Why are so many self-employed individuals choosing solo 401k plans over traditional retirement options? The answer is simple: A solo 401k plan, also referred to as an individual 401k or a self-employed 401k, offers several benefits that cannot be obtained through other retirement plans. These benefits are specifically designed to help self-employed people with financial situations that they frequently find themselves in.
The Solo Loan – Borrow When You Need To:
As any self-employed person knows, cash flow can be difficult to manage at times. When you’re going through a rough patch financially, you can take out a solo loan on your 401k plan. You can borrow as much as half of your account’s value up to $50,000. You cannot take out a loan from other self-employed retirement options, including SEP IRAs, IRAs and Keoghs.
Solo loans are tax free and can be used for any purpose. If you want to start a new business, you can get access to the funds you need. If you want to take a vacation from your business obligations, you can do that too. In fact, if you have an existing retirement account that does not allow loans, you can even consolidate your retirement funds into a solo 401k to gain the ability to take out a loan. The only retirement plan that cannot be rolled over into a self-employed 401k plan is a Roth IRA, unless your particular 401k plan allows after-tax salary deferrals.
Make More Contributions:
Another benefit unique to the individual 401k plan is that you can make higher contributions as compared to other types of retirement plans. This allows you to maximize your retirement contributions and tax deductions. In 2013, you can contribute as much as $51,000 if you are younger than 50 years old or $56,500 if you are 50 or older. This is more than you can contribute to any other kind of retirement arrangement other than a solo defined benefit plan. However, the administrative costs of a solo defined benefit plan are much higher than a self-employed 401k plan and you have to contribute a minimum amount of money each year. These stipulations can be a hardship for self-employed individuals.
You are also able to increase, decrease or stop contributions for up to an entire year if you have a solo 401k. This is much different than the rules of other kinds of retirement options, which, as mentioned above, require minimum contributions to keep the account active. This rule is designed to assist the self-employed individual with the flexible financial arrangements that are often needed when running a small business.
Tax Deferred Growth:
Any contributions you make to your solo 401k are tax deferred, so you can contribute to your account without them being taxed until you make a withdrawal. You will have to pay both federal and state taxes on your withdrawal amount no matter when you take your money out, but if you wait until you are 59 ½ years old, you can withdraw your money without incurring any penalties.
If you take out a loan on your 401k plan and you are unable to make payments, you could also be taxed on the amount of the loan and charged an early-withdrawal penalty as well. However, for small-businesses, it is often worth the risk of default because you are essentially only defaulting on yourself. It won’t affect your credit score and you won’t be denied a traditional small-business loan from a bank or other financial institution if you need one in the future.
Are You Eligible for a Solo 401k Plan?
To be eligible for an individual 401k plan, you must be the only employee of your company. Your spouse may also be an employee, as can a partner as long as he does not file a W-2 form at the end of the year. The following types of businesses are eligible for an individual 401k retirement plan:
- Sole proprietorships
- Limited Liability Corporations (LLCs)
- S Corporations
- C Corporations
You may also qualify for a solo 401k plan if you have employees that file W-2s but work fewer than 1,000 hours per year. You can work with as many independent contractors as you wish and still be eligible for a self-employed 401k because 1099 employees are not counted as employees, even if they work more than 1,000 hours per year.
There are some other employee conditions that would still make you eligible for a self-employed 401k plan. These include:
- Employees under 21 years old
- Employees who have been with your company for less than a year
- Some union employees
- Some non-resident alien employees
You may also get an individual 401k plan if you work for an employer but have a part-time self-employed business on the side. You can even be participate in your employer’s retirement plan and still have an individual 401k plan for your company. However, the contributions you make to your employer’s retirement plan will be applied to your self-employed 401k’s deferral limits.
If you are a business owner and are looking for a more flexible retirement account to accommodate your income fluctuations, a solo 401k could be the answer. You can access funds when you need them, make more contributions to boost your retirement income and can start and stop contribution as business needs dictate. You aren’t a huge corporation. Get a 401k account that doesn’t treat you like one.
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