By: Matt Romney

Last Updated: 11/29/18


I like to say that I pride myself on thinking outside the box but within the framework. What do I mean by that? It’s simple. I believe it is important to think of creative solutions that are outside the box without sacrificing principles or regulations (including, but not limited to IRS regulations).

It is that mentality that has made tax planning a specialty of mine. Unfortunately, some of the tax planning that is being done either crosses the line or gets way too close to the line when it comes to what is allowable with the IRS. You see, I believe that with the right knowledge and planning, there shouldn’t be a need to take on significant tax risks to save a lot in taxes.

In order to accomplish the best tax planning possible, all options must be considered, and I mean all options. One of the tools in our tax planning toolshed that we will examine here is the use of a Solo 401(k) as a tax planning vehicle.

If you would like to better understand the basics of a Solo 401(k), please refer to my previous article titled: Solo 401(k) – Understanding the Basics.

*Important Note: As with anything regarding your money, this article is for education and informational purposes only. Your circumstances, needs, and goals, are unique; which is why I always recommend that you consult with a qualified professional to discuss your individual situation.

Tax Planning is Not Retirement Planning

You know that saying, “a square is a rectangle, but a rectangle is not necessarily a square? Well that’s kind of what we’re talking about here. Proper retirement planning involves heavy tax planning but tax planning doesn’t have to heavily involve retirement planning. Okay, the metaphor might not exactly fit, but you get the idea. The point is, it really is different.

Where many people, even the majority of advisers and accountants, get confused, is with the fact that about 50% of good tax planning strategies involves vehicles that are intended for retirement. Although we may use these so called “retirement vehicles”, the purpose doesn’t have to necessarily be for retirement. It can also be used to help you accomplish your short-term goals.

Here’s where thinking outside the box comes in handy. You see, we don’t care what somethings general purpose is; we care how it can help us serve our needs and goals. The Solo 401(k) is a great example of this. It is traditionally a retirement vehicle. The IRS gives us tremendous tax benefits within 401(k) plans to encourage our society to save for retirement. Yet, with proper planning, they can help us throughout our life, not just for retirement.

Guidelines for Tax Planning Strategies & Vehicles

Believe it or not, I often times get laughed at for how many rules I have. Rightfully so, I have a lot of them. I guess that’s just my nature, but I also believe that rules (even with their exceptions) help us to make better decisions, and do so more consistently. Here are my 7 rules for considering a strategy or vehicle for tax planning:

1.     Current Needs & Goals

Your current needs and goals must be prioritized. For example, if an option interferes with your business goals, then it should likely be immediately set aside.

2.     Future Needs & Goals

It’s easy to consider your short-term needs & goals; yet having a vision of the future is important too. This helps us to avoid costly mistakes.

3.     Current Year Tax Savings

This is simple, how much will this option save you on taxes this year? What about option B? And so on…

4.     Lifetime Tax Savings

This is where it gets trickier. One must be careful not to save money on taxes this year, just to pay more down the road. Conversely, we may be willing to pay more taxes this year if it means greater lifetime tax savings. The concept of opportunity cost and time value of money becomes very important here.  Estate taxes, when applicable, should also be considered within lifetime tax savings.

5.     Liquidity Needs

For some, this is the most important factor. How much liquidity do you need? This may be for an emergency, for your emergency, possible investments, or just for reserves. Sometimes we’re willing to sacrifice some or all liquidity for tax savings. Generally speaking with the tax planning that I like to do, I always favor achieving the most tax savings while maintaining the most possible liquidity. This is especially true for business owners and entrepreneurs.

6.     Flexibility

While sometimes we simply accept that we may lose a certain amount of flexibility with our future decisions, we will always place an emphasis on options that provide optimal flexibility in future years. In other situations, maintaining flexibility becomes non-negotiable. This flexibility comes down to what are the options/costs if circumstances change to require change in the strategy, or even make it non-viable altogether.

7.     Income & Tax Control

With added flexibility comes greater control. However, I do separate the two because I want to place a greater emphasis on how an option may give us greater control over our income. Often times this control over our income or deductions can allow us to realize significant tax savings throughout our lifetime. This isn’t just in terms of how much in deductions we’re taking, but also when we’re doing it. With proper tax planning, we’re not just thinking about this year. We’re also looking at the big picture to save the most money overall.

