When you’re self-employed, you can feel like you’re all on your own. For everything.
Fortunately when it comes to your retirement savings, there’s a little known savings device for the self employed that is far more beneficial than a traditional 401k plan. It’s called a solo 401k retirement plan.
A Solo 401k is the term for a one-participant 401k plan that is designed for sole proprietors, independent consultants and small business owners with no employees other than the owner and his or her spouse. Any business that is classified as an LLC, sole proprietorship, partnership or corporation can set up an individual 401k, as long as there are no employees that work more than 1,000 hours per year.
The individual 401k, which is also referred to as a Single 401k or Personal 401k, is very similar to a self-directed IRA, but you don’t have to hire a custodian or trustee. You can keep that money in your pocket, meaning you don’t have to pay as much to pay yourself.
The Solo 401k is very popular because it was established by the IRS specifically for self-employed individuals and therefore, offers them significant benefit. Here are some of the advantages of having an individual 401k plan.
Why a Solo 401k Retirement Plan is Beneficial:
- Higher contribution limits. IRAs have relatively low contribution limits, currently set at $5,500 for a person younger than 50 and $6,500 for a person older than 50. Individual 401k accounts have much higher limits that are currently set at $52,000, which includes both an employee deferral limit of $17,500 and the profit sharing limit of 25 percent (20 percent for sole proprietorships and LLCs). If there’s anything to know about saving for retirement, it’s that you want to hit those high 401k contribution limits!
- Nearly unlimited investment opportunities. You are able to invest in just about any commodity you choose, including real estate, peer-to-peer lending, private businesses, precious metals, stocks, mutual funds and so on. You are only limited to your imagination. Any gains you earn from these investments are returned to your personal 401k account on a tax-free basis. Moreover, while you have more responsibility as to the management of your account, the process is as simple as writing a check. You do not have to get consent from a custodian to make your transactions, giving you the freedom to manage them as you see fit.
- Loan Capabilities. With an IRA, you cannot take out a loan even if your business needs the money to stay afloat. With a 401k, however, you can take a loan of up to $50,000 or 50 percent of the balance, whichever is less. You pay yourself back with interest, but you don’t have to qualify for the loan or wait a specific period of time for a loan to be approved. You can make the request and have your money within a week if you need it to keep your doors open. Most experts recommend against taking out a loan on your 401k, but as a business owner, you know that sometimes you need that extra cash when times are difficult.
- No Custodian fees. Since you do not have to have your individual 401k managed by a trustee or custodian, you also don’t have to pay their fees. You are the trustee and you have complete control over the fund’s management. You can open a Solo 401k at any bank or credit union, both of which do not charge custodial fees as they do for an IRA.
- Flexible contribution rules. As you know, some years are better than others for your business. You might not be able to contribute as much to your 401k this year as you did in the past. Fortunately, this is perfectly fine with a Single 401k. You don’t even have to contribute anything if you don’t want to. This allows you to manage your future needs with your present needs to make the best decisions for your business and your family.
- Easy to Administer. Other than managing your investment, the individual 401k is simple to operate. You usually won’t even have to file a tax form for your account unless it is larger than $250,000. In that case, you would file a short information return at the end of the year.
- Tax deduction for business expense available. Since you pay for your individual 401k with business funds, you can claim a deduction for any costs associated with your plan, including maintenance fees. This deduction can help you lower your overall income tax liability for your business. Be sure to seek advice from a tax expert to make sure you claim this expense correctly.
- Retirement fund consolidation. With the exception of a Roth IRA, most retirement savings accounts can be rolled over to your Solo 401k account. This will allow you to have all of your savings in one place. It also allows you to have access to more money if you need a business loan.
- UDFI Exemption. If you use a self-directed IRA to purchase real estate, you automatically create Unrelated Debt Financed Income, which requires you to pay 35 percent taxes on the amount you used to buy the property. With an individual 401k, though, you are exempt from this tax, giving you better tax benefits over an IRA.
You already know you need retirement accounts to help you save for your future. However, you might not have realized that a Solo 401k is superior to the retirement plans that have been available to self-employed individuals in the past. If you don’t have an individual 401k yet, it would be wise to start looking into one as soon as possible to make your life as a business owner a whole lot easier.
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