Managing 401 Plans For A Small Business
Setting up a 401 can be complicated, but you don’t have to do it alone. Look for a provider with an excellent track record that can help you get started, manage your plan, and even share ideas and guidance to maximize the value to you and your employees. Doing so can go a long way in ensuring an ongoing, positive benefit for years to come.
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Our reporters and editors focus on the points consumers care about most how to save for retirement, understanding the types of accounts, how to choose investments and more so you can feel confident when planning for your future.
What Are The Potential Tax Benefits Of A Solo 401
One of the potential benefits of a Solo 401 is the flexibility to choose when you want to deal with your tax obligation. In a Solo 401 plan all contributions you make as the “employer” will be tax-deductible to your business with any earnings growing tax-deferred until withdrawn. But for contributions you make as an “employee” you have more flexibility. Typically, your employee “deferral” contributions reduce your personal taxable income for the year and can grow tax-deferred, with distributions in retirement taxed as ordinary income. Or you can make some or all of your employee deferral contributions as a Roth Solo 401 plan contribution. These Roth Solo 401 employee contributions do not reduce your current taxable income, but your distributions in retirement are usually tax-free. Generally speaking, there are tax penalties for withdrawals from a Solo 401 before 59 1/2 so be sure to know the specifics of your plan.
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Selecting A Brokerage Firm For Your Solo 401k
When selecting a brokerage firm for your solo 401k, you want to select the firm that offers the most options.
If you’re okay with a prototype plan, you can use our Solo 401k Brokerage Comparison to see which major firms offer the options you’re looking for.
If you’re using a custom solo 401k plan, you need to take your solo 401k documents to the brokerage of your choice and they will open a custodial account on your 401k’s behalf. Some firms offer this service, and others don’t. For example, Fidelity and Charles Schwab are two brokerage firms that allow for customers to use third-party 401k plans with their brokerage services.
However, when using a third party plan, it adds to the complexity of using a solo 401k. For instance, as a custodial account, the firm will not keep track of your trades and investments – that’s your responsibility. If you need to fill out tax forms, such as a 1099-R, these firms will not help you. You either have to do it yourself, or pay someone to do it for you.
We decided to go with ETrade for our Solo 401k because they had the most robust free plan.
What Is A 401k Retirement Plan
A 401k retirement plan is a retirement savings plan or fund sponsored by a business. Typically, an employer will withhold a certain amount of an employees pay, add to it, and then transfer it into a 401k in the employees name.
Many companies offer a 401K retirement plan as part of their overall benefits package. This is designed to attract top talent and to keep them. Lets give an example of how this could work.
Jimmys Juice, located in a suburb of Chicago, is a fruit juice manufacturer. Although not a huge company, profits have been steadily increasing since it opened for business three years earlier. Back then, Jimmy Johnson, the companys owner, could not offer much for his employees in the way of benefits except what was mandated by law. Recently he introduced a 401k plan for his employees.
Sarah Thompson works for Jimmy. Her salary is $60,000 per year. She contributes a certain percentage of her paycheck to this new 401k plan. The payroll department at Jimmys company routes this money directly into an account theyve opened in Sarahs name, meaning deposits into it will never actually pass through Sarahs hands.
Sarahs contributions equal $8,000 over the course of the year. The IRS now looks at Sarahs gross income for the year as $52,000, not $60,000. For this reason, less tax has been taken off her regular biweekly paycheck.
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Figure Out What You Already Have
Take stock of all the money and assets that you have saved. If youre just starting and you dont have much, thats fine. But understand what you do have so that you can build off it and make it work for you.
Sometimes people overlook money that they have saved in a previous employers 401. If you have money in a 401 account that you no longer use, consider an IRA rollover. You can usually transfer the money into your current employers 401 without having to pay any taxes or fees. You could also open an IRA and transfer the money into that account. Either way, dont lose progress youve already made toward your retirement plan.
Look over any investments you have and make sure they align with your retirement goals. If you plan to retire in 10 years, you probably dont want all of your savings invested in high-risk stocks. Though it depends on your plan. Maybe you do have some savings that you want to invest in higher-risk stocks. And if you arent sure how to allocate your investments, you should consider getting the help of a financial advisor.
