Solo-k: Smart Retirement Planning for Self-Employed

Before you go, we thought you'd like these...
a mature man toasting.
Auremar/Shutterstock
In 2001, the government gave self-employed workers a gift: a 401(k) plan that allows for greater amounts of tax-deferred income with less hassle to set up than any other retirement plan. The new plan, mostly called a Solo 401(k) or a Solo-k, beats traditional corporate 401(k)s in higher savings limits and in the ability to invest in a variety of options.

You are an excellent candidate for a Solo-k if:
  • You are self-employed or a solo-business owner and have no full-time employees (except for your spouse).
  • You have enough profit/earnings to save up to $52,000 (younger than 50) or $57,500 (50 and older) and still pay your mortgage, eat and pay taxes. Your spouse can save the same amounts depending on his/her earnings.
  • You need to boost your retirement savings because you are behind.
  • You wish to pay less taxes.
  • You like the tax-free benefits of a Roth Individual Retirement Account, but haven't been able to open one due to income limitations.
  • You want the option to take out a loan if necessary.
  • You income is inconsistent, and you want flexibility in the amount you save each year.
  • You don't like lots of paperwork and complicated requirements.
This Is How It Works
  • Open your Solo-k (or direct your financial adviser to open it for you) at a plan sponsor, including TD Ameritrade (AMTD), Charles Schwab (SCHW), T. Rowe Price (TROW), Fidelity or many other financial institutions. In addition to the application, you will sign an adoption agreement. The deadline for establishing a Solo-k is Dec. 31 of the year in which you like to receive the tax deduction, or for corporations, at fiscal year-end. There is no extra paperwork or annual reporting requirement until the account balance reaches $250,000, and then it is minimal.
  • Each year, decide how much to contribute to your plan and whether you want to make a pre-tax or after-tax contribution. Acting as an employee, you can defer up to $17,500, plus $5,500 if you are 50 or older. As the employer, you can make a profit-sharing contribution up to 25 percent of your W-2 earnings or 20 percent of your net self-employment income. Total possible contribution in 2014: $52,000, plus $5,500 in catch-up. If your spouse works in the business, these limits apply as well for a total contribution of $104,000/$115,000.
  • As with anything related for the Internal Revenue Service, deadlines aren't negotiable. They are slightly different depending upon whether your business is incorporated (C, S, Partnership) or not (Sole P, LLC). For corporations, the deadline to make employee salary deferrals is 15 days after the close of the fiscal year, and for the unincorporated, the deadline is April 15 plus extensions. For the profit-sharing amount, the deadline is the same for both: tax filing deadline, plus extensions.
  • Invest the funds. You can do this yourself or work with a financial adviser. Depending on the plan sponsor (your 401(k) custodian), you can invest in a wide array of mutual funds, exchange-traded funds, stocks and even alternative investments.
Solo 401(k) or SEP IRA

Many self-employed business owners have a SEP IRA. This isn't a bad choice, but once your business takes off, you can sock so much more away in a Solo-k. For example, a sole proprietor under the age of 50 making $150,000 in net pre-tax business profit can save $45,467.00 to a Solo 401(k), while the same person could contribute $28,147.48 to a SEP IRA. This equates to thousands of dollars in tax savings.

%VIRTUAL-article-sponsoredlinks%Other interesting things to know about the Solo-k. Contribution limits are per person, not per plan. If you are a corporate employee with a 401(k) plan and have your own business on the side, you can contribute to both as long as you don't exceed the annual limits.

You can borrow against your Solo 401(k) limited to $50,000 or half of your account balance, whichever is smaller. Caveat: some plans do not have a loan feature; be sure and check if this is important to you.

Designated Roth Accounts in a Solo-k have unique features. The Roth contribution limits don't apply to designated Roth accounts in a Solo-k, making it possible for high-income earners to take advantage of the Roth's long-term tax-free benefits.

Roth 401(k)'s are subject to required minimum distributions at age 70½. However, you can avoid those distributions by rolling the Roth Solo-k into a Roth IRA at retirement.

Not all Solo-k plans allow a Roth feature, so be sure and check with the plan sponsor if this option is important to you.

One last note: if your business is growing and you plan to hire full-time employees down the road, it makes more sense to set up a traditional 401(k) plan. But if you are committed to staying Solo, the Solo-K is for you.

12 PHOTOS
10 Easy Ways to Pay Off Debt
See Gallery
Solo-k: Smart Retirement Planning for Self-Employed
"Your daily habits and routines are the reason you got into this mess," writes Trent Hamm, founder of TheSimpleDollar.com. "Spend some time thinking about how you spend money each day, each week and each month." Do you really need your daily latte? Can you bring your lunch to work instead of buying it four times a week? Ask yourself: What can I change without sacrificing my lifestyle too much? 
Remove all credit cards from your wallet and leave them at home when you go shopping, advises WiseBread contributor Sabah Karimi. “Even if you earn cash back or other rewards with credit card purchases, stop spending with your credit cards until you have your finances under control,” she writes.
If you do a lot of online shopping at one retailer, you may have stored your credit card information on the site to make the checkout process easier. But that also makes it easier to charge items you don't need. So clear that information. "If you’re paying for a recurring service, use a debit card issued from a major credit card service linked to your checking account," Hamm writes.  
Reward yourself when you reach debt payoff goals. "The only way to completely pay off your credit card debt is to keep at it, and to do that, you must keep yourself motivated," Bakke writes. Just make sure to reward yourself within reason. For example, instead of a weeklong vacation, plan a weekend camping trip. "If you aim to reduce your credit card debt from $10,000 to $5,000 in two months," Bakke writes, "give yourself more than a pat on the back." 
“Establish a budget,” writes Money Crashers contributor David Bakke. “If you don't scale back your spending, you'll dig yourself into a deeper hole." You can use personal finance tools like Mint.com, or make your own Excel spreadsheet that includes your monthly income and expenses. Then scrutinize those budget categories to see where you can cut costs.    
Sort your credit card interest rates from highest to lowest, then tackle the card with the highest rate first. "By paying off the balance with the highest interest first, you increase your payment on the credit card with the highest annual percentage rate while continuing to make the minimum payment on the rest of your credit cards," writes Mint.com spokeswoman Hitha Prabhakar.
To make a dent in your debt, you need to pay more than the minimum balance on your credit card statements each month. "Paying the minimum -– usually 2 to 3 percent of the outstanding balance -– only prolongs a debt payoff strategy," Prabhakar writes. "Strengthen your commitment to pay everything off by making weekly, instead of monthly, payments." Or if your minimum payment is $100, try doubling it and paying off $200 or more. 
If you have a high-interest card with a balance that you’re confident you can pay off in a few months, Hamm recommends moving the debt to a card that offers a zero-interest balance transfer. "You’ll need to pay off the debt before the balance transfer expires, or else you’re often hit with a much higher interest rate," he warns. "If you do it carefully, you can save hundreds on interest this way."
Have any birthday gifts or old wedding presents collecting dust in your closet? Look for items you can sell on eBay or Craigslist. "Do some research to make sure you list these items at a fair and reasonable price," Karimi writes. “Take quality photos, and write an attention-grabbing headline and description to sell the item as quickly as possible." Any profits from sales should go toward your debt. 
If you receive a job bonus around the holidays or during the year, allocate that money toward your debt payoff plan. "Avoid the temptation to spend that bonus on a vacation or other luxury purchase," Karimi writes. It’s more important to fix your financial situation than own the latest designer bag.
of
SEE ALL
BACK TO SLIDE
SHOW CAPTION +
HIDE CAPTION
Read Full Story

People are Reading