This article is reprinted by permission from NextAvenue.org.
There are many perks to being self-employed — flexible hours, the possibility of working from home and, of course, being your own boss. But one major downfall that has historically burdened solopreneurs is the lack of access to traditional employer-sponsored retirement plans, such as a 401(k).
Because of this, paired with misconceptions that saving for retirement is too expensive, many freelancers and others in the gig economy are drastically undersaving for retirement. This is a mistake they can’t afford to make.
Here’s what you need to know about one of the most attractive retirement savings options for the self-employed: the Solo 401(k), also known as a Self-Employed 401(k), Individual 401(k) or One Participant 401(k).
What is a Solo 401(k)?
A Solo 401(k) is a 401(k) retirement plan specifically designed for self-employed people or sole proprietors and, if applicable, their spouses.
It permits 100% employee salary deferral of up to $19,000 in 2019 if you are under 50; up to $25,000 if you are 50 or older. It also allows an employer profit-sharing contribution of up to $56,000 a year, letting you stash away extra savings by serving as both the employee and employer of your business.
Overall, this can save you more than $14,000 in taxes a year (assuming a $56,000 contribution and a 25.7% corporate tax rate), while simultaneously offering a loan provision in case you need to tap your savings.
Who qualifies for a Solo 401(k)?
Any person who is truly self-employed, whether as a full-time business venture or side hustle, can participate in a Solo 401(k) plan. Your business qualifies whether it’s structured as a sole proprietorship, partnership or corporation, as long as there are no other employees or employees aren’t eligible to participate in a traditional 401(k). Examples of those: people who work fewer than 1,000 hours a year or are under 21.
For these reasons, the Solo 401(k) can be a good option for husband/wife partnerships or small businesses that generally have only part-time employees. Examples: real-estate agents, bookkeepers and personal trainers.
The benefits of a Solo 401(k)
A Solo 401(k) provides the flexibility to contribute as much as you want from year to year (within the standard limits). So in years when business is booming, you can save a lot; in lean years, a little.
Additional benefits include:
- Reduced taxable income for pretax salary contributions
- Ability to make after-tax Roth 401(k) contributions
- Built-in profit-sharing for maximum savings deductible against business income
- Plan expenses that are deductible to the company
- Tax-deferred growth on investments
- Higher contribution limits than alternative retirement savings plans for the self-employed: SEP and SIMPLE IRAs
There’s often no cost to set up a Solo 401(k) and there may or may not be annual maintenance fees (when charged, they can run between $20 a year and $25 a month). You’ll owe commissions for online trades. But you won’t need to file annual reports with the Internal Revenue Service until the plan exceeds $250,000 in assets.
You typically need to make contributions by the end of the calendar year for them to count for that year, but employer contributions can be made until April 15 of the subsequent year.
Chad Parks is founder and CEO of Ubiquity Retirement + Savings, a web-based, flat-fee retirement plan provider for small businesses that is based in San Francisco.
This article is reprinted by permission from NextAvenue.org, © 2019 Twin Cities Public Television, Inc. All rights reserved.