How to Choose a Solo 401(k) Provider





Creation of the individual 401(k) with the Bush-era tax cuts went practically unnoticed, and the financial services industry was slow to set up these retirement plans and still has not done much marketing.

But the solo 401(k) can be a boon to a sole proprietor like a freelancer or small business owner with no full-time employees, allowing the same tax deduction for contributions available to employees of corporations.

In fact, the solo 401(k) can be even better, because the single participant is in charge of choosing the investment options and can even get a tax deduction for additional contributions in his or her role as the employer.

This year, a plan participant can put in $18,000 as employee ($24,000 if 50 or older), plus an employer's contribution of up to 25 percent of his compensation, with total contributions limited to $54,000 ($60,000 if 50 or older).

[See: 12 Steps to a Stronger 401(k).]

As with all 401(k)s, investment gains are tax-deferred, and withdrawals are taxed as ordinary income. You can set up a solo 401(k) as a tax-free Roth account, or convert to a Roth later.

But along with latitude and high investing limits come some tough choices: which fund company, bank or brokerage should you choose as the plan's provider? While the law allows participants to invest in just about anything they want, some providers limit the options. What should you look for in choosing a provider, or in switching if you're not happy?

What investments are allowed? As mentioned, some custodians allow just about any mutual fund, exchange-traded fund or individual stock or bond, while others keep it to in-house products. Obviously, you should know the policy before setting up the account.

"If you go with a single firm you may run onto restrictions, but if you use a brokerage account platform then there should not be any investment restrictions," says Scott W. Cody, partner in Denver-based Latitude Financial Group.

If you want the greatest possible freedom to invest, make sure the provider, whether a mutual fund company, bank or brokerage, can set up the account as a brokerage account.

Fees. Keep an eye out for administrative fees that could gnaw at your investment returns. Some providers do not charge account maintenance fees but may charge trading commissions (though probably not for reinvesting dividends). You would, of course, pay ordinary expense ratios on any funds in your plan.

"Typically, year one of the plan will be slightly more expensive because there may be a one-time setup fee," Cody says. "After year one, there may be an ongoing administration fee."

How fast are they? If you're not happy with the provider you started with, you can shift to another in the same way you'd move assets from one individual retirement account to another. But it's important to know just how this will be done.

Often, it can be an "in-kind" transfer of fund shares to the new account, leaving you with the same holdings you started with. In other cases holdings must be sold and only the cash moved to the new account. Though the sale is tax-free if the cash goes to another 401(k), this means missing any investment gains while the money sits on the sidelines for a week or two.

[See: 9 Ways to Avoid 401(k) Fees and Penalties.]

"It's important to have the check made out to your new qualified plan to your benefit," says John F. Knolle, a planner with Saranap Wealth Advisors in Walnut Creek, California, who made a switch with his own solo 401(k). "You can have the check made out to you directly and as long as you deposit it (in the new account) within 60 days, it isn't a taxable event. However, your former provider will, by law, withhold 20 percent for taxes so if you want to make a full contribution you'll have to come up with 20 percent from outside sources until you file your taxes at year end and receive a refund. As you can see it's much easier to have the check made out directly to your new plan."

Odds and ends. "Individual 401(k)s can allow for loans, so if you are needing or potentially may need to take a loan, you will want to select an administrator that will assist you in the loan administration," says Justina R. Welch, principal at Independent Wealth Management and Investment Advisory in Greenwood Village, Colorado.

Remember that the term "loan" is somewhat misleading when it comes to 401(k)s. Rather than borrowing against assets in the account, as you would with a margin account, you sell holdings to raise cash. That means missing investment gains until the loan is repaid and the investments are re-purchased.

The administrator must also be equipped to file IRS Form 5500, required for accounts over $250,000, Welch adds.

Though you have no employees now, what if you do someday? If you hire one or more who work 1,000 or more hours a year and receive a W-2 form, you'll need to convert to a regular 401(k), Welch says. Then you'll have to go through a "non-discrimination" process to assure the plan does not favor the business owner or executives over ordinary employees.

[See: 12 Great Things About Retirement.]

So if this is a possibility, make sure your provider will be able to do this quickly, smoothly and cheaply.



Jeff Brown spent nearly 40 years as a newspaper reporter, columnist and editor, including 20 years writing about investing, personal finance, the economy and financial markets. He spent 20 years at The Philadelphia Inquirer and has been freelancing since 2007.

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