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Give Yourself the Gift of Tax Savings with a Solo 401(k)

  |  By Karen Walls

Are you a small business owner or self-employed? Do you want to lower your self-employment tax bill? Then you may want to consider opening a Solo 401(k) plan before you close the books on 2015.

A Solo 401(k) plan is one of the least understood options for small business owners, but it is one of the best for maximizing tax-deferred savings. It is essentially a 401(k) plan for an individual, which is why these plans are also referred to as Solo (k)s or Individual 401(k)s. As Laura Adams, host of the Money Girl podcast explains, that means that even if you don’t work for a big company, you can still use a retirement plan to cut taxes and save for the future.

Let’s go over the basics of a Solo 401(k) plan:

Who Qualifies?

Sole Proprietors or small business owners who have no full-time employees. Spouses also qualify.

How Does It Work?

Solo 401(k) plans can be a powerful tool for the self-employed because they allow for both employee and employer contributions. That means participants in a Solo 401(k) make employee salary deferral contributions, which are similar to those made by workers into a 401(k) plan. But Solo 401(k) participants also own their own companies, which means they can contribute additional money to their plan through an employer contribution.

Solo 401(k) plans vary based on provider so be sure to check on the details before choosing one. PENSCO offers a Solo(k) that can invest in alternative assets, like real estate, private equity, notes, and crowdfunding platforms. It also allows account owners to combine up to four different types of contributions, including after-tax elective salary deferrals (through a Roth 401(k)), pre-tax elective salary deferrals (through a traditional 401(k)), employer contributions through a profit sharing plan and a rollover from another tax-advantaged account.

Contribution Limits:

Because there are different contribution limits on the various types of contributions offered in a Solo 401(k), consulting with a tax advisor to discuss your personal limits is strongly recommended. Generally speaking, in the 2015 tax year, you can defer up to $18,000 in elective salary deferrals (pre- and post-tax). If you are 50 or older, you can make a catch-up contribution of an additional $6,000.

The profit sharing contribution limit is $53,000 and there is no limit on the amount you can rollover from another retirement account. (You can visit the IRS page outlining contribution limits to learn more.)

As you can see, the Solo(k) plan allows you to contribute a great deal for your tax sheltered retirement income as long as you qualify.

Additional Items to Consider:

  • Just like a 401(k) plan for a large company, a third-party administrator must be retained for record keeping purposes.
  • A loan feature exists where you can take up to 50% of the cash available up to $50,000
  • If the investment held within the Solo 401(k) plan is an operating company, the income generated off this business is not subject to the Unrelated Business Taxable Income (UBTI) like it is in self-directed IRAs.

The deadline to open a Solo(k) plan is Dec. 31 or fiscal year-end, whichever comes first. Keep in mind that additional time is needed to process your plan’s paperwork, so the sooner you can get started with establishing your Solo(k) the better. To learn more about how PENSCO can help, please contact our Business Development Center at 866-818-4472. 

This Blog does not provide investment, tax, or legal advice nor does it evaluate, recommend or endorse any advisory firm or investment vehicle. Investments are not FDIC insured and are subject to risk, including the loss of principal.

Editor’s Note: This is an updated version of a post we originally published in December 2014. We welcome new comments and questions below.