Saving Solo: 401(k) Retirement Plans for the Self-Employed. Often called a Solo 401(K) or Individual 401(K) this plan can help you slash your tax bill. Not to menetion stay on track for your retirement goals.
What solopreneurs, freelancers and small business owners need to know and need to do to fund their retirements utilizing a solo 401(K) Plan.
By David Rae Certified Financial Planner™, Accredited Investment Fiduciary™
Update: Contributions limits have increased for 2018 to a total of $55,000. The New GOP Tax Bill will make these plans even more valuable for many small business owners. Talk to your Financial Planner and CPA about the 20% pass through tax break.
The fastest way to clear a crowded room is not to run in and yell, “Fire!” but to walk in and start talking taxes and retirement planning. But hear me out. If you are a solopreneur, freelancer or small business owner, you’re going to want to stick around for this. The responsibility for picking out – and sticking to – a retirement plan falls squarely on your shoulders, as you probably know. But here’s some good news; setting up a retirement plan for yourself doesn’t have to be complicated or expensive.
If nothing else these retirement plans can help you minimize you current tax bill. Do you really want to write a check to Donald Trump?
Many millions of self-employed Americans think they are too small to set up their own 401(k) plans. They also fear large bills to set up and manage the plans. While setting up a solo 401(K) plan is more involved than a basic IRA or investment account, the benefits can far exceed the trouble and cost.
To minimize your current income tax bill, retirement contributions may be a good way to go. If you are able to save more than the $5500 per year allowed for a traditional or ROTH IRA you may want to discuss a Solo 401(k) retirement plan with your trusted fiduciary financial planner.
Here are the three biggest ways you can benefit from a Solo 401(k) for your owner only business.
1) Tax-deferred investment up to $55,000 per year (plus $6000 more if you are 50+)
For many business owners who’ve spent years building their business, there hasn’t been much time planning for retirement. This option can be a good opportunity to play catch up. Since you are the owner and employee you can have some flexibility to pay yourself a profit sharing contribution. This is on top of contributing as an individual.
The biggest advantage a Solo 401(k) profit sharing plan compared to other retirement accounts is the ability to make higher contributions. A business owner can potentially contribute up to $55,000 per year into the plan for themselves. And if you are older than 50, that figure jumps to $61,000 per annum. Contributions this large could drastically cut your current tax liability on current income. Would you rather write a large check to the IRS or contribute to your own retirement account? I would love to save people are saving to for retirement to ensure their financial security. In reality I know many are motivated by the huge tax savings.
2) Individual 401(k) plans for multiple owners and spouses
These plans could be a good fit for businesses with more than one owner. The benefits or tax deferral can potentially apply to multiple owners as well as spouses who receive income from the business. Discuss with your tax pro and fiduciary financial planner how partnerships and collective owners can leverage these vehicles in their favor.
Be aware that once a business hires employees who do not hold ownership of at least 5% in the company, they will be required to use the more traditional 401(k) plans. This can potentially increase the cost of the plan. Requiring employee matches or allocation of a portion of profit sharing contributions to non-owners. The plans can still be structured to heavily favor the owner. Vesting schedule also require employees to work for your for several years before they are allowed to keep the full amount of money you put in for them.
3) Solo 401(k) plans that minimize the annoyance of some complex regulations
401(k) plans are often considered onerous and complex because of all the government regulations that cover things like nondiscrimination and other tests that confirm a plan benefits all employees. Since a solo 401(k) just covers owners and their spouses there is no conflict of interest and no added testing. A little more paperwork than opening a traditional IRA. But way more potential tax savings.
If you think a solo 401(k) profit sharing plan might benefit you and your retirement plan, contact your trusted fiduciary Certified Financial Planner™. You must set up your plan by December 31st, but you have until you file your taxes to make your contributions.
Extra credit- Defined Benefit Plan Solo 401(K) combo
If you are already maxing out your 401(k) contributions, you might wanted to consider adding a Defined Benefits Pension plan for potentially even more tax deferral. I just set up a Defined Benefit plan for a new client. He was able to contribute an additional $111,000 on top of his solo 401k plan.
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Being in business for yourself means you’ve chosen to live your own way and on your own terms. Taking advantage of Solo 401(k) benefits can see to it that you can retire your own way and on your own terms too.
Live for Today, Plan for Tomorrow.
DAVID RAE, CFP®, AIF® is a Los Angeles fiduciary financial planner with DRM Wealth Management, a regular contributor to Advocate Magazine, Huffington Post, Investopedia not to mention numerous TV appearances. He has been called a “Tax Wizard” on ABC Nighltine. He helps smart business owners across the USA get on track for their financial goals. For more information visit his website at www.davidraefp.com
The opinions voiced in this article are for general information only. Talk to your advisor to pick the best small business retirement plan for you.