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Flying Solo

Ross Menke

THE RANKS of self-employed Americans are expected to rise to 42 million by 2020. It’s easy to understand why folks flock to self-employment. These workers report higher job satisfaction and overall happiness. The downside: They need to craft a benefits package that mirrors what they lost by leaving traditional fulltime positions.

Other than health insurance, the cornerstone of any employee benefits package is the employer-sponsored retirement plan. Most often, this is a 401(k), 403(b) or similar plan. Self-employed individuals, however, will want to use a retirement account designed just for them: the solo 401(k) plan.

As a self-employed business owner, I’ve opened and funded a solo 401(k). Having been stuck with both a high-fee 401(k) plan and a low-contribution SIMPLE IRA at former employers, I was eager to open a solo 401(k), because these plans offer a slew of attractive benefits:

High contribution limits. A solo 401(k) allows self-employed individuals to maximize retirement contributions as both an employee and employer. In 2018, total annual contributions are typically capped at $55,000. This consists of either an $18,500 employee elective contribution or 100% of net business income, whichever is less. The employer contribution can be up to $36,500 or 25% of net business income, whichever is less. If you’re age 50 or older at year-end, you can make a catch-up contribution of $6,000, for a total of $61,000.

Low cost. Each financial institution that offers a solo 401(k) plan has a slightly different fee structure, but most are extremely low cost. Vanguard’s offering charges $20 annually per fund held in the plan. This fee is waived if you have total assets of more than $50,000 held at Vanguard.

Easy administration. Overall, a solo 401(k) plan is almost as easy to administer as an IRA or Roth IRA. There are no annual filing requirements for plans with less than $250,000 in assets. Once that asset level is reached, the business owner is required to file a Form 5500-EZ on an annual basis. The information required to complete the form is provided by the financial institution that oversees your plan.

Consolidating accounts. Former employer 401(k), 403(b), SEP, IRA and other retirement accounts can be rolled over into a solo 401(k). Besides simplifying your finances, this can be a huge plus if you’ve ever made—or plan to make—nondeductible contributions to an IRA.

By rolling over all IRA money, except your nondeductible contributions, into your solo 401(k), you’ll then be able to convert these nondeductible contributions to a Roth IRA and pay little or nothing in taxes. This strategy is known as the “backdoor Roth.” You can read more in HumbleDollar’s money guide.

Investment options. Gone are the days when an employer plan might be limited to high-fee actively managed funds. A solo 401(k) plan lets you manage your investments as you wish, similar to the investment choices you have with your IRA and Roth IRA.

An added bonus: Spouses who are employed by the business may also participate in the solo 401(k). This potentially increases a household’s annual contribution limit to $110,000, or $122,000 if both are age 50 or older.

Ross Menke is a Certified Financial Planner. His previous article was Slow Going. Ross strives to provide clear and concise advice, so his clients can achieve their life goals. Follow him on Twitter @RossVMenke.

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Richard Adams
Richard Adams
2 years ago

My wife is self-employed and we have funded an SEP IRA for her for many years through Vanguard, and this has worked quite well. I have never heard of a solo 401(k) and am trying to figure out any advantages over an SEP IRA. I have a 401(k) with my employer and am not employed in my wife’s business, so the spousal advantage doesn’t apply to us. Are there any other advantages over an SEP IRA that we should consider?

Jonathan Clements
Jonathan Clements
2 years ago
Reply to  Richard Adams

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