution limits. The method and amount depend on the type of plan you have (e.g., Solo 401(k) vs. IRA).
To take a distribution, you'll request funds through your custodian or plan administrator. Distributions may be taxable depending on your account type and age. Early withdrawals may be subject to penalties.
For 2025, the Solo 401(k) max contribution limit is $81,250 if age 60-63, $77,500 if age 50-59 or 69+, and $70,000 if under 50. Traditional and Roth IRAs have a limit of $7,000 ($8,000 if age 50+). Limits are subject to IRS adjustments.
Yes. IRA contributions are typically due by your personal tax filing deadline (e.g., April 15). Solo 401(k) contributions follow your business tax filing deadline, including extensions.
IRS reporting requirements vary depending on the type of self-directed retirement plan you have. Here’s a quick breakdown of what you need to know
Please note: Our team can help you understand what’s required for your specific account, but we don’t provide tax or legal advice. We always recommend working with a qualified tax professional to ensure full IRS compliance.
Self-Directed IRA (Traditional or Roth)
- Form 5498 – Filed by your custodian each year to report contributions, rollovers, and the fair market value (FMV) of your account.
- Form 1099-R – Issued if you take a distribution or move funds out of your IRA.
- Annual Valuation – You'll need to provide updated FMV for any alternative assets held in the account, such as real estate or private placements.
Solo 401(k)
- Form 5500-EZ – Required if your plan assets exceed $250,000 as of year-end. Must be filed annually by the plan participant.
- Form 1099-R – Required if you take a distribution or roll funds out of the plan.
- Contribution Tracking – Keep records of employee and employer contributions. These are not filed with the IRS but may be needed for tax reporting or audits.
SEP IRA
- Form 5498 – Filed by your custodian to report contributions and FMV.
- Form 1099-R – Filed by your custodian. Issued for any distributions.
- Employer Contributions – Must be reported on your business tax return (and on employee W-2s, if applicable).
Health Savings Account (HSA)
- Form 5498-SA – Filed by your HSA custodian to report contributions.
- Form 1099-SA – Filed by your HAS custodian. Issued for any distributions.
- Form 8889 – Must be included with your personal tax return to report contributions, distributions, and how funds were used.
