A minimum of 20% withholding is mandatory for a distribution from the 401(k) paid to this account owner because such a distribution is eligible for rollover. (Section 3405(c)(1)(B)) Only a direct rollover is exempt from mandatory withholding. (Section 3405(c)(2)) An indirect, 60-day rollover will be subject to mandatory withholding and to complete the rollover of the entire distribution you would have to substitute other funds to replace those withheld for taxes.
Distributions from an IRA are *not* subject to mandatory withholding, but 10% must be withheld unless ones specifies that nothing be withheld or that more than 10% be withheld. By performing a direct rollover of some or all of the 401(k) to an IRA, then taking a distribution from the IRA and specifying that no taxes be withheld, withholding on a distribution can be avoided.
You decision on how much to roll over from the 401(k) to the IRA will depend on how frequently your 401(k) plan permits you to take distributions (for a solo 401(k), probably unlimited), whether or not the investments available in the 401(k) plan are more desirable than the investments available in an IRA, whether or not your state provides any bankruptcy protection in the solo 401(k) over that of an IRA, and whether or not your state provides any state tax exclusions for distributions from a solo 401(k) but not from an IRA. You'll likely also want to keep your solo 401(k) balance under the $250,000 threshold where filing Form 5500-EZ becomes required.
