Opening and Managing a Self-Employed Individual / Solo 401(k)

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So, you’ve decided that you want to open up a self-employed retirement plan for your small business. Next, you spent hours pouring over all of the information you could find from the Internet, personal finance blogs, your accountant, your friends/family, and the IRS (whose information is put together in a coded format that is seemingly more cryptic than a 2000 year old extinct civilization for some reason or another) over the various self-employed retirement plans such as a SEP IRA, SIMPLE IRA, and Individual 401(k).


And, after all of that, you came to the conclusion that an individual / solo 401(k) is the option that is best suited for your needs. 


This was my conclusion as well, after having done the legwork of deciding which self-employed retirement plan was right for me. After coming to the conclusion that I wanted to open up an individual 401(k), I figured that the actual opening process would be a breeze. After all, I’ve opened many online savings, checking, and IRA accounts in the past several years, and it usually only takes about 10 minutes each go-round!

However, what I found was that there was a significant lack of clear, no-nonsense information on the Internet regarding what I actually needed to do to physically or electronically open an individual 401(k). As such, the purpose of this post is to guide you through the individual 401(k) account opening process, using my experiences as a basis for helping you move forward with opening your account.

Before we get started, I would like to commend you for having made it this far in the self-employed retirement account decision making process. As confusing as the account opening process can be, I do have to conclude that actually deciding which self-employed plan to choose in the first place is much harder than the steps needed to open an account. So, pat yourself on the back!

Step 1 – Decide What Provider You’ll Use for Your Self-Employed Individual 401(k)

Naturally, a logical place to start setting up your new individual 401(k) account is deciding what company/brokerage/investing house will serve as the “home” for your plan. This is a very important decision, and you’ll want to make sure that the investing house you choose to hold your 401(k) is 1) a reputable name and 2) offers the types of investing instruments you prefer.

Personally, as a passive investor, I believe that 95% of business owners are best off placing their retirement funds in low-cost index mutual funds or ETFs. My two favorite investing houses for this application are Fidelity and Vanguard. For me personally, Vanguard was the natural choice since I had compared Vanguard vs. Fidelity previously, and had came to the conclusion that Vanguard offered lower-cost mutual funds and ETFs.

However, you should choose an investing house that you are comfortable with. Surprisingly, it’s very difficult to determine from the normal “individual investors” page that first shows up on most brokerage websites whether or not they offer self-employed retirement plans. As such, the best way to find the self-employed plans that a brokerage offers (if any) is to do a Google search for “PLACE NAME OF BROKERAGE HERE small business.” For example, I had trouble finding the listing of self-employed plans on the Schwab.com and T Rowe Price websites, but I very quickly found the relevant sites listed below when I performed the Google search.

Schwab.com – Small Business
T Rowe Price – Small Business

Step 2 – Download the New Individual 401(k) Account Application Form

After deciding upon an investing house in which you want to place your individual 401(k) retirement funds, it’s time to get started filling out the actual opening application form.

It is my understanding that unlike regular individual IRA’s, taxable investing/stock trading accounts, and online savings accounts, individual 401(k) account application forms CANNOT (unfortunately) be filled out and submitted online. Thus, you must locate and download a copy of the account application on to your computer.


Note: Once you download the application, don’t automatically just print out the entire document. See below for more details.

The individual 401(k) account application download link generally is found on the same page that gives a description of the retirement plan. For example, the link (listed below) to download the account application form for Vanguard can be found on the individual 401(k) account description page. Generally, there will be two account applications – one for employees, and one for employers. Since you’re the business owner and are setting up the plan, you’ll want to fill out the one for employers. If you decide to add your spouse to the plan at a later date, you’d download the employee application.


Vanguard.com – Individual 401(k) Account Application

Step 3 – Locate the Summary of Instructions for Filling Out the Application and Apply for an Employer Identification Number (EIN) Online

In these instructions, one key thing to notice is that generally, in order to open a self-employed individual 401(k), you cannot simply use your Social Security Number for identification purposes. Instead, you have to either have or newly obtain what’s called an Employer Identification Number, or EIN. Essentially, this number serves as an identifier for your business with the IRS, much like a Social Security Number does for a normal employee.

