What Is A Self
This plan goes by many names, including solo, individual and single-k, but they all refer to a 401 retirement savings plan for a self-employed person. You can contribute a large amount of money to this plan every year and then start taking distributions from the account after you turn 59.5 years of age.
Key takeaway: A self-employed 401 plan is a retirement savings plan started and contributed to by a self-employed person.
Things To Consider When Opening A Solo 401k
If you’re considering opening a solo 401k, there are a few things to consider when it comes to plan features.
There are five key areas that you need to decide before you open your solo 401k:
Everyone who opens a solo 401k will have different requirements. However, I would recommend you open a solo 401k plan with the most options and flexibility. While you can always amend your plan documents, it can be a hassle and can cost you money . As such, it makes sense to create a solo 401k plan with the most options up front.
What Does A 401k Do
A 401k allows employees of companies in the United States to save money in a defined contribution retirement account that is tax deferred. This deferral is an incentive for people to save so they will have an income stream upon retirement. Typically, any income contributed to a 401k in a given year will not be subjected to tax in that same year .
The IRS places limits on individual contributions every year, although the United States government allows for top ups in certain situations if you are over the age of 50.
The money will only be taxable when it is removed from the account.
The 401K was introduced in 1978 and the name refers to the section of code assigned to it – Section 401. Plans similar to that of a 401k exist in other countries. In Australia, the program is called Superannuation, in Canada it is referred to as an RRSP and in Japan it is called iDeCo.
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What Else Do I Need To Know
Here is some more important information that you need to know as a business owner when considering starting a 401 plan.
A 401 plan is considered a qualified plan, under IRS rules. That means it must meet the requirements of the Internal Revenue Code for this type of retirement plan, which include issuing periodic reports about the plan to participants and the IRS.
The 401 and some other types of employer-sponsored retirement plans are called defined contribution plans because the contributions are defined, but not the benefits, as is the case with traditional pensions. The value of the account changes with the level of contributions and the performance of the persons investments.
Contributions to deferred retirement plans, including 401 plans, are not taxed initially. But the account owner must pay tax on the investment and earnings when they are taken out of the plan, at retirement or under specially allowed circumstances.
Who Is Eligible For A Solo 401
Solo 401 plans are intended for the self-employed. If you have employees and are looking for a retirement plan, then you have other options such as the or SIMPLE IRA, both of which allow you to provide tax-advantaged benefits to your employees. A lesser-known program called a SIMPLE 401 also allows businesses to set up retirement plans.
While solo 401 plans are intended for one-person businesses, there is an exception. The spouse of the business owner can also participate in the plan. With a spouse in the plan, your small business can really stash away cash for retirement. A qualifying couple could save as much as $114,000 annually in the plan, and even more if they were eligible for catch-up contributions.
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Can I Set Up A 401k For My Llc
The federal tax law allows employees to participate in their employers 401k plan to take advantage of the tax deferral on contributions to the retirement account. However, if you are a self-employed member of a small business that operates as an LLC, the IRS allows you to set up a 401k plan for yourself.
Before you begin investigating investment options for your 401k plan, you must ensure that the IRS considers your activities within the business as self-employment. The IRS doesnt consider a members passive involvement in an LLC as self-employment when no services are provided to the business. In order to set up a 401k, you must actively engage in the management and operations of the business. In making this determination, it is irrelevant whether you receive a salary from the LLC or periodically take profit distributions.
Importance Of Selecting The Right Solo 401 Provider
There are several companies on the internet that advertise themselves to be a Solo 401k plan provider and expert. However, in most cases, the specialists who draft your Solo 401k Plan documents, as well as advising you, are not educated or trained tax attorneys or even tax professionals.
Many times, a salesperson or representative of a Solo 401k plan provider will offer you tax or ERISA guidance with respect to a 401 Plan feature or an investment, while lacking the adequate knowledge or expertise to do so. They may even tell you that you dont need a trained tax attorney or specialized 401 plan tax professional to help you establish the plan. As a result, we have had to, on many occasions, help individuals who worked with a number of these companies who found themselves in some IRS trouble because they have made improper plan contributions or invested in a prohibited transaction as a result of being mislead by a Solo 401k plan provider representative that was not qualified to provide proper tax advice regarding the unique features of the Plan.
