You Are A Sole Proprietor: How About A Solo 401(k)

I am seeing more and more people quit the corporate America lifestyle and venture into becoming their own business owner.  This shape of a business owner can be a freelancer, consultant, or someone who actually starts up a ‘brick and mortar’ operation.    Many of these folks will ask questions about whether they should incorporate their business, which I have discussed in other articles.    Once they become profitable, they often ask which kind of retirement plan would suit them the best.   For someone who is a sole business owner, the Solo 401(k) has been around for about a decade and provides a great alternative to helping maximize your retirement contributions.   Here’s a little history on the Solo 401(k) and how it can be a smart money move for your business.

The Solo 401k came about in 2002 after Congress passed Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA). EGTRRA added some small paragraphs to the tax code that put forward the solo 401(k) as the preferred retirement vehicle for those persons that were self-employed.

Before EGTRRA, a self-employed person had the ability to design a 401(k) plan just for themselves. However, there wasn’t a particularly compelling reason to do this because the deduction limit for a 401(k) plan was identical to a SEP-IRA.    Many small business owners set up plans like a SIMPLE IRA or a SEP-IRA because they are slightly easier to administer traditionally than 401(k) type plans.

The tiny paragraph in the EGTRRA changes basically states that the employee contributions to a 401(k) plan do not count toward the deduction limit. Since most business owners I have met over the years are usually interested in maximizing all available tax deductions for retirement, a solo 401(k) plan became preferred to a SEP-IRA.  If the plan is set up correctly, a small business owner can not only put away as the ‘employee’ up to $17,500 per year pre-tax, but you may be able to put away up to an additional $33,500 pre-tax here in 2013 through a profit share to make a total pre-tax contribution of $51,000.

Self-Employed individuals and owner-only (and the owner’s spouse) businesses and partnerships can save more for retirement through a 401(k) plan. The Self-Employed 401(k) allows you to take advantage of this increased retirement and tax savings opportunity with a full range of investment options.

Tax benefits Tax-deferred growth, tax-deductible contributions, and pre-tax deferral contributions
Fees No set-up or annual account fee
IRS maximum contribution Salary deferrals up to $17,500 for 2013.
Catch-up contribution Salary deferrals up to $5,500 2012 (if age 50+)1
Profit sharing contribution Up to 25% of compensation, up to the annual maximum of $51,000 for 2013 plan year
Establishment deadline The deadline to open a new plan is December 31 (or fiscal year-end)
Administrative responsibilities Annual Form 5500 filing after plan assets exceed $250,000
Withdrawals Minimum required distributions starting at age 70½. 10% early withdrawal penalty if under age 59½ and no exceptions apply

 

It’s important that you do your homework on making sure the calculations are done correctly and the plan is set up correctly so you don’t contribute more than your allowed especially if you are self-employed.   It’s a good idea not to fly solo on this 401(k), and get the help of a professional financial advisor.    Remember, if you own a business where you take salary and distribution, it is important to plan out what level salary and what level distribution to maximize your solo 401(k) contribution.  The company you choose to set the plan up with will help you determine the type of investment you have in the plan, but they should be very similar to a corporate 401(k) plan with many different types of mutual funds and/or a self directed brokerage account.

Perhaps a solo 401(k) is the right plan for you here in 2013!  But remember, these numbers are subject to change each and every year.

Written by:
Ted Jenkin

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Ted Jenkin, CFP®, AAMS®, AWMA®, CRPC®, CMFC®, CRPS®
Co-CEO and Founder oXYGen Financial, Inc.

Securities and Investment Advisory Services offered through NFP Advisor Services, LLC (NFPAS), Member FINRA/SIPC. Oxygen Financial is not affiliated with NFPAS.

About the author  ⁄ Ted Jenkin @ Your Smart Money Moves

Ted Jenkin @ Your Smart Money Moves

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My friends and family all think I’m a workaholic, but I say I’m just a guy that loves to help people do better in life.

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Ever since I was a little kid, I always loved money and being an entrepreneur. In fact, I still have cassette tapes of me talking to my grandmother at the age of five and my mother tells me all the time how much I played with money as a kid...

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Ted Jenkin is a frequent guest columnist for the Wall Street Journal and Headline News Weekend Express. He is the co-CEO of oXYGen Financial. You can follow him on LinkedIn @ www.linkedin.com/in/theceoadvisor or on Twitter @tedjenkin.

Securities offered through Kestra Investment Services, LLC (Kestra IS), member FINRA/SIPC. Investment advisory services offered through Kestra Advisory Services, LLC (Kestra AS), an affiliate of Kestra IS. oXYGen Financial is not affiliated with Kestra IS or Kestra AS. Kestra IS and Kestra AS do not provide tax or legal advice.

The opinions expressed in this commentary are those of the author and may not necessarily reflect those held by Kestra Investment Services, LLC or Kestra Advisory Services, LLC. This is for general information only and is not intended to provide specific investment advice or recommendations for any individual. It is suggested that you consult your financial professional, attorney, or tax advisor regarding your individual situation. 

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8 Comments

  • Mike
    August 28, 2013

    HI Ted:

    Nice job and thanks for summarizing Solo 401k. I have found many times that this is a great option for solo business owners or ones (building contractors) that only hire subcontractors to do work.

  • Ted Jenkin @ Your Smart Money Moves
    August 29, 2013

    So true!

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