If you already have an EIN, great! If not, you need to get one before you even think about proceeding with filling out individual 401(k) account application. I’ve listed some guidelines below for how to go about getting an EIN.

  • First, read this web page from the IRS that documents what an EIN is, why you need one, and the responsibilities that come with having this identifier.
  • Then, click here to visit the IRS’s online EIN application service for obtaining an EIN.
  • When you are filling out the EIN application (either online or on the phone), be prepared to provide the following information about your business:
    • 1) What will the business’ legal name be for tax purposes? This may seem straight-forward, but I actually hadn’t thought about this before calling the IRS to obtain an EIN. Ultimately, I decided to simply keep the legal entity name as my name, since with my business, I could possibly be offering multiple services under the same tax-reporting entity.
    • 2) What date do you want to set as when your EIN will go in to effect? They will also ask you what you want to set as the effective date for when your business started. For this, I simply used January 1st of the year when I first started earning income from my self-employed business.
    • 3) What legal address do you want to set up for your business? Here, you have the option of designating what address you want to have linked up for reporting purposes to your EIN. You’ll need to decide if you want to set this as your home address, office address, P.O. box, or a small-business mailbox at a UPS or Fedex shipping center.
    • 4) Do you want your EIN to be set up for your business in general, or just for your self-employed retirement plan? Yet another thing that I didn’t know about before obtaining an EIN myself was that EINs can be set up for a range of entities. For example, you can choose to have the EIN set up only as an identifier for your self employed retirement plan, or, you can choose to have it represent your business from a more general tax-reporting standpoint. Personally, I choose to have my EIN be linked to my business in general, not just as an identifier for my retirement plan, since I’d want to use it to report self-employed income on the 1040 Schedule C.
    • It’s important to be careful in choosing the details selected above, as these exact elections will need to be used when reporting your taxes from self-employed business operations. 


Note: If your business is set up as a sole-proprietorship (like mine is) and you have already requested/obtained an EIN for a previous business, you’ll obtain an error from the online system since an EIN will already be linked to your Social Security Number. If this happens, simply call up the IRS’s EIN hot line and obtain an EIN that way. The calling process only took me about 20 minutes, and I received an EIN that was activated immediately, so it wasn’t too painful of an ordeal by any means.


Step 4 – Determine If You Can Legally Avoid the Annual Account Maintenance Fee

After obtaining your EIN, you are armed with all of the information you need to fill out the account application. Nice work! However, by now, you’ve probably noticed that most of these self-employed retirement plans involve a yearly fee in order to keep your account open and in good standing. This is a fee in addition to the normal expense ratios carried by the individual investing instruments you choose for your account. For example, Vanguard charges a $20 annual account maintenance fee for self-employed retirement plans.

However, the good news is is that the brokerage houses often provide ways to get out of paying this annual fee. For example, you can often qualify to be “excused” from this fee if you meet one of the following criteria:

  • You have had an individual account with the investing house for X number of years.
  • Your individual (not self-employed retirement accounts) accounts have a balance of greater than $50,000-$100,000.
  • You sign up to receive electronic account documents, saving the investing house the cost of sending you these documents via hard-copy in the mail.
The specific criteria required by each investing company will be different, and these specifications can be found in the “fine print” on the individual 401(k) description page.
If you do meet any of the criteria for getting out of paying the annual fee, I would recommend typing up a very brief note explaining EXACTLY AND DIRECTLY why you qualify for being excused from the fee to mail in with your account application. This is what I did when I mailed my account application in to Vanguard (I met the account balance minimum they required for waiving the annual fee).


Step 5 – Discard Overwhelming Amount of Excess Paperwork Included in Individual 401(k) Account Application

As I mentioned briefly in Step 3 above, once you download the account application, your system will almost go in to shock upon noticing that the entire application is something crazy like 104 pages!