Working directly with a 401 Plan tax professional that has been specifically trained on the special tax aspects of the Solo 401k Plan to establish and maintain your Solo 401k is the only way you can guarantee your plan will remain in full IRS compliance and that you will not be engaging in any plan activities not approved by the plan or the IRS.
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Managing Your Retirement Funds
It’s important to start saving for retirement as soon as you begin earning income, even if you can’t afford to save that much at the beginning. The sooner you begin, the more you’ll accumulate, thanks to the miracle of compounding.
Let’s say you save $40 per month and invest that money at a 3.69% rate of return, which is what the Vanguard Total Bond Market Index Fund earned across a 10-year period ending in December 2020. Using an online savings calculator, an initial amount of $40 plus $40 per month for 30 years adds up to just under $26,500. Raise the rate to 13.66%, the average yield of the Vanguard Total Stock Market Index Fund over the same period, and the number rises to more than $207,000.
As your savings build, you may want to get the help of a financial advisor to determine the best way to apportion your funds. Some companies even offer free or low-cost retirement planning advice to clients. Robo-advisors such as Betterment and Wealthfront provide automated planning and portfolio building as a low-cost alternative to human financial advisors.
Take Your First Step Confidently
Starting down the path to saving for your retirement may be easier than you think: Begin by enrolling in your 401, 403, or other available workplace savings plan. That’s it. You don’t have to be a financial guru. It won’t take long at all to set up.
Taking that first step to enroll is important for a number of reasons. The earlier you start saving, the more time your money has to grow. That’s called compounding, and it can really help you reach your retirement savings goals. See the illustration on the right.
You’ll also gain a sense of achievement and maybe even some momentum to take the next step, whether it’s getting back on track after an event in your life has slowed your savings, or creating a plan for living out your dreams in retirement.
No matter where you are in life, know that you can take steps toward retirement confidently with the knowledge and tools you’ll find from Fidelity.
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How To Open A Traditional And Roth Solo 401k
Opening a solo 401k for your small business can make a lot of sense financially. When you’re self employed, the solo 401k allows you to save the most money versus all of the other self employed retirement plans . It is even better if you and your spouse run your business together, because you can save even more with your spouse.
But setting up and opening your solo 401k plan can be confusing. There are a lot of options to consider, and you want to select a plan that offers flexibility for the future. Unlike a SEP-IRA, there is a lot more paperwork to fill out, and there are more potential fees to consider.
Solo 401 Contribution Limits 2020
This is one of the coolest parts of having a solo 401 you can contribute nearly three times as much as you could to a 401 through a corporate employer!
Solo 401 contributions have two components: the employee component and the employer component .
Now, the contribution limits are based on ones earned income, so before we get into the specifics of the contribution amounts, we first have to discuss what earned income means in this context.
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You Can Take A Loan From Your Solo 401
Most solo 401 providers let account owners take out 401 loans from their accounts. With a Solo 401, you can borrow up to the lesser of 50% of the plan value or $50,000. You must pay back the loan in five years or lessunless its used to buy a primary residence, in which case you have up to 30 years.
Just because youre borrowing from yourself doesnt mean it wont cost you. Youre required to pay your account interest comparable to what youd pay for a similar non-401 loan. Youll also miss out on potential returns that money would have earned if it had stayed invested. While you will eventually earn what you borrow back, plus interest, that interest rate may be less than the returns the money would have earned if you had left it untouched and invested in the stock market.
Understand The Eligibility Requirements For A Solo 401
Because IRS regulations say Solo 401 plans can only have one participant, these plans are only appropriate for self-employed individuals and small business owners who have no full-time employees. Solo 401 plans will require a plan administrator, also known as an investment provider, wholl help ensure regulatory paperwork is completed. If you plan to hire full-time employees in the future, a Solo 401 plan can convert easily to accommodate additional full-time employees within the companys 401 plan.
An alternative to the Solo 401 is the simplified employee pension individual retirement account . While both plans allow you to contribute a maximum of $58,000 each year, the SEP-IRA only allows you to contribute up to 25% of your income or $58,000, whichever is less. Also, if you have a SEP-IRA and hire additional full-time staff, you are required to make contributions for those employees whenever you make contributions for yourself. That said, a SEP-IRA can be rolled over to a new 401 plan, whether it be solo or traditional, should you unexpectedly need to hire staff.
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Employer Component: Employer Nonelective Contribution
The second component of solo 401 contributions is the nonelective contribution available to you as your own employer.
