The Truth About the Solo 401k

By Chase Rimmer / March 20, 2019

A solo 401k is a retirement solution that allows people who are independently employed to enjoy many of the benefits of a traditional 401k, without having to punch a time clock and work for someone else. Being self-employed offers a lot of benefits. You don’t have to work a schedule that someone else sets for you. You don’t have to abide by the rules and regulations of an employer. Most importantly, the hard work that you do benefit you directly, rather than helping to line the pockets of your employer. While there are risks involved with being self-employed, most people who enjoy this type of lifestyle will tell you that those benefits make the risks well worth it.  You get the freedom to work on your terms, and you have an earning potential that is determined by your work ethic, not by what your employer chooses to pay you.

What Is A Traditional 401k?

Even people who are not familiar with the ins and outs of retirement planning have probably heard about a traditional 401k. A traditional 401k is a retirement plan that is partially funded by an employer. Generally speaking, an employer will match a percentage of contributions that the employee makes, which are withdrawn from their pay. In other words, your employer offers you free money, and free money is always a good thing.

What’s a Roth 4011k? A traditional 401k has funds deducted from your pay before taxes. This is beneficial in that it can be used to lower your tax liability. But, when you retire, you are then taxed on the money as you withdraw it from your 401k. A Roth 401k is income deposited into your retirement account after it has already been taxed. The benefit here is that you don’t have to pay taxes on the money after you have retired. Since you are no longer drawing a paycheck once you are retired, this type of 401k offers a lot of benefits.

Solo 401k – Retirement Option for The Self-Employed

While there are a lot of benefits to being self-employed, one of the pitfalls is the lack of an employer-sponsored retirement plan. There’s no pension waiting for you when you are self-employed. That means you can either rely on social security for your financial needs post-retirement, which is never a good idea, or you can find another option for funding your retirement. Enter the solo 401k.

A solo 401k is a retirement plan for self-employed people. If you run your own business and have any employees, you won’t be able to participate. This is a retirement plan for self-employed people. Small business owners qualify, but only if they are the owner of said business, and they are the only employer as well.

To start a solo 401k, you can contact any number of reputable online brokerage agencies. Make sure that you choose a reputable and well-known company to work with. This is a company you are going to be giving money to. Not just money, but money that you are counting on for the future. So, you need to choose a company that you know you can trust, because your financial future literally depends on it.

Once you contact an online broker, you’ll be required to provide an employer identification number to them. A solo 401k gives you the same type of tax benefits as a traditional 401k. You can choose to pay taxes on the money you put into it now, or you can choose to pay them later. That’s why it’s a better option than a simple retirement account. Plus, with a retirement account, you can access the money whenever you want to. Even if you are an incredibly responsible person, having money for the future available whenever you want it is a bad idea.

With a solo 401k, there are contribution limits in place. When you have a solo 401k, you have limitations on income that are based upon you being both the employer and employee. As the employee, you can contribute up to $19,000 a year to your solo 401k. Now, you can increase the amount of money contributed to your solo 401k because you are the employer as well. This is kind of like the matching contribution of a business from a traditional 401k. This contribution can be up to 25% of the net income that you derive from running your business. You are also allowed to add your spouse to a solo 401k if she is an employee of the business. This is the one exception to the no employees’ rule when setting up a 401k. Your spouse’s contribution limit for the year is $19,000.

Is A Solo 401k Right for You?

If you are self-employed then it’s important that you plan for the future. Many people plan for the future by setting up various retirement accounts through their employer. This, combined with smart financial planning, and social security, often provides retirees with sufficient income to have a good standard of living once they stop working. As a self-employed person, you may not have to go to work when your boss says you do. You may not have to follow someone else’s rules, or generally, have to answer to anyone. You are your own boss, and it’s a wonderful way to live. But, for all of those freedoms, you are also going to experience some drawbacks. One of the main drawbacks is the lack of an employer-sponsored retirement plan.

A solo 401k eliminates this lack of retirement options, giving you a retirement plan that offers tax advantages. It also gives you a dedicated savings account for your retirement. If you are thinking of starting a solo 401k, the earlier you start the better. Even if you are still quite young, there’s no such thing as starting to save for retirement early. The earlier you start the more you will save. So, if you are hesitating and aren’t sure you can afford to start a solo 401k, then start small. But, start today, so you can ensure yourself a better tomorrow.

About the author

Chase Rimmer

Chase is an expert in finance and uses his expertise and understanding of links between different financial products and life stages to analyze the latest finance news and products. When he's not writing you can find him in first class using his credit card points. Or staying at home with his cat if he's not saved enough yet!

Click here to add a comment

Leave a comment: