Solo 401(k) Asset & Credit Protection Benefits

Retirement accounts have become many Americans’ most valuable assets. It is important that you have the ability to protect your assets from creditors, such as people who have won lawsuits against you. The strategies for asset/creditor protection that are available to you depend on the type of retirement account you have, your state residency, and whether the assets are yours or have been inherited. Solo 401(k) can help protect your assets in your 401(k) from creditors in the event of bankruptcy.

What Is a Solo 401(k)?

The solo 401(k) is a retirement account that offers tax advantages for self-employed business owners and their spouses who work for them at least part-time.

A Solo 401(k) is a great retirement savings option for self-employed individuals and small business owners. Also known as an individual 401(k), one-participant 401(k) plan or a self-employed 401(k), a Solo 401(k) allows you to make contributions as both an employer and an employee. If you have a full-time job with access to a workplace retirement plan, you may also be able to save for retirement through a solo 401(k), which is a retirement account that you fund with money from a side hustle.

There are no age or income restrictions for opening and saving in a solo 401(k). The amount you can contribute to your retirement savings plan may increase in the next few years, reaching up to $61,000 in 2022 and $66,000 in 2023. If you’re 50 or older, you may be able to contribute even more.

Solo 401(k) vs SEP IRA

Small business owners who have no employees other than their spouses have to decide between a solo 401(k) and a Simplified Employee Pension IRA (SEP IRA) when saving for retirement.

Both accounts give the self-employed a tax-advantaged way to invest money for retirement, but there are a few key differences that could make the solo 401(k) a better fit:

You may be able to save more with a solo 401(k). With a SEP IRA, your total contributions cannot exceed 25% of your net adjusted self-employed income, up to a total of $61,000 in 2022 and $66,000 in 2023. Unless your business income is substantial, you may be able to save more in a solo 401(k).
You can make both employer and employee contributions. Like a workplace 401(k), there are “employer” and “employee” contributions for solo 401(k)s. You can contribute up to 100% of your net adjusted self-employed income or $20,500 in 2022 and $22,500 in 2023, whichever is less, as an employee. Then as an employer, you can contribute up to 25% of your net adjusted self-employed income.
There’s a Roth solo 401(k) option. If you’d prefer to make tax-free withdrawals in retirement, you may want to choose a Roth solo 401(k). SEP IRAs currently only allow pre-tax contributions and are not available as Roth accounts.
Catch up contributions for savers who are 50 or older. For people who are 50 and older, a solo 401(k) allows you to make additional catch-up contributions as an employee, $6,500 in 2022 and $7,500 in 2023. SEP IRAs are only funded with employer contributions, so catch-up contributions are not allowed.

How Do Solo 401(k) Withdrawals Work?

If you withdraw money from your solo 401(k) before you turn 59½, you may owe taxes and penalties depending on which type of account you withdraw from—traditional or Roth. There may be taxes or fees associated with taking money out of your solo 401(k). Before you make any withdrawals, it’s important to understand the rules and regulations to avoid any penalties.

Solo 401(k) Early Withdrawal Rules

The rules for early withdrawal from a solo 401(k) account depend on the type of account you have. If you make a withdrawal from your traditional solo 401(k) account before you turn 59 ½, you will usually have to pay a 10% penalty tax on the amount withdrawn, as well as income taxes. There are a few exceptions to this rule.

With a Roth solo 401(k), contributions can be withdrawn without paying the 10% tax penalty or income tax, but you pay the penalty and income tax on earnings. You can’t just take out the money you’ve put in- you’ll have to pay taxes and a penalty on at least part of it if you do.

Exceptions for Solo 401(k) Early Distribution Penalties

The government agency responsible for collecting taxes in the United States, the Internal Revenue Service (IRS), may choose to not charge the standard 10% penalty for people who withdraw money from their retirement accounts before they turn 65. This is allowed in specific situations. Taxes will still be owed on any contributions or earnings that have not been taxed. The exceptions include:

Medical expenses that exceed 10% of your adjusted gross income
Permanent disability
Certain military service
A Qualified Domestic Retirement Order (QDRO) issued as part of a divorce or court-approved separation

If you get a distribution from your 401(k) that is paid to your ex-spouse under a QDRO, you will not owe any income tax on the distribution. The recipient of the distribution can deferred taxes on the distribution by rolling it into an IRA.

A Solo 401(k) doesn’t have the same benefits as an IRA or SEP IRA when it comes to withdrawals for higher education expenses or first-time homebuyers. With a Solo 401(k), you will be subject to penalties if you make withdrawals for these expenses.

Solo 401(k) Withdrawals in Retirement

If you are over the age of 59 ½, you can take money out of your solo 401(k) without being charged any penalties. However, the amount of taxes you pay on the money you withdraw will depend on what type of account you have.

When taking withdrawals from a Roth solo 401(k) account, there will be no taxes if the account has been open for at least five years. Withdrawals from a traditional solo 401(k) are taxed as income at the individual’s current tax rate.

When you have a solo 401(k), you will eventually be required to start taking money out of your account in the form of required minimum distributions (RMDs). If you want to avoid the RMDs requirements, you can roll a Roth solo 401(k) into a Roth IRA. Roth IRAs don’t have mandatory RMDs.

The first RMD for a Solo 401(k) must be taken by April 1 of the year after the account owner turns 72. RMDs must be taken by December 31st of the year after the year in which the account holder turns age 70 1/2.