Should You Do A Roth Solo 401k
One of the options that’s become important is allowing for a Roth solo 401k. Surprisingly, many brokerage firms currently don’t allow a Roth solo 401k, but it can be a valuable option.
When it comes to your solo 401k, it’s important to remember that you have two aspects of contributions to your plan:
Where a Roth option comes in handy is if you’re looking for tax diversification. With Roth contributions, you are using post-tax money. So, you will pay more in taxes today, but you will pay less in the future. However, if you’re putting in large profit sharing contributions into your solo 401k, then it might make sense to make Roth contributions.
The reason? It will give you tax diversification in retirement. You can choose whether you use taxable or tax free money in the future – and options are always great.
The important thing to remember here is options. You just want the options to be able to invest how you choose.
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Contribution Limits For Self
You must make a special computation to figure the maximum amount of elective deferrals and nonelective contributions you can make for yourself. When figuring the contribution, compensation is your earned income, which is defined as net earnings from self-employment after deducting both:
- one-half of your self-employment tax, and
- contributions for yourself.
Use the rate table or worksheets in Chapter 5 of IRS Publication 560, Retirement Plans for Small Business, for figuring your allowable contribution rate and tax deduction for your 401 plan contributions. See also Calculating Your Own Retirement Plan Contribution.
How To Start A 401
Setting up a 401 plan can be as simple or as complicated as you like. Most people outsource at least some portion of the process. In particular, they use a template legal document to establish the 401 plan, which is substantially less expensive than hiring attorneys to draft original documents. Unless your retirement plan is especially complicated or youre trying to get fancy , youll probably use preconfigured programs from 401 vendors. These programs are often called volume submitter or prototype plans, and theyre an excellent choice for most companies and nonprofits.
Here are the crucial pieces of any 401 plan. While this list seems extensive, in some cases, a single company provides several of these services.
The plan document is a legal document that details the rules of your 401 plan. It defines specific terms, and provides a roadmap for any questions that come up when administering the plan. The plan document is a long legal document that most people never see. Instead, employees receive a shorter version of the document, known as the Summary Plan Description , when they enroll in the plan. For reference, heres a sample of a plan document.
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How Do You Open A 401
Do the following to open your 401:
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The thrill of funding the next big thing makes investing in a startup exciting, however, it also includes a high degree of risk. Crowdfunding or focused investment platforms are a few ways that startups reach out to both potential investors and future customers.
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Step : Form A Legal Entity
Establishing a legal business entity such as an LLC or corporation protects you from being held personally liable if your Retirement Community is sued.
Form Your LLC
You can start an LLC yourself and pay only the minimal state LLC costs or hire one of the Best LLC Services for a small, additional fee.
Recommended:You will need to elect a registered agent for your LLC. LLC formation packages usually include a free year of registered agent services. You can choose to hire a registered agent or act as your own.
What’s So Great About 401 Accounts
A 401 is a popular type of employer-sponsored retirement plan that’s available to all employees 21 or older who have completed at least one year of service with the employer, usually defined as 1,000 work hours in a plan year. Some employers enable new employees to join right away, even if they haven’t met this criterion yet.
In 2021 you’re allowed to contribute up to $19,500 to a 401 or up to $26,000 if you’re 50 or older. These limits are much higher than what you find with IRAs, and they enable you to set aside a fairly large sum annually.
Most 401s are tax deferred, so your contributions reduce your taxable income each year. You must pay taxes on your distributions in retirement, but you may be in a lower tax bracket by then, in which case you would save money. Some employers also offer Roth 401s. You pay taxes on contributions to these accounts now, but you’ll get tax-free withdrawals in retirement.
Some employers also match a portion of their employees’ 401 contributions, which can make the task of saving for retirement a little easier. Each company has its own rules about matching, so consult with your HR department to learn how yours works.
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What Other Options Do I Have
If you work for a nonprofit or other tax-exempt organization, a 403 plan is another great pretax investment option that works a lot like a 401.
Federal employees can save for retirement through the Thrift Savings Plan . TSPs usually come with matching contributions and allow you to make after-tax contributions with the added plus of tax-free withdrawals when you retire. You can also choose how to split your TSP contribution among several investment options.
