Solo 401K

The Big Benefits of an Individual 401(k)

Being a small business owner may be one of your dreams come true. Making all the business decisions and calling all the shots sounds great, most of the time.  If there’s a downside, it may be the lack of an employer-sponsored retirement plan. If you’re self-employed, you’re on your own when it comes to retirement saving.  However, the Solo 401 (k) (One Participant 401k Plan), for those who qualify, can be one of the most attractive plans available.

The self-employed aren’t limited to traditional IRAs.  The Solo 401 (k) is an employer-based retirement plan that offers higher contribution amounts and potential tax deductions.   

What is an Individual 401(k)?

An individual 401(k), also known as a Solo 401(k) or One-Participant 401(k), is a retirement plan for small business owners with no full-time employees other than the owner and his or her spouse. The small business may be any type of business – such as a sole proprietorship, partnership, LLC, or corporation – that has earned ordinary income or self-employment income.

Setting up an individual 401(k) plan involves choosing a trustee to hold plan assets and executing a written plan agreement. Many trustees or plan providers make the set-up process easy with limited ongoing maintenance. To make full use of a Self-Directed individual 401(k), however, it’s important to choose a provider that offers a full range of traditional and alternative investment options.

With an individual 401(k), the business owner can make contributions in two capacities, as an employer and as an employee, which illustrates one of the plan’s major benefits.

What are the Big Benefits?

An individual 401(k) plan is a great retirement saving opportunity for the self-employed. If you’re eligible for this type of plan, you’ll reap more rewards than you would with a typical IRA.

The benefits of a self-directed individual 401(k) include:

High contribution limits   On the employee side, you can contribute up to 100% of your compensation, up to the annual contribution limits ($19,000 for 2019, or $25,000 for 2019 if age 50 or over).  On the employer side, you can make an additional contribution of up to 25% of your compensation, or net self-employment income. Your total contributions, as both employer and employee, cannot exceed $56,000 for the 2019 tax year.

Flexible annual contributions   Annual contributions are not required. This gives you the flexibility to make a higher contribution in good years or no contribution when business is down.

Tax advantages  Employer contributions are typically tax-deductible as a business expense. Employee contributions can be done pre-tax with a traditional individual 401(k), in which case distributions in retirement will be taxed at a time when you may be in a lower tax bracket. You also have the option of a Roth individual 401(k), in which contributions are done post-tax, but distributions in retirement will be tax-free.

Easy set-up and administration  As compared to the typical employer-sponsored 401(k), the individual 401(k) is easier to set up, and maintenance is less complex. There is no testing required (such as the non-discrimination testing when you have employees), and the plan may be exempt from certain IRS filing requirements depending on the amount of its assets.

Loans. Similar to a typical 401(k) plan, you can borrow against your individual 401(k) plan’s assets. The rules for loans are the same. Your plan document must specify that loans are permitted. If they are, the plan will outline how much can be borrowed as well as the repayment terms for the loan.

Alternative investment options  With a self-directed individual 401(k), you control your portfolio and make your own investment decisions. Unlike a typical 401(k) plan, you’re not limited to traditional mutual fund investments; you can access a variety of alternative assets like real estate, commodities, and private equity.

The Bottom Line

Opening your own business is a great accomplishment. Some days being in charge of all the decisions is empowering, while at other times it may seem overwhelming.  Even so, there are considerable advantages with Self-Directed IRAs and the Individual 401 (k).  Retirement planning can be exciting when you have all the possibilities presented.  Again, for those who qualify, an individual 401(k) is a powerful way to build a sizable retirement savings.