Federal Protection for 401(k) Qualified Plans for Bankruptcy

Since October 17, 2005, retirement funds have been protected from bankruptcy by exempting them from the bankruptcy estate. 522, protects certain assets of the debtor from being sold to satisfy debts This text is discussing the fact that certain assets are exempt from being sold in order to satisfy debts. This exemption is found in section 522 of the Bankruptcy Code. The exclusion is allowed for any size distribution The exemption for retirement assets exempt from taxation for Section 401(a) is $522. This exemption is allowed for any size distribution. This means that both ERISA qualified plans and Solo 401(k) plans are not affected by bankruptcy. This means that if someone with a 401(k) plan declares bankruptcy, their 401(k) assets will not be affected by the bankruptcy and can’t be taken by the bankruptcy estate’s creditors.

Federal Protection for 401(k) Plan Qualified Plan Funds Outside of Bankruptcy

The 2005 Bankruptcy Act does not apply to debtors who are not under the jurisdiction of the federal bankruptcy court, but are instead involved in state law insolvency, enforcement, or garnishment proceedings. In these cases, the ERISA rules and state laws would govern.

ERISA’s Title I requires that a pension plan’s benefits cannot be assigned or alienated, meaning that the plan must have a clause that prevents this from happening. The anti-alienation clause will only be effective if the pension plan it is a part of is recognized as an “Employee Retirement Income Security Act” pension plan. ERISA is a plan that provides retirement income to employees. A perspective plan that doesn’t have any sort of benefit for common-law employees is not protected under ERISA. This means that the Solo 401k Plan is not subject to the same rules and regulations as an ERISA Plan.

” The text states that a 401(a) plan cannot be qualified unless the benefits cannot be assigned or alienated. A retirement plan won’t be considered qualified unless it doesn’t allow employees to choose to end their participation or be forced to end their participation.

The following types of retirement plans are not protected under ERISA or Code: individual retirement arrangements, simplified employee pension plans, government plans, or most church plans.

In addition, ERISA section 514(a) states that ERISA overrides state laws to the extent that those laws relate to employee benefit plans. The anti-alienation and preemption provisions in ERISA mean that state laws on attachment and garnishment do not apply to someone’s benefits under an ERISA-covered employee benefits plan.

Exceptions

There are a number of exceptions to ERISA’s and the Code’s anti?alienation provisions:

Qualified domestic relations orders (“QDROs”), as defined in Internal Revenue Code Section 414(p), may be exempted (Internal Revenue Code §401(a)(13)(B); ERISA §206(d)(3)). This means that retirement plan assets are a marital asset subject to division in divorce and attachment for child support.
Up to 10 percent of any benefit in pay status may be voluntarily and revocable assigned or alienated (Internal Revenue Code §401(a)(13)(A); Treas. Reg. §1.401(a)-13(d)(1); ERISA §206(d)(2)).
A participant may direct the plan to pay a benefit to a third party if the direction is revocable and the third party files acknowledgment of lack of enforceability (Treas. Reg. §1.401(a)-13(e)).
Federal tax levies and judgments are exempted. The Treasury Regulations under Code section 401(a)(13) provide that plan benefits are subject to attachment by the IRS in common law and community property states.

of which the individual has been convicted. In addition to the exceptions that are noted in the law, there have been several cases where the court has said that someone’s retirement plan benefits can be taken away if they owe money for federal criminal penalties or restitution because of a crime that they were convicted of.

Solo 401(k) Plans

Pensions, profit-sharing plans, and 401(k)s are usually safe from creditors, both in and out of bankruptcy. This is because of the anti-alienation protections in ERISA and the Code. However, a plan that only benefits an owner (and/or an owner’s spouse) is not an ERISA plan according to case law and Department of Labor Regulations, which means that the anti-alienation protections usually given to ERISA plans do not apply. This means that state law will determine how much protection Solo 401k Plans have from creditors outside of bankruptcy.

State Law Protection of Solo 401(k) Plan Assets Outside of Bankruptcy

A Solo 401(k) Plan is a retirement plan that is not subject to the same anti-alienation protections as other ERISA plans. This is because the only people who benefit from the Solo 401(k) Plan are the owner and their spouse.

Asset Protection Planning

The different creditor protections afforded to 401(k) qualified plans by the federal government and state governments present a number of important asset protection planning opportunities.

If, for example, you have left an employer where you had a qualified plan, rolling over assets from a qualified plan, like a 401(k), into an IRA may have asset protection implications. This means that the assets in your IRA may be protected from creditors in the event of bankruptcy. If you are considering bankruptcy and have over $1million in assets, it is better to leave them in a company qualified plan, where they will be protected from creditors.

The Solo 401(k) Asset & Creditor Protection Solution

Solo 401(k) Plans usually protect your assets from creditors, meaning that if you have any debts, your creditors will likely not be able to access your Solo 401k assets to pay off the debt. This means that if you have a Solo 401(k) Plan, your assets in the plan may not be protected from divorce settlements or federal tax liens.

How to Open a Solo 401(k)

Making sure you open your Solo 401(k) in a timely manner is important. The deadline to establish a 401(k) for you and your business is Dec. 31 of the year you want to contribute. Here’s how to open a Solo 401(k):

Choose your provider. Most online brokers offer solo 401(k)s. Generally, you’ll want to pick the broker whose investments you prefer. Roth solo 401(k)s are not as common as traditional solo 401(k) offerings, so check to make sure your brokerage offers them.
Get an EIN number. You can get an Employer Identification Number, which is essentially a tax ID for employers, from the IRS .
Fill out an application and any required plan documents. Because this is a retirement plan, the IRS requires some paperwork. Your broker will provide you with the documents you need and can guide you through the process.
Fund the account. You can fund the account by rolling over money from another retirement account or setting up a transfer from a checking or savings account .
Choose investments. As with any retirement account, you’ll need to determine how you want your money invested.