A Solo 401(k), also known as an individual 401(k), is a retirement plan designed for self-employed individuals or business owners with no employees, other than a spouse. The Solo 401(k) allows for higher contribution limits than traditional IRAs and other retirement plans, making it a popular option for those looking to maximize their retirement savings.
Here’s how a Solo 401(k) works:
- The plan is established by the business owner, who serves as both the employer and employee.
- As the employer, the business owner can contribute up to 25% of their compensation, up to a maximum of $58,000 for 2021. As the employee, they can contribute an additional $19,500 for a total contribution limit of $64,500 (or $68,000 if age 50 or older).
- Contributions are tax-deductible and grow tax-deferred until withdrawn in retirement.
- Withdrawals from a Solo 401(k) are taxed as income and may be subject to a 10% penalty if taken before age 59 1/2.
The Solo 401(k) offers several benefits, including high contribution limits, tax-deferred growth, and the ability to borrow against the account. It also allows for more flexibility in terms of investments than traditional employer-sponsored plans.
However, it’s important to note that the Solo 401(k) is only available to self-employed individuals or business owners with no employees, other than a spouse. If the business owner hires employees, they may be required to offer a different retirement plan or transition to a traditional 401(k) plan.
Here are some reasons why self-employed individuals or business owners with no employees may choose to establish a Solo 401(k):
- Higher contribution limits: Solo 401(k) plans offer higher contribution limits compared to other types of retirement plans. As both the employer and employee, self-employed individuals can contribute up to 25% of their compensation, up to a maximum of $58,000 for 2021. This can allow for significant tax savings and help boost retirement savings.
- Tax-deferred growth: Contributions and earnings in a Solo 401(k) grow tax-deferred until withdrawn in retirement. This can help maximize the potential for growth and reduce the tax burden in retirement.
- Flexibility in investments: Solo 401(k) plans offer a wide range of investment options, including stocks, bonds, mutual funds, and more. This can allow for more flexibility and potentially higher returns than other retirement plans.
- Ability to borrow against the account: Solo 401(k) plans allow for loans against the account, which can be a useful option for those in need of short-term financing.
- Simplified administration: Solo 401(k) plans are relatively easy to set up and administer compared to other types of retirement plans. There are no annual filings required unless the plan exceeds $250,000 in assets.
However, it’s important to carefully consider all of the factors before choosing a Solo 401(k) or any other retirement plan. This is something a financial advisor can help with.