What is a Solo 401k?

A Solo 401(k), (also referred to as a Self Employed 401(k) or Individual 401(k)), is a qualified 401(k) retirement plan for employers that do not have full-time employees other than the actual business owner(s) and their spouse(s). The standard 401(k)...

A Solo 401(k), (also referred to as a Self Employed 401(k) or Individual 401(k)), is a qualified 401(k) retirement plan for employers that do not have full-time employees other than the actual business owner(s) and their spouse(s). The standard 401(k) plan provides an incentive for employees to save for their retirement by letting them allot funds specifically for their 401(k) and not have to pay taxes on the money until the employee retires.

With a Solo 401(k), both the employer and employee make contributions to the plan. This plan is different because it only covers the owner(s) of the business and their respective spouse(s), which means that it is not subject to the complex ERISA (Employee Retirement Income Security Act of 1974) rules. Self-employed workers who meet the requirements for the Solo 401(k) can have the same tax benefits as those with a standard 401(k) plan.

When is a Solo 401(k) a Good Idea?

Solo 401(k) plans are ideal if you intend to set aside a large sum of money. With an individual 401(k), you are allowed to save for retirement both as an employee or as an employer, which usually enables people to contribute more than they would with any other retirement plans.

How so? As an employee, you can put away as much as $18,000. As the employer, you can contribute an extra 25% of your pay, with a limit of $53,000, which includes your employee contribution.

Keep in mind that these contributions are optional, so you can save the maximum during years where you’ve made excess income and then not contribute during years where you income is scarce. If you add your spouse to the plan, and collectively you have a stellar income year, you could save a total of $106,000. If both of you are 50 years old or above and qualified for catch-up contributions of $6,000 per person, the total climbs to an impressive $118,000.

Who Can Contribute?

A Solo 401(k) is firmly for sole proprietors who have no employees unless you have a spouse in which case they contribute if they earn income from your business.

When You Can Get Access to Your Solo 401(k)

Usually, you have to keep the deposited monies in your retirement account until you reach 59 1/2 years of age. If you withdraw money before that age, then you’ll have to pay a 10% early withdrawal penalty, in addition to the income taxes you’ll have to pay on the withdrawn amount.

However, there are a few exceptions to the rule. Every plan’s rules differ, and you may be allowed to take money out of your account penalty-free before age 59 ½ if it’s used for:

  • Qualified medical expenses
  • The purchase of a home
  • Payments you may need to make to prevent eviction or foreclosure
  • Higher education expenses

There are also other options for gaining access to the funds if you really need it.

Getting Money from Your Solo 401(k) Beforehand

Normally, the best solution is to take out a Solo 401(k) loan, that uses the accumulated balance of the account as collateral it to borrow up to half of the total balance so long as the loan doesn’t exceed $50,000. The remaining balance is still invested in your plan, with tax-deferred investment earnings growth.

Your other option is just to withdraw money from your individual 401(k). Just remember that if you choose to do so before the age of 59 ½, you’ll owe a 10% early withdrawal penalty. You’ll also owe income tax on the withdrawal. That’s true even if you have a Roth 401(k). There are, of course, exceptions to this rule as well. The IRS will allow the 10% penalty to be waived for specific “hardship withdrawals” like funeral expenses or large high medical bills that you have to pay out-of-pocket.

How You Should Invest Your Solo 401(k) Money

When your investment goals are long-term, as with a retirement plan, you generally want to give emphasis to stocks, because they have the best chance to generate returns that beat inflation. Adding some cash or bonds to the mix can help decrease the overall instability of your holdings.

How It Will Be Taxed in Retirement

If you go for a Solo 401(k) and set aside money on a pretax basis, your money will grow tax-deferred. Although it will be considered taxable income when you choose to withdraw it. If you invest in an individual Roth 401(k), you deposit after-tax dollars now, and your money grows tax-free, which means you won’t pay taxes upon withdrawal.

The Roth version may make sense if you anticipate your tax bracket to rise considerably by the time you start making withdrawals.

Does a Solo 401(k) Make Sense for You?

These plans are attractive if you intend to sock away large sums – you can contribute up to $53,000 in 2016. But 401(k) plans require more paperwork than SEP IRAs. If your account balance exceeds a certain amount, you have to file a special tax return for the plan, which can add slightly to tax-preparation costs and hassles.

There is no better way to secure your future than using a firm that can properly manage your investments. Please contact us to help you create a stable and reliable financial plan.