However, the good news is is that only about the first 20 pages or so of the application actually are required for you to fill out.


The remaining 80-90 pages contain page…after-page……after-page…..after-page……of tax code amendments, self-employed retirement plan rights, and plan descriptions that your brokerage is required by law to provide to you. They mention (only officially because they are required by law to do so) that you need to “read the entire packet.” However, I did NOT find that to be necessary one bit. Instead, what I did was flip through the 80 extra pages once and then narrowed my focus to the first 20 pages that matter.

Step 6 – Fill Out ONLY The Sections of the Account Application That The Instructions Explicitly Ask You For

Having narrowed your focus to the areas of the account application that actually matter, you’ll want to again locate the account application instructions. These generally can be found on the first two pages.

Once you locate the instructions, simply follow what they instruct you to do to complete your application. The account applications for Vanguard’s individual 401(k) that I had to follow are listed below:

  • Fill out Individual 401(k) Plan Adoption Agreement
    • Essentially, the purpose of this section of the account application is to say, “Hey, I am a legitimate self-employed small business, and I would like to open an account with your brokerage.”
    • Filling out this section requires you to provide the following types of information:
      • Adopting employer name (name you chose when getting an EIN).
      • Address.
      • Employer Identification Number (EIN). A Social Security Number CANNOT be used.
      • Legal business structure (partnership, sole-proprietorship, etc).
      • Name of plan.
      • Effective date of plan
      • Attachment A – Vanguard is legally obligated to provide each plan adopter with an Attachment A that allows for space in which you can claim any additional provisions or account benefit protections. However, if you are not a tax-professional, do yourself a favor and throw this page away. If it is sent in with your application, it will not be accepted. 
  • Fill out Individual 401(k) Plan Authorization Form
    • The purpose of this form is to designate WHO within your organization has the power to administrate the plan, access private banking and account information, and who can contact Vanguard on behalf of your retirement plan.
    • This section is somewhat confusing because for many common-folk self-employed business owners (such as you and I), it’s not entirely clear whether you have the power to be this all-mighty “plan administrator.”
    • However, this is exactly what is appropriate to do! Place your name (as the business owner) as the plan administrator. You have the absolute power! haha
  • Fill out Individual 401(k) New Account Form for Each New Plan Participant (Only You, if You Are the Only One in Your Small Business)
    • Having filled out the two forms above to request to set up your plan and designate who can administrate it, it is now time to open the sub-accounts within the plan for all employees.
    • For the most part, people reading this will probably be single-person run business (or maybe run a business along with their spouse). If this is the case, you’ll just fill out one New Account Form to open up your “employee” sub-account in the self-employed retirement plan.
    • Remember: In an individual 401(k) as the sole business owner, you have the ability to contribute to retirement both as your sole-employee and also as the employer. It’s quite a nice set up for achieving tax benefits!
    • To fill out this section of the application, it’s good to have the mindset that you will remove your business owner “hat” for a moment and place back on your employee “hat.”
    • The following information is needed to fill out this section of the form:
      • Name, address, Social Security Number, etc.
      • Which mutual fund you want to invest in and what amount (you’ll actually link up your bank account and fund the account later on once your online profile is established in the Vanguard system).
      • Primary and secondary beneficiaries.

Step 7 – Mail In Account Application and Wait

After filling out the three sections of the application discussed above, simply mail the forms in to the mailing address provided multiple times throughout the application. In about 10 days or so, you’ll receive an email from Vanguard saying that they’ve received your application.

 

Funding and Managing Your New Individual 401(k) Account

In this same email you’ll receive from Vanguard after the 10 day waiting period, there will also be a link that you can click to go to Vanguard Small Business Section of their website where you’ll set up your Individual 401(k) administration account.

Setting up Your Individual 401(k) Small Business Account


Setting up your 401(k) account in the Vanguard Small Business system is not completely straight-forward.