Enough Background – Where does the Solo 401(k) fit in?

I encourage you to read the basics of the Solo 401(k) article that was referenced earlier if you have yet to do so.

The first step is to determine if it should be up for consideration. Although the Solo 401(k) is much simpler than a normal 401(k) and carries very little cost, there are important considerations that should be made. In general, this should not be a short-term solution for tax planning. It can be used as a short-term decision if we’re just talking about retirement planning, but rarely for tax planning.

Assuming one is eligible to have a Solo 401(k), let’s see how the Solo 401(k) does with my guidelines.

  1. Current Needs/Goals – Cannot evaluate here as it is unique to the individual.
  2. Future Needs/Goals – Cannot evaluate here as it is unique to the individual.
  3. Current Year Tax Savings – With up to $55,000 in potential contributions, one can save as much as $23,100 in taxes (assuming maximum federal rate of 37% & 5% state taxes).
  4. Lifetime Tax Savings – This is also more on the case by case side; however, the key component here is tax deduction and tax deferral. This can generate significant tax savings over time.
  5. Liquidity – This is where I like the Solo 401(k). You can access 50% of the balance up to $50,000 total without any tax penalty. If married, we may be able to double that. Depending on the situation, that may provide us with the necessary liquidity while still accomplishing the tax savings. When we go into it with the expectation of accessing the money, the investments in the account must be managed appropriately. More on that below.
  6. Flexibility – The nice part about the Solo 401(k) is that year in and year out, you get to decide on how much to contribute, or if you’ll even contribute at all. With that being said, if liquidity is a priority, and you shortly find yourself hiring a full-time W-2 employee, you either have to turn it into a traditional 401(k), subject to greater testing and cost, or you have to close it down. By closing it down, you lose the flexibility. That’s why it’s best to plan properly before opening a Solo 401(k) plan.
  7. Tax Control – Here we have a lot of ability to control our income, and deductions. We can pick & choose how much and when we’re going to contribute. This comes in handy with the new 199a Qualified Business Income Deductions as briefly discussed below.

Spouses Can Participate

When reasonable, a part of the strategy may be to hire a spouse in your business. This enhances the tax savings, but more importantly, it doubles the available liquidity. That’s generally the biggest benefit to employing the spouse. It is important here to consider the IRS guidelines on this.

Investment Management

As briefly mentioned before, careful consideration should be made to how the funds will be managed. If you’re using the vehicle as a retirement and tax savings tool, then you’ll likely want to manage it as you would your other retirement or long-term investments. However, if this is a tax planning move, and you’re requiring liquidity and maybe even expecting to access the funds, then the account(s) should be managed more like a Short-Term or Mid-Term portfolio. I have even implemented a strategy where a % of the funds in the same account were invested as part of the long-term portfolio and the rest as part of a short-term portfolio.

Whatever the strategy, if there is a liquidity need, it is important that funds are managed to reduce volatility in order to preserve liquidity. Since there is at least 50% of the funds that must stay in the account, it may be wise to develop a strategy that brings in a certain amount of volatility on those funds that are not accessible.

Important Considerations

As detailed in the Basics of the Solo 401(k) article, there are a number of important considerations that must be made prior to making any decisions, including but not limited to:

  • Controlled Group Testing
  • Future Business Plans
  • Hiring Employees

199a Qualified Business Income Deduction

The recent tax reform has made the use of a Solo 401(k) even more popular. In fact, tax planning in general is drastically more important for business owners and non-business owners, as a result of the 2017 tax reform. Small business owners may be eligible for a 20% deduction on their business income. However, if that business is what’s deemed a “Specified Service Industry” (e.g. doctors, lawyers, advisers, consultants, real estate agents, etc….), and the overall taxable income (all sources) is greater than $157,500 if single ($315,000 if married), then the deduction begins to phase out until the income is above $207,000 if single ($415,000 if married). After that, the deduction is lost altogether.

For those business owners that are in a specified service industry, the primary goal is to drive income below the $315,000 (if married). If we’re able to accomplish this without sacrificing too much liquidity and cost, then that is best case scenario.

Sometimes the gross income of the business is high enough that getting below the $315,000 mark is unreasonable. Getting below the $415,000 mark then becomes very important because we’re talking about completely risking losing the deduction altogether.

