Open a solo 401k plan online in under 10 minutes – The Carry Solo 401k Plan is a featured-packed self-directed account that lets you invest in both traditional and alternative assets, take out a loan, or do a mega backdoor Roth conversion with a few clicks.
One of the most attractive features of a solo 401k is the ability to invest in virtually any asset class. Instead of being limited to just investing in traditional assets like stocks, bonds, and ETFs, you can invest your plan in alternative investments like crypto, real estate, and startups. Investing in startups through a solo 401k plan can have many advantages, but comes with a few rules and restrictions that you need to be aware of. Here’s everything you need to know about investing in private companies with your solo 401k.
Are you allowed to invest in startups and businesses through a solo 401k?
Yes, you can use your solo 401k to invest in startups and businesses.
Investing in startups through a solo 401k is largely the same as if the investment was made by you as an individual. The main transactional difference is that the investment would be done in the name of your solo 401k plan, instead of in your name.
However, you can only do so with a self-directed solo 401k that lets you invest in alternative asset classes. Solo 401k plans that you can open through major banks and brokerages are prototype plans that only let you invest in traditional assets like stocks and ETFs. To invest in startups and private companies, you would need to open a non-prototype plan through a self-directed plan provider.
3 rules for investing in startups with a solo 401k
1. You must be an accredited investor
While some alternative assets like crypto and real estate allow anybody to make investments, only accredited investors can invest in private companies. If you’re an accredited investor as an individual, your retirement plan also becomes qualified as an accredited investor.
How to become an accredited investor
To become an accredited investor, you simply need to meet any one of the following criteria.
- Have an annual income of $200,000 or more (single) or $300,000 or more (joint) in each of the last two years, and expect to reasonably maintain that level of income.
- Have a net worth of over $1 million, either alone or jointly with a spouse.
- Hold a Series 7, Series 65, or Series 82 license and be registered with your state or other regulatory body.
There is no official paperwork or application process involved. As long as you meet one of the criteria above, you’re automatically considered an accredited investor, which would also carry over to your solo 401k plan.
2. You cannot invest in an S corporation
You can invest in almost any type of business entity, except an S corporation. Shareholders of an S corporation must be individuals, estates, certain types of trusts, or certain tax-exempt organizations. Nonresident aliens, partnerships, corporations, and most types of trusts are generally not eligible shareholders.
When you make an investment through your solo 401k, the investment is owned by your solo 401k trust, not you personally, so would not be eligible to be a shareholder of an S corporation.
3. You cannot invest in a business with disqualified persons
A transaction between a retirement plan and a disqualified person is considered a prohibited transaction by the IRS. Essentially, your investment into the startup must not personally benefit you or any disqualified person, either directly or indirectly.
Disqualified persons include you, your spouse, parents, grandparents, children, grandchildren, fiduciaries, and several others. You also cannot invest in a business through a solo 401k if you’re an officer of the business, director, or own more than 10% of the company.
The rules and definitions around disqualified persons are complex, and the penalties for breaking the rules are steep, so you should speak with a tax attorney or other professional to make sure that your transaction is not self-dealing before making any investments.
The advantage of investing in startups with a solo 401k
The biggest advantage of investing in startups through a solo 401k is using your Roth solo 401k to avoid capital gains tax if your investment balloons in value. Startups are a riskier investment, but often have the potential for greater returns. A Roth retirement account is funded with after-tax income, but lets you take tax-free withdrawals in retirement, no matter how large your gains.
Peter Thiel turned $1,700 into $5 billion investing in startups through his Roth IRA.
In 1999, Peter Thiel used his Roth IRA to invest $1,700 for 1.7 million shares of PayPal at $0.001 per share. Three years later, PayPal went public and was acquired by eBay, turning his initial $1,700 investment into $28.5 million.
Instead of withdrawing the funds, he reinvested the money into more startups, including Facebook and Palantir. By 2019, his Roth IRA had grown to a value of over $5 billion. And because he had invested through his Roth retirement account, he owed zero capital gains tax to the IRS and could withdraw the entire earnings in his account completely tax-free.
This works the same way with a Roth solo 401k.
A Roth solo 401k has bigger limits
A solo 401k has a much higher contribution limit than a Roth IRA, meaning you can invest a lot more money into startups through a solo 401k than you can with a Roth IRA.
- The Roth IRA contribution limit for 2024 is just $7,000 if you’re under 50 years of age, and $8,000 if you’re 50 years of age or older.
- The Roth portion of a solo 401k plan has a contribution limit of $23,000 if you’re under 50 years of age, and $30,500 if you’re 50 years of age or older.
- With a mega backdoor Roth solo 401k, you have the ability to contribute up to $69,000 into your Roth solo 401k for 2024, giving you even more capital to invest in startups.
Can I invest in my own startup with a solo 401k?
As mentioned earlier, investing your solo 401k plan into your own business is considered a prohibited transaction. However, an alternative method for using your solo 401k to fund your startup is to take out a solo 401k loan.
With a solo 401k loan, you’re allowed to borrow up to 50% of your account value, up to a maximum of $50,000. You have 5 years to repay the loan, and interest rate is usually prime rate plus one or two percent. Because you’re borrowing money from your account, getting the loan is quick, as there is no application process and no credit checks required.
The downside of a solo 401k loan is that you’re depleting your retirement savings of funds that would otherwise be invested and earning you interest. So if you’re considering a solo 401k loan, make sure to check all funding options available to you before making a decision.