What Are Some Regulations On Self
The self-employed 401 plans have several regulations designed to help you contribute towards retirement. Here are the main solo 401 rules:
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If you withdraw from the account before age 59½, you may pay a 10% early withdrawal penalty and applicable income taxes.
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Once you reach age 72, in accordance with the SECURE Act,* you must take Required Minimum Distributions .
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You may structure the plan to fund loans and hardship distributions.
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They may transfer savings from another compatible 401 plan or an IRA account into a self-employed 401.
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If your business adds employees later, you must either convert the solo 401 to a standard 401 or close the account.
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Gift Solo 401k Question:
- Neither the IRA nor the solo 401 regulations allow for gifting retirement money.
- The rules do not allow for transferring, assigning or gifting of solo 401k funds during the account owners lifetime.
- The only exception to the no transfers during life rule is for transfers due to divorce where the solo 401k funds are transferred to the ex-spouse to satisfy a QDRO.
Who Can Have A Solo 401 Plan
You can open an individual 401 if:
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You make self-employment income through a product or service such as working as an independent contractor, painting, or driving for ride-hailing companies.
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You own a sole proprietorship, a limited liability company, limited partnership, S corporation or, C corporation.
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You are the only employee in your business.
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Taking Rmd From Roth And Pretax Solo 401k Funds Question:
With respect to taking the RMD from the solo 401k plan, the standard practice is to take a separate RMD amount from each account . In that case, two separate calculations would need to be performedone on each source . If the plan allows you to do so, however, the amount of the distribution may be aggregated across account balances meaning that the total required minimum distribution amount can be satisfied in any combination between the two accounts. Please note that our Solo 401k plan would allow for this approach to satisfy the RMD requirement. A scenario where this approach may be preferable would be one where the requirements to make a qualified Roth distribution have not been satisfied .
How To Set Up A 401k For A Small Business
Setting up a 401 for your small business includes some crucial steps, some of which can be outsourced. It’s important to remember that the employer maintains a fiduciary duty to ensure that the plan is providing a benefit to participants. The U.S. Department of Labor provides in-depth details of the process:
1. Create a 401 plan document
Create a plan document that complies with IRS Code and outlines the details of your retirement plan. Set up procedures to ensure the document is followed.
2. Set up a trust to hold the plan assets
A plan’s assets must be held in trust to assure its assets are used solely to benefit the participants and their beneficiaries. At least one trustee must handle the plan’s activities regarding contributions, plan investments, and distributions. Given that these decisions affect the plan’s financial integrity, selecting a trustee is a critically important decision. Another fiduciary, such as the employer who sponsors the qualified retirement plan, will generally assign the trustee.
3. Maintain records of 401 employee contributions and values
Maintain accurate records that track employee contributions and current plan values. Many small businesses choose to work with a 401 recordkeeper to help them manage plan setup and ongoing record management.
4. Provide information to plan participants
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Bankruptcy & Creditor Protection For Solo 401k Plan
QUESTION 4: I am trying to better understand the protections of the solo 401k. I believe it qualifies for unlimited bankruptcy protection, but does it also have unlimited lawsuit protection under ERISA ?
ANSWER:
- Bankruptcy: Solo 401K plans have creditor protection under the federal bankruptcy rules.
- As far as protection from non bankruptcy creditors, the protection falls at the state level. While solo 401K plans are not covered by the federal creditor protection rules of ERISA, they are generally protected under most state laws subject to certain carve outs .
Deadline To Set Up And Fund
- For taxable years 2020 and beyond, individual 401 plans may be set up by tax filing deadlines plus extensions. Note: It can take 30 or more days to establish a plan.
- Salary deferral portion of the contribution must be deducted from a paycheck prior to year end, with some exceptions for certain business structures.
- Business owner contribution may be made up through the business tax filing due date plus extensions.
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Ira Or Solo 401k Question:
They both allow for investing in alternative investments including real estate, but the solo 401k is generally more advantageous. For example, the contributions limits are higher for a solo 4o1k plan, you can borrow from a solo 4o1k plan, and the ongoing fees are also generally much less. See the following link for more on this.