For example, if you already have a Vanguard Individual account(s), you will be unable to use the same user name and password that you used for your Individual sign-on with your Small Business Account. Additionally, you’ll be unable to view your Individual Vanguard holdings from your Small Business account profile. In most cases, you actually have to sign out, clear your browser cookies, and then log-in to the Individual Vanguard page in order to view your personal holdings.


Funding Your Individual 401(k) and Viewing Your Account Positions


Funding your 401(k) and viewing your investment positions is also not entirely straight-forward.

In order to fund your Individual 401(k) either with employer contribution or employee-salary deferral funds, this action must be done while logged in to your Vanguard Small Business administration interface. The process of selecting the investment you want is much like using the normal individual Vanguard interface.

However, once the money is taken from your bank account and the mutual fund is purchased, you are only able to view the overall account balances from your Vanguard Small Business interface. In order to actually see what mutual funds you are holding and the value they possess, you must be logged in to your normal Individual account. This makes it sort of a pain to manage multiple accounts. However, it is set up this way with larger companies in mind in order to protect the privacy of the individual employees and what investments they are holding.


How about you all? Have you ever opened an Individual 401(k) account or another type of self-employed retirement plan? If so, where did you choose to invest the funds and why? Did you find the account opening process overly cumbersome or pretty straight-forward? 


Share your experiences by commenting below!


Also, if you’re wanting to read more about the individual 401(k) account opening process, Flexo from Consumerism Commentary wrote up a great piece on this which can be accessed by clicking here. It definitely helped give me a guide to opening my individual 401(k) account. Thanks Flexo!

***Photo courtesy of http://3.bp.blogspot.com/_4RUa3sMeqtc/Rb-wWS2oayI/AAAAAAAAAFY/o3i6RIVm5HI/s400/cash.jpg

Comments

  1. Great ideas! I use ROTH-IRA. Thankfully, everything is automatic so I don't even have to worry about my investments. It keeps me accountable. Great post!
    My recent post Savvy Shopper Sites for Bargain Hunters

    • Roth's are great! I use one as well, but I tend to max it out early in the year and don't have any other tax-sheltered outlets to save money in now that I no longer have a 401k at the company I work for in my day job. The individual 401k is a good way to fill this gap.
      My recent post Easy Like Sunday Morning Weekly Recap and Roundup – # 5 – December 17th, 2011

  2. IRA and Roth IRA can also be good options for a self employed. Very detailed post
    My recent post How Use of Alternate Energy Can Save Money

  3. Very nicely written with great instructions! Are you self-employed? Sorry, I forget.

    Do you know what the MAXIMUM contribution is, and what the formulas are if you do the solo 401k? Thanks!
    My recent post Passed Over For A Promotion And No Raise

    • I'm a graduate student in my day job, nope, not self employed. I just opened the Individual 401k to invest income from blogging.

      I was planning to include the contribution details of an Individual 401k in a future post about deciding between a SEP IRA and this account type, so be on the lookout for that!

      However, for an individual 401k the maximum contribution is 20% of your income as an employer contribution plus the lesser of 100% of your business income or $16,500 as an employee contribution.
      My recent post Easy Like Sunday Morning Weekly Recap and Roundup – # 5 – December 17th, 2011

  4. Very informative Jacob! I've opened IRAs and regular brokerage accounts at a number of brokerages, I found Fidelity was the easiest and WellsTrade the most frustrating.
    My recent post If You Own Mutual Funds Or ETFs, Don’t Ignore This Metric

  5. pamellala says:

    Thank you for the detailed instructions. I've heard you don't have to use an investment house. If that is the case, would I just create a document modeled after others such as Vanguard or Fidelity? Would it have to be filed with a government agency, or would I just keep it in my own files? And if I rolled over IRA funds into a bank account, would I then just declare in this paperwork that this is my 401k fund?

