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Retirement Plans for the Small Business Owner: The Solo 401k

By: Ted Jenkin



I am seeing more and more people quit the corporate America lifestyle and venture into becoming their own business owner. This shape of a business owner can be a freelancer, consultant, or someone who actually starts up a brick and mortar operation. Many of these folks will ask questions about whether they should incorporate their business or not, which I have discussed in other articles.

Once they become profitable, they often ask which kind of retirement plan would suit them the best. For someone who is a business of just one, the Solo 401(k) has been around for about a decade and provides a great alternative to helping maximize your retirement contributions. Here’s a little history on the Solo 401(k) and how it can be a smart money move for your business.
The Solo 401(k) came about in 2002 after Congress passed Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA). EGTRRA added some small paragraphs to the tax code that put forward the Solo 401(k) as the preferred retirement vehicle for those persons that were self-employed.
Before EGTRRA, a self-employed person had the ability to design a 401(k) plan just for themselves. However, there wasn’t a particularly compelling reason to do this because the deduction limit for a 401(k) plan was identical to a SEP-IRA. Many small business owners set up plans like a SIMPLE IRA or a SEP-IRA because they are slightly easier to administer traditionally than 401(k) type plans.
The tiny paragraph in the EGTRRA changes basically says the employee contributions to a 401(k) plan do not count toward the deduction limit. Since most business owners I have met over the years are usually interested in maximizing all available tax deductions for retirement, a solo 401(k) plan became preferred to a SEP-IRA. If the plan is set up correctly, a small business owner can not only put away as the “employee” up to $17,500 per year pre-tax, but you may be able to put away up to an additional $33,500 pre-tax here in 2013 through a profit share to make a total pre-tax contribution of $51,000.
Self-Employed individuals and owner-only (and the owner’s spouse) businesses and partnerships can save more for retirement through a 401(k) plan. The Self-Employed 401(k) allows you to take advantage of this increased retirement and tax savings opportunity with a full range of investment options.
  • Tax Benefits. Tax-deferred growth, tax-deductible contributions, and pre-tax deferral contributions.
  • Fees. No set-up or annual account fee.
  • IRS Maximum Contribution. Salary deferrals up to $17,500 for 2013.
  • Catch-up Contribution. Salary deferrals up to $5,500 for 2012 (if age 50+)
  • Profit Sharing Contribution. Up to 25% of compensation, up to the annual maximum of $51,000 for 2013 plan year.
  • Establishment Deadline. The deadline to open a new plan is December 31 (or fiscal year-end).
  • Administrative Responsibilities. Annual Form 5500 filing after plan assets exceed $250,000.
  • Withdrawals. Minimum required distributions starting at age 70 ½. 10% early withdrawal penalty if under age 59 ½ and no exceptions apply.
It’s important that you do your homework on making sure the calculations are done correctly and the plan is set up correctly so you don’t contribute more than you’re allowed, especially if you are self-employed. It’s a good idea not to fly solo on this 401(k), so get the help of a professional financial advisor and/or accountant. Remember, if you own a business where you take salary and distribution, it is important to plan out what level salary and what level distribution to maximize your solo 401(k) contribution. The company you choose to set the plan up with will help you determine the type of investment you have in the plan, but they should very similar to a corporate 401(k) plan with many different types of mutual funds and/or a self-directed brokerage account.
Perhaps a Solo 401(k) is the right plan for you here in 2013! These numbers are subject to change each and every year.
Published: July 29, 2013

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Ted Jenkin

Ted Jenkin is the co-CEO and Founder of oXYGen Financial (www.oxygenfinancial.net) and Editor-In-Chief of the top ranked personal finance blog Your Smart Money Moves (www.yoursmartmoneymoves.com).   oXYGen Financial is a leader in financial services for the X & Y generation. Ted is the author of Real Life, Real Money: 100 Smart Money Moves.

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