The Biggest Misconception Regarding the Solo 401 k Eligibility
To qualify for a self directed Solo 401k plan, you have to be a small business owner or have a self-employed business activity. Many investors mistakenly assume that any LLC is qualified to set up a Solo 401k. This misconception about the Solo K eligibility can lead to tax consequences and even disqualification of the plan.
The Solo K Eligibility Requirements
Although designed for individuals, a Solo 401k plan is still required to be sponsored by a business to offer benefits to the employees of that business. In the case of a Solo 401k, the sole employee is also the owner (and perhaps their spouse).
To address the needs of other individuals who work as independent contractors and freelancers, a Solo 401k can also be set up as long as the person has a self-employed business activity (in other words Solo K can be adopted by sole-proprietors).
LLC with Rental Income Cannot Sponsor a Solo 401k
With the eligibility summarized as above, many investors and even their plan providers mistakenly assume that LLCs that are set up to own rental property can qualify. However, if the LLC only earns profit from rental income, it is not considered an eligible sponsor for the Solo 401k.
The reason is that, rental income cannot be contributed to a retirement account. Rental income is considered passive income and is taxed differently. Rental income is not considered wages, and therefore, is not eligible for contribution.
To qualify as a plan sponsor, a business must be able to pay the employees with wages and earned income that can be contributed to the retirement plan. If the LLC only earns rental income, it does not meet the Solo k eligibility requirement.
Who Can Sponsor a Solo 401k
To set up a self directed Solo 401k, you must have a self-employment income that can be reported on Schedule C. The form of business – whether LLC, corporation, or sole proprietorship – doesn’t matter, as long as your earned income meets this requirement.
Don’t forget that as the Solo 401k is designed for individuals, you cannot have any full time employee. The only eligible plan participants are you and your spouse, if your spouse is also involved in the business.
The Solo 401k offers a lot of benefits to those who qualify. As the plan owner, you can contribute up to $59,000 annually as of 2015. There is a wide variety of investment choices to choose from. You will also have checkbook control, ability to contribute into a Roth portion to invest tax-free and have access to the participant loan option.
To take advantage of these benefits, however, the plan owner must meet all the Solo k eligibility requirements to avoid tax consequences or even the disqualification of the plan. Therefore, review these requirements carefully and consult a professional before setting up your plan.