How can a solo 401(k) plan be advantageous for small business owners?

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The self-directed solo 401(k) plan is also known as the independent 401(k) plan. With an independent plan, you don’t have to be classified as an employee to get the benefits of a 401(k). Small business owners, freelancers, and contractors can plan their retirement with the solo 401(k) plan. 

Why do small business owners choose a solo 401(k) plan?

The self-directed solo 401(K) plan gives you control over your investment and retirement decisions.

Here are several benefits of the solo 401(k) plan:

A. The ‘solo’ plan is not entirely solo. Your spouse can invest in it to strengthen retirement planning.

B. Unlike the Individual Retirement Account (IRA), the self-directed plan has no income limit. The contribution limit of the solo 401(k) is much higher than that of the IRA.

C. You can invest in real estate, promissory notes, and valuable metals like gold and silver with the solo 401(k) plan.

D. You can transfer your assets to your beneficiaries tax-free.

Benefits of Self-Directed Solo 401(k) Plan

What’s in the self-directed solo 401(k) account in 2021?

In 2021, the IRS allows annual contributions of $58,000 in the self-directed solo 401(k) plan. There is a chance of an additional $6,500 catch-up contribution if you are age 50 years or over. This brings the total contribution for 50+ to $64,500.

The taxable income from the self-directed solo 401(k) plan is $290,000 in 2021.

You can take a look at how to calculate taxable income for the small business:

Your net business profit – half of your self-employment tax + the employer plan contribution you have made for yourself = the taxable compensation.

(This is the annual contribution limit and taxable income for 2021.)

How can the self-directed solo 401(k) provide tax benefits to small businesses?

Small business owners can get several tax benefits from investing in the self-directed solo 401(K). There is also flexibility in how you handle your tax obligations depending on your classification.

1. As an employer: All your earnings as an employer will be tax-deductible. Your earnings are tax-deferred until you withdraw the amount.

2. As an employee: The employee contribution is also tax-deferred. When you retire, the IRS will deduct the normal tax amount from your self-directed solo 401(k) withdrawals. This reduces your taxable income as an employee, as well.

With the additional $6,500 catch-up contribution for people over 50, you have potential to receive benefits from a solo 401(k) plan as both an employer and an employee.

“Checkbook control” advantage with the self-directed solo 401(k) plans

The solo 401(k) plan gives you “checkbook control” over the plan as the trustee. With this benefit, there is no need for you to hire an outside trustee to manage the account for you. You have sole authority over the 401(k) as the plan participant.

As the trustee, you have complete authority over the 401(k) plan to take any action you choose and make any decisions you feel are best for your investment.

You can open a solo 401(k) account in any local bank or credit union with the “checkbook control” designation. There are no custodial fees for maintaining the account.

Two reasons a self-directed solo 401(k) plan is better than a SEP IRA retirement plan

The SEP-IRA, or Simplified Employee Pension Individual Retirement Account, is another great retirement plan. It is suitable for people who are self-employed, freelancers, and small business owners.

However, a self-directed solo 401(k) plan has advantages over a SEP IRA retirement plan.

Solo 401(k) is a reliable option for small business owners

A. You can take out a loan from your solo 401(k) plan

It’s against the rules of the SEP-IRA to take out a loan against this type of retirement account. However, the solo 401(k) is structured to allow you to borrow against it, if necessary. You can borrow up to 50% of the amount in your solo 401(k) account or a maximum of $50,000. Since this is a loan, and not a withdrawal, the funds are still tax-free.

Solo 401(k) loans have a repayment period of 5 years. However, that is extended to 15 years if you use the loan to purchase a house or other permanent residence.

With the self-directed solo 401(k), you have the added option to borrow against your own investment, which could be beneficial. The SEP-IRA does not give you this freedom. This is an important consideration of your needs when deciding how to invest your money.

B. You can never get the authority over your SEP-IRA account

A financial institution will always have investment authority of your SEP-IRA account. This means they will decide how to invest your money in the stock market or mutual funds. You do not have any say in their decision.

This is not the case with your self-directed solo 401(k) plan. Since you have full authority over your solo 401(k) plan, you get to choose where and how to invest your money.

So, there is an opportunity for better savings for small business owners who invest in the solo 401(k) account than the SEP-IRA account.

Final words

If you are self-employed or running a small business, it doesn’t mean you can’t have a retirement savings plan. The self-directed solo 401(k) plans are set up specifically for the self employed. Proper planning with the solo 401(k) retirement plan can set you up for the long-term. A comfortable and secured retirement is waiting for you.

Author Bio: 

Phil Bradford is a financial content writer and an enthusiast. He has expert knowledge about personal finance issues and he is a regular contributor of DebtConsolidationCare. His passion for helping people who are stuck in financial problems has earned him recognition and honor in the industry. Besides writing, he loves to travel and read books. 

Paul Sundin

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