About one out of three Americans is an independent worker or freelancer. This truly is the land of entrepreneurs. That’s a very good reason why the Solo 401k has become such a popular and powerful retirement plan since it first became available in 2001 when the U.S. Congress passed the Economic Growth and Tax Relief Reconciliation Act (EGTRRA).
The Internal Revenue Service refers to this entrepreneurs’ retirement plan as a “one-participant 401k plan.” However, it is commonly known as a Solo 401k along with other names such as uni-k, self-employed k, and self-directed 401k. The common theme among all of these names is the implication that only one person can be a participant in the plan. But that can be misleading. The one-employee rule doesn’t apply to the spouse of the business owner. Your spouse can work (or partner) at your sole proprietorship and invest through your Solo 401k plan.
3 Ways to Structure Your Sole Proprietorship to Include Your Spouse
The IRS makes special provisions when your spouse works in your business. Generally, there are two structures. One is when your spouse is an employee of the business and the other is when both spouses share ownership of the business. Importantly, the employment tax requirements for a spouse/employee can vary from those applying to other employees. These are the three most common business structures involving spouses.
- One spouse is the sole business owner of the Solo 401k and the other spouse receives a W-2 as an employee in the first spouse’s business. This tends to be the simplest solution. It works best when the second spouse has only minimal duties and activities in the business.
- As a couple, you act and file as a Partnership, where each partner receives a K-1(Form 1065). The partnership does not pay income taxes itself. Instead, the partnership passes the profits and losses on to each partner. When both spouses contribute materially to the business, a partnership becomes the default structure in the eyes of the IRS.
- As a couple, you file as a Qualified Joint Venture. This solution is possible when both spouses work and contribute materially to the business and file a joint tax return. This allows you to avoid forming a partnership. Also, both spouses receive credit for social security and Medicare coverage purposes. Each spouse reports separate income gains and losses, as well as business deductions and credits on Form 1040 Schedule C.
Solo 401k Spouse Plan Options
If your spouse is an employee of the business that you own, your spouse can participate in your new or existing Solo 401k. She or he can participate with his or her own annual contributions and rollovers. Your spouse can also and take out loans from his/her 401k plan funds. He or she will benefit from the same features and services that come with your account. But for clarity, all retirement accounts are individual. There is no actual joint Solo 401k or any other joint retirement account.
While you and your spouse may be able to participate in the same 401k and pool funds together in a single investment – each of you has a participant account and you must track the balance for each account. You’ll establish one Solo 401k plan. However, each spouse has his or her own bank checking (investing) or brokerage account. Open the account in the name of the Solo 401k for the benefit of that person. Each spouse is contributes income and profit sharing percentages to their respective account under the plan. The employee/spouse makes contributions based on his/her compensation. Only the business owner is entitled to other business tax write-offs.
What if My Spouse Owns His/Her Own Business?
If your spouse owns part of the business, he or she can set up a separate Solo 401k. In most cases, this is not necessary but there can be reasons to make this selection. Your spouse might need different plan documents to ensure IRS compliance, future amendments, restatements, and updates to his or her plan, or have other unique requirements. Your spouse or you might also have legal reasons why a separate Solo 401k plan is preferred.
A time when a spouse might consider a separate Solo 401k plan is if they have their own sole proprietorship (or LLC, C or S Corporation). They have a separate employer identification number (EIN) and operate the business independent from your business. There can be intermingled business relationships but the businesses are separate entities. (Note: intermingled business relationships are not the same as disqualified persons and prohibited transactions that apply to Solo 401k transactions.)
Co-Invest with Separate or Joint Spouse Solo 401k Accounts
If you have a Solo 401k, you can co-invest funds with your spouse with either a joint or a separate account(s). A highly valued advantage of any Solo 401k account is that investors can combine retirement funds to generate more income back to their individual Solo 401k accounts. Real estate co-investing has proven to be one of the most profitable for maximizing retirement savings along with the other tax benefits that come with real estate investing. This is an awesome strategy when spouses combine the buying power of both of their Solo 401k accounts to invest in one or more quality rental properties.
More purchasing power can enable investing in a small or medium size apartment building rather than a single-family house. Multiple tenants mean multiple income streams. Multiple units also mean less income disruption if a single unit goes vacant temporarily.
Of course, the purpose of a Solo 401k is for each of you to be able to invest in what you want. Your co-investments are not limited to real estate. For instance, other co-investments can include private placements, gold/silver, cryptocurrency, conventional brokerage accounts, and almost any other creative investment type.
Also, neither you nor your spouse has to place all of your investment funds in one place. You can join part of your funds into one investment and still make different investments that do not involve your spouse. Solo 401k accounts are all about flexibility.
Why Both Spouses Should Participate in a Solo 401k
A Solo 401k remains the most powerful retirement investment vehicle available to a single owner business and their spouse. The same rules apply whether the basic account(s) is in the name of one or both of you.
- When you and your spouse both contribute to a Solo 401k plan in 2021, you can each contribute $58,000 (up from $57,000 in 2020). If you are age 50 or over, you can add another $6,500 to bring the total contribution limit to $64,500. This is well over twice what is available from other plans. When your spouse also participates in a Solo 401k, the potential contribution limit doubles to $129,000!
- Solo 401k plans allow loans direct to the participant. You and your spouse can each borrow up to 50% of your account value or $50,000 (whichever is lower) tax-free and without penalties. You can do anything you want with this tax-free money including using it for emergencies, a major purchase, a down payment on a home, vacations, or for other profit generating opportunities.
- Annual Solo 401k funding is flexible. Once established, you can fund it to the maximum each year or anywhere between zero and the max. There is no minimum funding requirement.
- Easy to establish and maintain. Unlike the traditional 401k, there is no discrimination test required to establish the account. IRS form 5500-EZ only needs to be filed annually after the value of the account exceeds $250,000.
- Can also use debt financing for investments.
- Solo 401k accounts allow creative investing strategies to generate both long and short-term retirement fund growth.
- Earnings are tax-deferred with a traditional solo 401k or tax-free with a Solo Roth 401k account.
My husband and I have had a Solo 401k since 2014, but our provider hardly provided any guidance. So happy to have moved over to your services where we are learning so much more. We were under the impression that we had to separately make investments but in this post, I see we are able to jointly invest.
In a community property state, where each spouse owns and runs their own non incorporated different businesses and are sole proprietor s and have their own Einstein, does the IRS regard their business as community property and require benefit plans like DBPor 401ks to include the other spouse?
Not Einstein SIRI, EIN!
You, SIRI, are no Einstein.
Neither am I, sorry!
Great question, Hugh! We’d recommend you double check with your tax professional but typically we’d write a Controlled Group plan if there are two distinct sole proprietorships where both businesses will be contributing to the Solo 401k plan.