This contribution amount is based on a percentage of your earned income:
- Corporation shareholder-owners can contribute up to 25% of their W-2 wages.
- Sole proprietors can generally contribute up to 20% of their earned income.
Research Retirement Options For Your Business
It’s important to do your due diligence in researching firms that provide recordkeeping and third-party administration services for 401 plans. As you assemble your list, include a range of established, reputable mutual fund companies, brokerage firms, and insurance companies. Focus on providers that can serve you and your employees long-term with extensive resources and excellent customer service.
You may also want to hear from owners of businesses that are similar to yours, as they may be able to offer insights from their own experiences selecting 401 plan service providers.
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What To Look For In A Solo 401k
Going through the process of shopping around for a solo 401k provider, I’ve learned a lot about what to look for. There are a lot of options and nuances that you should look for when shopping for a 401k. Many of the “free” providers offer simple generic plans, and if those don’t work for you, you can have a third party provider create a custom 401k plan for your business, which you can then take to a brokerage.
Whoa, that sounds confusing, and it can be. So let’s look at the major options that you need to consider when selecting a solo 401k provider.
- Does the 401k provider offer both Roth and Traditional contributions?
- Does the 401k provider offer after-tax contributions to do a mega backdoor Roth IRA.
- Does the 401k provider offer loans from the plan?
- What types of investment options are allowed in the plan?
- Does the provider allow rollovers into the plan and rollovers out of the plan?
- The costs to maintain the plan
- The costs to invest within the plan
Based on your wants and needs, there are a lot of things to compare when shopping for a solo 401k provider. Let’s compare some of the main firms that offer solo 401ks. We’re going to start with the 5 major firms that provide Prototype Plans. These are the “free” plans that the companies advertise.
Should I Choose A Traditional Or Roth Solo 401
For many investors, deciding between a traditional or Roth solo 401 comes down to whether you believe youre in a lower tax bracket today than you will be in retirement. If you think you are paying lower taxes now, you might choose a Roth solo 401. If you anticipate being in a lower tax bracket in retirement, a traditional solo 401 may be a better bet.
Theres another wrinkle with a Roth solo 401 account: You can only contribute up to $19,500 in 2021 , plus catch-up contributions of $6,500 if youre 50 or older. If youre able to save more than this amount, you will need to contribute the extra into a traditional solo 401 account. You can make both employer and employee contributions to a solo 401, but your employer contributions cannot be saved in a Roth account.
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Important Guidelines To Operating A 401k Account
Dont postpone participating in 401k, even if you think you cant afford it. So long as you want a beautiful retirement, the sooner you start contributing, the better off you are going to be in retirement.
Which is why we encourage college students to start a 401k plan. No matter how small you set aside from your earnings, say one or two percent, it will make a big difference.
A 401k is a retirement plan and not a savings account. So, money you place in a 401k will not be easy to access in an emergency. While some plans allow loans and hardship withdrawals, the rules governing such 401k plans are restrictive.
Your 401k plan sponsor, that is, your employer, should provide you with a Summary Plan Description. Request for it if your employer doesnt provide you with one and read it! It contains a lot of good information regarding the working of the plan, what options are available to you, who the trustees are, and other important information. You can always ask for another Summary Plan Description if you misplace your copy.
Because you are the only person who has your own full interest at heart, it is up to you to ensure that you know what your plan is all about and how to take full advantage of it.
So you have to adequately educate yourself on the 401k plan. Go to all educational opportunities that your employer offers. Read all the material your employer provides on the 401k plan and ask questions where you dont understand something.
How Do Small Business Owners Choose The Best 401 For Their Needs
To find the right 401 for their small business, employers generally look for plan providers that:
- Charge reasonable plan and investment fees and have no hidden costs
- Provide real-time integration between the 401 recordkeeping and payroll systems to eliminate manual data entry and reduce errors
- Offer a simplified compliance process
- Make administrative fiduciary oversight available
- Offer ERISA bond and corporate trustee services
- Help with investment fiduciary services and plan investment responsibilities
- Make investment advisory services available for employees
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Strategies For Saving When Youre Self
The joys of self-employment are many, but so are the stressors. High among those is the need to plan for retirement entirely on your own. You are in charge of creating a satisfying quality of life post-retirement. When it comes to building that life, the earlier you start, the better. Luckily, there are several retirement plans for those who are self-employed.
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