    • Good question Pamella! Thanks for reading. I'm not sure how the process would work if you were to open a solo 401k outside of an investment house. However, for individual investors like you or I, I would imagine it is easier overall to use established processes at investing houses like Vanguard and Fidelity to capitalize on the tax deferred advantages of solo 401ks.
      My recent post Sensible Spending and Saving For You And Your Family

  6. Extremely informative! I am actualy in the process of opening this plan. One question – what do you enter on the 'plan name' ? Do you make this up or leave it blank if I am opening a new plan?

    • Thanks for reading Arch. The name of the plan can be anything you like it to be. For example, I named mine, “Jacob's Individual 401K.”
      My recent post Sensible Spending and Saving For You And Your Family

  7. Hello and thank you for this helpful information. I have one question. I am a sole proprietorship, but my spouse would like to benefit by contributing to this individual 401k…is there an area I need to fill out to include so he can do so?.

    • Thanks for reading Cindy. Yep! In order for your husband to participate in the plan as an employee, you'll have to fill out a form for him. In Step 2 above, I talk about what form to fill out for your spouse. Let me know if you have any other questions!
      My recent post Simple But Scary Truth: Money = Time

  8. I am a contractor (no employees) and have established LLC with an associated business checking account (using the business's TIN, not my own SSN). I recently opened an indiviual 401K plan with Vanguard and am ready to start making contributions. I need to set up banking info with Vanguard, and am wondering if I should use the business checking account or my own personal checking account? LLCs have pass through taxation (I'm not filing as S-corp or C-corp) so I don't think it truly matters either way from a tax point of view, but I'm leaning towards using my business account. Any opinions? Get an accountant?

    • Interesting question! I would probably run it by an accountant or look in to it more online. However, I would guess that if you are making the contribution as an employee salary deferral, you'd want to use your own personal checking account. If you were making an employer contribution, you'd want to make it from the business account.
      My recent post Should You Invest or Pay Off Debt First?

  9. Great post! I have been searching for a clear setup guide in setting up my own solo 401k. My question is, I have a part time employee (under 1000 hours per year) and as I understand it, I can still open up a solo 401k plan because I am the only “full time” employee of my company. Looking at Vanguard's Individual 401k Kit it states “You cannot establish the plan if you employ others, including children” so I am a little confused on this issue. I would really like to open and establish my plan with Vanguard.

  10. PhilipCox says:

    I have a question. I have set up several Indv 401(k)s for clients with Invesco during the past several years. I have never had to get an EIN for the plans. I have only used the business EIN or the individual’s if unincorporated. Recently, I have been told by a benefits company that you must apply for an EIN. Invesco has insisted that this is just an OPTION, not an IRS rule. None of my plans will ever go over the $255, 000 mark, so I will never have to file a Form 5500. My feeling is that if I apply for the EIN and it is never filed against, eventually, the IRS will drop the EIN and reissue it. I would like anyone thoughts regarding this. Is Invesco wrong? or is the EIN thing just an option. Thank you…

    • Good question. The only reason I got an EIN was b/c Vanguard needed it on their form. I never inquired if it was an IRS requirement or an internal one.

      Either way, I think it is good to have an EIN (they are free after all). I use it on my W9’s so that I don’t have to give out my personal SSN.

  11. Jeff Rutledge says:

    Now for a tough question. The 2013 ATRA (aka fiscal cliff bill), makes it possible for nearly anyone to convert in-place from an individual 401K to an individual Roth 401k. First of all, the provider must allow an individual Roth 401k. Second, they must allow the conversion. My plan is with Vanguard and they don’t allow the conversion, and claim they have no intention of allowing it. After calling the major providers, only ETrade said they would allow it, but it is not in their adoption agreement, so I wonder if I was told that to bait me. I will rollover my Vanguard individual 401K to the first reasonable low cost provider that allows it. I still hold out hope this year for being able to use a law that is on the books.

  12. It looks like your link to the IRS EIN page is now broken. I think http://www.irs.gov/Businesses/Small-Businesses-&-Self-Employed/Employer-ID-Numbers-EINs is the new one?

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