Individual 401 (k) Plans
Looking for the right retirement plan can be difficult, especially if you don’t know where to start. If you are interested in taking control of your retirement plan, there are many individual options to take advantage of for long-term growth and comfort.
One option that puts you in charge of your future is an individual 401 (k) plan. If you are self-employed, a solo 401k may be the best option for you to grow your nest egg for secure golden years.
But how exactly do 401 (k) plans work?
What is an Individual 401 (k) Plan?
Individual, or solo 401K plans cover a business owner with no employees. If you are self-employed, whether part-time or full-time, you are eligible to open an account for yourself. While you cannot cover any other full-time employees under this plan, you can also cover your business partner or your spouse. As both the business owner and the employee, you can contribute to the account.
As the account holder, you have the freedom to split contributions between different accounts, borrow against your savings, and take advantage of tax breaks from your 401 (k) . If you are interested in opening a solo401 (k) , there are few options for making investments.
What are the Qualifications?
Before attempting to open an individual 401 (k) , be sure you meet the qualifications. Account holders must claim self-employed income. While you do not need to be “full-time,” you must have some accumulated form of income from a side business before you can be considered. These plans can be adopted by any self-employed business, like LLCs, partnerships, C-Corporations, or S-Corporations.
Again, those included in your401 (k) cannot extend to any full-time employees other than a business partner or a spouse. In any case, you must be the sole proprietors to qualify. If you do, you can take advantage of the different tax breaks afforded by the plan.
What are The Different Types?
Based on your plan documents, there are many options available. Individual 401 (k)s come in both the traditional 401k and Roth versions, much like IRAs. Traditional401 (k)s allow your contributions to grow on a pre-tax basis, tax-deferred. It isn’t until you make your withdrawals that you would need to pay any taxes, at which point it would be taxed as earned income.
Roth versions allow your contributions to grow ‘after-tax.’ Your account will accumulate funds, tax-free and you will not be taxed on withdrawal after age 59 ½. Due to the tax advantages with these accounts, the IRS has strict rules on withdrawals. Anything taken from the account before 59 ½ is open to taxes and penalties.
In addition to the traditional and Roth plans, there are two different types of401 (k) options: a brokerage solo 401k, and a self-directed 401k. Each plan has its advantages. As you consider each one, keep in mind what will align with your goals.
Brokerage Solo 401 (k)
If you are interested in a more traditional investment, consider the brokerage 401k. This type of account offers market-based assets such as stocks and mutual funds. There are limited investment options, and it does not allow for conversion of traditional 401k or 403k to a Roth sub-account.
If you plan to invest mainly in stocks or mutual funds, the best option for you would be to invest in the brokerage account. If you wish to expand your asset options, a self-directed 401K may be a better choice.
Self-Directed 401 (k)
If you are looking for “checkbook control” and multiple alternative asset options, consider a self-directed 401k. These accounts have the option to invest in real estate and other alternative investments. Additionally, SD 401ks have built in Roth sub-accounts, and include Roth deferrals.
Account holders can benefit from a loan feature that allows participants to borrow the lesser of $50,000 or 50% of their account value. Also, checkbook control allows account holders to withdraw without going through a consultant. If these options align with your investment interests, a self-directed 401k may be the right choice for you.
As both employee and employer, you as the account holder can contribute in a unique way. Special computations can be made to figure out the maximum number of deferrals and contributions you can make. You can make elective deferrals, which is up to 100% compensation up to the annual contribution limit. You also have the option of employer nonelective contributions. This is 25% compensation as defined by the plan you’ve selected, or for self-employed individuals.
It’s important to note that total contributions to your account, not including any catch-up amounts, cannot exceed $55,000. Much like the standard ERISA 401 (k) , contribution limits are broken down into a profit sharing contribution from your “employer” and your self-contributions.
Since an account holder acts as both for a solo 401K, there’s a bit more to it. As a sole member, your limit is capped at 20% of the self-employed income. On the profit sharing, IRS states the amount of the employer contributes is limited to 25% of the entity’s income subject to self-employment tax. Of course, there are forms to file and follow issued by the IRS to be sure everything is in line for your fund. Additionally, if you are over the age of 50, account holders can make additional contributions to catch-up their retirement funds up to $6,000.
Selecting the Retirement Plan for You
As you look toward your retirement, be sure to perform your due diligence to select the right retirement plan for your future. An individual 401 (k) can help you take the steps you need toward a brighter future. Consider all your options before making any investments and consult your financial advisor.
Whether you’re a small business owner or a self-employed freelancer, you can still build toward your retirement with the right plan. Take control today by contacting Horizon Trust.