The Solo 401(k) can be a great tool in managing income in order to maximize this deduction. We are able to contribute a significant amount of money, thus driving down income, and we still maintain access to some of the money. The 199a deduction enhances this benefit. There have even been scenarios where a client gains liquidity by using the Solo 401(k) when factoring in tax savings as well.

Another very important consideration here is the fact that those individuals who are a Specified Service Business and near these thresholds, need to be very mindful of investment income. The advantage to the Solo 401(k) is that income from the investments is tax deferred. That is a big deal because it allows us to keep taxable income as low as possible without sacrificing returns.

While we could go with municipal bonds for tax-free income in a taxable account, we can usually get a higher return by having taxable bonds in a tax-deferred account, resulting in even more benefit.

Potential Uses & Examples

Example 1

John, married, owns an S-Corp that is a specified service business. He pays himself a salary of $120,000 a year and the business income was $180,000 ($300,000 total). John’s wife, Jane, works for a company with a W-2 salary of $100,000 per year. They have a total of $50,000 in itemized deductions.

As it stands, John & Jane are at $350,000 in taxable income. They are in that phase out range. Their QBI deduction is $15,210 for a tax savings of $4,867.

If John contributes $35,000 to a Solo 401(k), the QBI deduction is now $36,000 for a tax savings of $11,520. Let’s look at the net result of the $35,000 401(k) contribution. For this, we will assume 5% state taxes.

Prior to the 401(k) contribution, the total net tax liability was $84,259. After the $35k contribution, the total net tax liability was reduced to $73,607, a difference of $10,652. By contributing $35k, John & Jane save $10,652 on taxes.

Let’s look at it with a focus on liquidity. John & Jane now have $35,000 in the Solo 401(k). Of which, $17,500 is accessible. They took the $10,652 that was saved and put it in a savings account. They net liquidity result is $28,152. In essence, they contributed $35k, lost $7k in liquidity, yet have increased their net worth by $10,652 because of the tax savings. Was it worth it for them? As long as it falls in line with their current and future needs/goals, then yes, it was definitely worth it.

Example 2

Suzy, single, is a consultant. She also is skilled at investing in real estate and has a sizeable real estate portfolio with plans to purchase additional properties every 2 to 3 years. Suzi utilizes the Solo 401(k), to drive down her income in order to maximize the QBI deduction. She also is able to use loans from the Solo 401(k) for the down payments on her properties.

In this simplified example, the Solo 401(k) is not the only tool Suzy uses for her goals; however, it is a great illustration that the Solo 401(k) can actually help her to achieve her other goals. Likewise, Suzy is now better diversified from a holistic perspective as the remaining balance of her 401(k) is invested in an efficiently managed diversified portfolio.

Example 3

Mark and Mary have 700,000 in taxable income. $400,000 of it is from business income in a specified service industry. Although there are strategies that can get them below the thresholds to realize some or all of the QBI deduction, those strategies don’t yet fit in with their overall goals.

Instead of shrugging their shoulders and accepting the fact they’ll miss out on the savings, we develop a tax plan for Mark and Mary that involves taking control of their income and deductions using the Solo 401(k) & a Donor Advised Fund. While it doesn’t make sense to drive down income each year, we are able to drive down the income enough every 3 years in order to qualify for the maximum deduction once every 3 years. By doing this, the couple is able to able to save over $85,000 in taxes every 3 years. That’s not even taking into account reinvestment of the money saved.



There is no such thing as a one size fits all solution. There never is when it comes to your money. This is can be a tool in our financial toolshed; however, it needs to be carefully planned. I will say that when a client is eligible to have a Solo 401(k) and it aligns with their needs/goals, it is generally one of the most popular tax planning tools.

Tax planning almost always comes with costs involved. However, when done correctly, the benefits will far outweigh the costs. The biggest savings with tax planning tend to be with business owners; however, even those without businesses should engage in tax planning, even if it’s on a more basic level.

Tax planning is complex. It is difficult. Working with an adviser that is skilled at examining all possibilities and assisting you to understand your options and make educated decisions can make it a very rewarding endeavor. If you would have any questions or if you’d like to discuss this as a possibility for yourself, we are happy to help.