Schwab solo 401k plans are without a doubt a great option for small business owners. However, we’ve noticed that a lot of people spend hours time trying to determine how to best utilize them.
This post is a comprehensive guide to setting up a Schwab solo 401k to your best advantage. We’ll answer the one important question:
Is a Schwab solo 401k plan the best option for my business and, if so, how do I get the maximum benefit from the plan? When considering a solo 401k plan you really can’t go wrong with Schwab. But you can consider a Mega Backdoor or adding a cash balance plan.Table of contents
The Basics
The individual 401K is for entrepreneurs that don’t have any employees. The only exception to the rule is if your spouse works with you. In that case, you and your spouse can have a Solo 401K, which helps increase your retirement savings. Both you and your spouse will be able to take advantage of the tax advantages of the 401K, just as you would if you worked for someone.
The Solo 401K is the equivalent of the 401K you would get if you worked for an employer. It helps increase the amount you can contribute to your retirement account. If you stuck with the traditional IRA, you could only contribute a maximum of $6,000. That’s not nearly enough to get you to your retirement goals if you work for yourself.
The Solo 401K has much higher contribution maximums of $57,000 per year. The contributions come from a combination of your own contributions and contributions from your company’s profit sharing. You don’t have to be a specific age to make these contributions either. If you are over the age of 50, though, you can contribute even more to your account – with an additional $6,500 allowed in ‘catch-up contributions.’
Benefits of a Schwab Solo 401K
You contribute funds before tax. Your earnings grow tax-deferred and you don’t need to pay taxes on your account until you withdraw the funds. The hope is that you’ll be in a lower tax bracket when you retire so that you pay fewer taxes on your withdrawals.
You can’t make withdrawals until you are age 59 ½ or older. If you do withdraw sooner, you’ll pay taxes right away as well as a 10% early withdrawal penalty.
You have many options when opening an individual 401K, all of which are great, including Charles Schwab. With no monthly service fees or set up fees, it’s affordable to get started and maintain your account. Charles Schwab has $0 online trade commissions and $0 Schwab ETF online trade commissions, but just like any account, other trading fees may apply.
How do They Work for Small Business?
The largest difference with the Solo 401K is the fact that you are the employer and the employee. Both contributions come from you – one is your earnings and the other is your share of profit-sharing. As the ‘employee’ you are able to contribute up to $19,500 toward your retirement account. If you earn less than that per year, you may contribute up to 100% of your earnings, but $19,500 is the maximum.
As the ‘employer’ you may contribute the lesser of $57,000 or 25% of your earned income minus ½ your self-employment tax. If you are over 50 years old, you may also contribute an extra $6,500 for catch-up contributions, helping you get even further with your retirement savings.
The Schwab 401k Plan Document
Starting a Solo 401K with Charles Schwab is simple with the following steps:
- Apply for your EIN, Employer Identification Number. You apply for the number with the IRS. The process is completely online and only takes a few minutes.
- Complete the Schwab required paperwork including the plan document, adoption agreement, and account application.
- Send all original copies to Schwab, but make sure to keep a copy for yourself.
- Make sure all parties (you and your spouse if applicable) complete the Elective Deferral Agreement. This determines how much you agree to have withheld from your earnings.
Charles Schwab requires you to send your money in via check. On the check, you must include your company name and a list of the amount to be deposited in each account with the corresponding account number.
You must make all contributions for the year by the tax filing date, which is normally April 15th. If you need an extension (not this year) you can apply for it and use the dates accordingly.
What About Roth Contributions?
Roth 401K – Your contributions in a Roth 401K are made after taxes. While you don’t get the tax advantage now, you get it when you withdraw the funds. Your contributions grow tax-deferred, but you also get to withdraw your contributions and earnings tax-free during retirement.
Choosing your Solo 401K investments is an important part of the process. You need to make sure you take into consideration:
- Your age – The older you are, the more conservative you should be with your investments because you’re closer to retirement age
- Your risk tolerance – Everyone has a different tolerance for risk (diversifying your portfolio is the best way)
- Goals for retirement – What do you want in retirement? Will you live the same lifestyle, travel, or downsize? Your goals will help determine how much money you need.
Covering your Spouse
As we stated above, your Solo 401K is for you alone. If you have employees, you don’t qualify, but there is one exception. If you have a spouse that works with you, your spouse can have a Solo 401K too. Essentially, this helps you get the most out of the program as it doubles the amount you can save for retirement as well as doubles your tax advantages.
Your spouse has the same contribution limitations that you have. He/she may contribute up to $19,500 himself/herself. You, as the employer, may contribute up to 25% of his/her income as well.
An individual or Solo 401K helps entrepreneurs save for retirement with the same tax advantages as those that work for somebody. As you fulfill your dreams as an entrepreneur, you can make sure that you save for retirement, making your future goals matter too.
Top 5 Contribution Strategies
- Consider taking advantage of the Retirement Savers Credit. The credit still exists but most people are not aware of it. It can be 50%, 20% or 10% of the contribution depending on your adjusted gross income.
- Take advantage of profit sharing. You can contribute up to $57,000 total so take advantage of it.
- Consider adding a defined benefit plan. A defined benefit plan or cash balance plan can combine with your 401k plan. You may be able to get an add’l $100,000 into a combo plan.
- Consider catch up contributions. Remember that folks over 50 can get an extra $6,500 into the plan.
- A Mega Backdoor Roth is an option. If you like after-tax contributions, consider the Mega Backdoor Roth.
Are you an entrepreneur that feels like you’ll never save enough money for retirement? The limits on IRA contributions are small and nowhere near what you could contribute if you were an employee of a company. Fortunately, the Solo 401K gives you the chance to save for retirement while fulfilling your dream of entrepreneurship.
