Filed under: Retirement PlansIn 2001, the government gave self-employed workers a gift: a 401(k) plan that allows for greater amounts of tax-deferred income with less hassle to set up than any other retirement plan. The new plan, mostly called a Solo 401(k) or a Solo-k, beats traditional corporate 401(k)s in higher savings limits and in the ability to invest in a variety of options.
You are an excellent candidate for a Solo-k if:
- You are self-employed or a solo-business owner and have no full-time employees (except for your spouse).
- You have enough profit/earnings to save up to $52,000 (younger than 50) or $57,500 (50 and older) and still pay your mortgage, eat and pay taxes. Your spouse can save the same amounts depending on her earnings.
- You need to boost your retirement savings because you are behind.
- You wish to pay less taxes.
- You like the tax-free benefits of a Roth Individual Retirement Account, but haven't been able to open one due to income limitations.
- You want the option to take out a loan if necessary.
- You income is inconsistent, and you want flexibility in the amount you save each year.
- You don't like lots of paperwork and complicated requirements.
- Open your Solo-k (or direct your financial adviser to open it for you) at a plan sponsor, including TD Ameritrade (AMTD), Charles Schwab (SCHW), T. Rowe Price (TROW), Fidelity or many other financial institutions. In addition to the application, you will sign an adoption agreement. The deadline for establishing a Solo-k is Dec. 31 of the year in which you like to receive the tax deduction, or for corporations, at fiscal year-end. There is no extra paperwork or annual reporting requirement until the account balance reaches $250,000, and then it is minimal.
- Each year, decide how much to contribute to your plan and whether you want to make a pre-tax or after-tax contribution. Acting as an employee, you can defer up to $17,500, plus $5,500 if you are 50 or older. As the employer, you can make a profit-sharing contribution up to 25 percent of your W-2 earnings or 20 percent of your net self-employment income. Total possible contribution in 2014: $52,000, plus $5,500 in catch-up. If your spouse works in the business, these limits apply as well for a total contribution of $104,000/$115,000.
- As with anything related for the Internal Revenue Service, deadlines aren't negotiable. They are slightly different depending upon whether your business is incorporated (C, S, Partnership) or not (Sole P, LLC). For corporations, the deadline to make employee salary deferrals is 15 days after the close of the fiscal year, and for the unincorporated, the deadline is April 15 plus extensions. For the profit-sharing amount, the deadline is the same for both: tax filing deadline, plus extensions.
- Invest the funds. You can do this yourself or work with a financial adviser. Depending on the plan sponsor (your 401(k) custodian), you can invest in a wide array of mutual funds, exchange-traded funds, stocks and even alternative investments.
Many self-employed business owners have a SEP IRA. This isn't a bad choice, but once your business takes off, you can sock so much more away in a Solo-k. For example, a sole proprietor under the age of 50 making $150,000 in net pre-tax business profit can save $45,467.00 to a Solo 401(k), while the same person could contribute $28,147.48 to a SEP IRA. This equates to thousands of dollars in tax savings.
You can borrow against your Solo 401(k) limited to $50,000 or half of your account balance, whichever is smaller. Caveat: some plans do not have a loan feature; be sure and check if this is important to you.
Designated Roth Accounts in a Solo-k have unique features. The Roth contribution limits don't apply to designated Roth accounts in a Solo-k, making it possible for high-income earners to take advantage of the Roth's long-term tax-free benefits.
Roth 401(k)'s are subject to required minimum distributions at age 70½. However, you can avoid those distributions by rolling the Roth Solo-k into a Roth IRA at retirement.
Not all Solo-k plans allow a Roth feature, so be sure and check with the plan sponsor if this option is important to you.
One last note: if your business is growing and you plan to hire full-time employees down the road, it makes more sense to set up a traditional 401(k) plan. But if you are committed to staying Solo, the Solo-K is for you.