Solo 401(k) – 3Posted on Monday, February 11th, 2002 by Kevin Kaiser
Planning for retirement? Take a look at another option brought about by recent tax changes.
Jim is a very successful small business owner in western Colorado. And like most entrepreneurs, he is concerned with not only growing his business, but also with effectively funding and securing his retirement. After all, he is hoping (like most business owners) that he will one day be able to lounge on the beach or leisurely cruise the ski slopes with his wife.
But, like most business owners, Jim is uncertain about how to best fund that dream. Up until recently, business owners like Jim could choose from a short list of options that are geared toward their situation. Among the most popular over the years have been SIMPLE and SEP IRAs and Keogh plans. However, none of these options is exceptional at meeting the needs of individuals like Jim, who want (or need) to save more than SEPs and SIMPLEs can provide, and who do not want the hassle of cumbersome administrative expenses that come along with some defined contribution plans.
Enter a product of the 2001 Tax Changes: the Solo 401(k) plan. Relatively new to the scene, Solo 401(k) plans are geared toward self-employed individuals that have no employees or work only with their spouse. It is designed for business owners who want to save more than “traditional” plans allow and desire to take advantage of tax-deductible company contributions.
The mechanics of a Solo 401(k) are quite simple. It is essentially a profit-sharing plan that allows pre-tax salary deferral contributions. Unlike its corporate equivalent, all accounts are 100 percent vested (like a SEP/SIMPLE IRA), there is no expensive “nondiscrimination” testing, and administrative costs are relatively small (as low as $200 per year). Let’s look at some of the highlights:
- High contribution limits. What makes a Solo 401(k) different than another type of plan is the contribution limit. With a SEP IRA, a contributor is limited to the lesser of 15 percent compensation or $30,000. A SIMPLE IRA further limits you to $7,000 this year. With a Solo 401(k), a business owner is able to save the littlest of 100 percent of eligible compensation or $40,000. Also, up to 25 percent of the company’s contribution may be deductible.
- Flexibility. Solo 401(k) plans also provide the business owner with flexibility in contributing to the plan. Because it is a profit-sharing plan, Solo 401(k) s enable the entrepreneur to make contributions at his or her discretion. If earnings are lower in a particular year, the retirement plan contribution can be postponed or eliminated altogether. For an individual whose income is cyclical, this can provide some peace of mind and the ability to better weather tough times.
- Access. Much like a large corporation’s 401(k), Solo 401(k) s also often allow loan provisions. Therefore, if a business owner needs to access the money for a home purchase, educational expenses or an emergency, it is quite easy to take a loan against the assets. This is a provision that is not currently available with IRAs.
The bottom line: As of the writing of this article, there are only a handful of mutual fund companies offering this type of retirement plan. Perhaps the company at the forefront is AIM Funds. Their particular plan, aptly named the “Solo 401(k) ,” carries a nominal one-time setup fee of $150 and an annual administration fee of $150. Are the fees worth it? Considering the upside presented by this particular type of plan, it will make sense for most business owners to at least consider a Solo 401(k) when setting up or revising their retirement plan. If you are not sure, consult with your financial advisor. New opportunities are wonderful, but only if you take advantage of them.
Retirement is an expensive prospect. Having the ability to take advantage of new strategies and services can often help get you closer to that ultimate goal. And, like Jim, you may one day find yourself on a beach or ski slope thinking back to the “good ol’ days” when you worked hard and made your money work even harder for you.