Benefits of an Individual 401(k) for Self Employed

With over 15 million self-employed working professionals in the United States as of 2015 (and that number is growing), retirement planning options beyond traditional company-sponsored 401(k) plans are increasingly important.

These self-employed professionals contribute significantly to the American workforce. They employ approximately 29.4 million people and account for 30% of the entire American labor force, estimated at 44 million jobs, according to Pew Research in the fall of 2016.

Given the higher costs of traditional 401(k) plans, many freelance workers and businesses whose owners employ contractors fear that they cannot have traditional retirement plans and are unsure of what to do next. However, there is an individual 401(k) plan that fits the bill quite nicely, being simple to set up and easy to manage. Contributing to an individual 401(k) plan will also lower your tax bill. (For more, see: 401(k) Plans for the Small Business Owner.)

Below are some of the key benefits of an individual or solo 401(k) plan:

1. Large Tax-Deferred Investments

An individual 401(k) plan offers you up to $53,000 in tax-deferred investments annually if you are 49 years old or younger, and up to $59,000 if you are 50 years old or older. This is significantly more than an IRA, which only allows a maximum $5,500 contribution. This deferment can also potentially bring you into a lowered tax bracket while helping you save for your retirement.

2. Profit Sharing

As a solo entrepreneur, you can also reach your individual 401(k) cap through profit sharing for an LLC, for up to 20% of your income or up to 25% if the business is a corporation.

3. Maximize Contributions

You can make a contribution as an employee up to $18,000 per year to reach the maximum threshold amount or up to $24,000 at the age of 54 or older. As a solo entrepreneur, you are both the employer and the employee in your individual 401(k) plan. Thus, you can both pay yourself and contribute as an employee if you wish.

4. Multiple Owners and Spouses

If your business has multiple owners or you wish to include your spouse, you can do so with your individual 401(k) plan. Multiple owners and spouses who receive income from these businesses can enjoy tax-deferred benefits. When your business has employees that do not have an ownership stake or own less than 5%, then you would have to convert the plan into an employee-based 401(k) plan. (For more, see: Independent 401(k): A Top Retirement Plan for Sole Proprietors.)

5. Avoid Complex Regulations

Having an individual 401(k) plan helps you avoid complex regulations that come with traditional 401(k) plans. Traditional 401(k) plans have requirements such as following nondiscrimination tests and other requirements to confirm that the plans are for all enrolled employees and not just the owners or select employees. Individual 401(k) plans are not subject to these tests or reviews because they only involve the owners and spouses.

6. Investment Opportunities

You can invest in a variety of investments ranging from real estate to private business, peer-to-peer lending, precious metals, stocks and mutual funds. Your income and gains are deposited into your solo 401(k) plan without paying taxes.

7. Loan Option

The solo 401(k) plan offers the opportunity to borrow 50% of account value or $50,000 (whichever is lower) for any use at a lower interest rate. This includes paying personal debt or funding a business.

8. Control of Assets and No Custodian Fees

As a trustee of your individual 401(k) plan, you can have “checkbook control” where you can make an investment just by writing a check and you do not need an outside bank or trust company to manage as trustee. You have full control over all assets.

You also are free of the fees and delays that come with having an IRA custodian so you can act when you need to right away to make any investment. You do not have to pay custodian fees like you do for an IRA and can open your individual 401(k) plan at any local bank or credit union such as Chase, Citibank, Wells Fargo, etc.

Deadlines

To enroll in an individual 401(k) plan, you must purchase your plan by the end of the year, December 31. You have up until tax time to make your employer contributions, which is up to March 15 for an S corporation or C corporation and April 18 for an LLC, 1099 or sole proprietor.

As you grow your business and expand, you may have several strategies in place for your own savings and retirement. Getting an individual 401(k) plan can assist you in planning for your future retirement and also lower your immediate tax bills. (For more from this author, see: Disaster Preparedness for Small Business Owners.)