By Jeff Brown
Millions of U.S. workers rely on employer-sponsored 401(k)s to
save for retirement. But what about freelancers, sole proprietors
and workers in the mushrooming gig economy, or people who want to
leave the corporate cocoon and strike out on their own?
Financial advisers say that far from being left out in the cold,
these workers have access to an often-overlooked retirement-savings
vehicle that offers some distinct advantages: an "individual" or
"solo" 401(k).
Available to self-employed people, as well as business owners
and their spouses, solo 401(k)s allow participants to make
contributions as both an employer and employee. That means
individuals can sock away large sums that dramatically reduce
income taxes, among other perks.
Although enrollment data is hard to come by, financial advisers
say solo 401(k)s have been slow to get the respect they deserve
since they were created by Congress in 2001. Many
financial-services firms waited years to start offering the plans,
and many business owners who could have them don't know they
exist.
"You'd be surprised how many people don't know about solo
401(k)s, especially accountants," says Sean Williams, wealth
adviser with Sojourn Wealth Advisory in Timonium, Md.
Perks advisers like
Solo K's, as some call them, allow participants to avoid the
complex rules covering corporate 401(k)s. Not only do solo K's
permit virtually unlimited investing options, they allow
participants to choose between making traditional tax-deductible
contributions or after-tax Roth contributions. Some advisers prefer
them over better-known options for people who work on their own,
such as SEP-IRAs (simplified employee pension individual retirement
arrangements) and Simples (savings incentive match plan for
employees).
"Solo 401(k)s are better than the other options," says Vincenzo
Villamena, a certified public accountant with Online Taxman in New
York, "because of the ability to contribute to a Roth and the
higher contribution limits."
Like corporate 401(k)s, the maximum contribution this year for
solo K's is $56,000, including up to $19,000 in pretax individual
income, plus an employer contribution. (For people age 50 or older,
the maximum is $62,000, due to a catch-up provision.) By
comparison, Simples limit employee contributions to $13,000 this
year ($16,000 for investors age 50 or over), and employer matches
to 3% of compensation up to a maximum of $5,600. SEPs, meanwhile,
limit annual employer contributions to $56,000 or 25% of income,
whichever is less, and there is no employee contribution.
Contribution to solo K's cannot exceed self-employment income,
which is counted separately from any income earned by working for
others.
According to Donald B. Cummings Jr., managing partner of Blue
Haven Capital in Geneva, Ill., contributions can come from other
sources if regular income from the business is needed to pay
ordinary expenses. "Say a 50-plus-year-old business owner inherits
$500,000 from a deceased relative. She now has access to better
cash flow and can theoretically contribute 100% of her
compensation" up to the limit, he says.
An investor also can move cash into a solo K from a taxable
investment account, reducing taxable income and getting tax
deferral on any future gains.
Opening one up typically takes only a few minutes of paperwork
with a financial firm such as Vanguard Group, Fidelity Investments
or Charles Schwab Corp. Providers typically don't require a minimum
contribution to open an account, or minimum annual
contributions.
Business owners who set up the solo plan as a traditional 401(k)
get a tax deduction on contributions, tax deferral on gains and pay
income tax on withdrawals after age 59 1/2 . (If they withdraw
before 59 1/2 , they generally will pay both income tax and a
penalty.) If they choose to go the Roth route, contributions are
after taxes but qualified withdrawals are tax-free, which can be a
plus for those who expect to be in a higher tax bracket later in
life. And unlike ordinary Roth IRAs, which are available only to
people with incomes below certain thresholds, anyone who opens a
solo K can pick the Roth option.
"The single largest benefit of a solo 401(k) is the ability to
contribute Roth dollars," says Brandon Renfro, a financial adviser
and assistant finance professor at East Texas Baptist University in
Marshall, Texas. "Since you are the employer in your solo 401(k),
you can simply elect that option," he says. "This is a huge benefit
over the other types of self-employed plans."
Another plus is that account holders can borrow against the
assets in a solo 401(k), says Pedro M. Silva, wealth manger with
Provo Financial Services in Shrewsbury, Mass. That isn't allowed
with alternatives such as SEPs.
"Business owners often write large checks, and having access to
an extra $50,000 for emergencies or opportunities is a valuable
feature of the plan," Mr. Silva says.
Words of caution
A solo 401(k) must be set up by the end of the calendar year for
contributions to be subtracted from that year's taxable income.
But, as with an IRA, money can be put in as late as the tax
deadline the following April, or by an extension deadline.
Investors who want to change providers can transfer assets from
one solo 401(k) to another with no tax bill, as long as the
investments go directly from the first investment firm to the
second. But if the assets go to the investor first there may be tax
consequences, even if they are then sent to the new provider.
Business owners should be aware that the hiring of just a single
employee aside from a spouse would require the plan to meet the
tricky nondiscrimination test that applies to regular 401(k)s, says
Stephanie Hammell, an investment adviser with LPL Financial in
Irvine, Calif. That test is designed to make sure executives don't
get a better deal than employees.
Business owners in that situation might do better with a SEP or
Simple plan, which don't have the nondiscrimination hurdle,
according to Dr. Renfro.
And as with all financial products, it pays to shop around for
the best combination of investment offerings, fees and customer
service, experts say.
"Set up your account with an investment provider that either
doesn't charge fees for the administration of the account, or
charges very minimal fees," says Natalie Taylor, an adviser in
Santa Barbara, Calif. "Choose an investment provider that offers
high-quality, low-cost investment options inside of the individual
401(k) account."
Mr. Brown is a writer in Livingston, Mont. He can be reached at
reports@wsj.com.
(END) Dow Jones Newswires
July 08, 2019 22:27 ET (02:27 GMT)
Copyright (c) 2019 Dow Jones & Company, Inc.
Charles Schwab (NYSE:SCHW)
Historical Stock Chart
From Mar 2024 to Apr 2024
Charles Schwab (NYSE:SCHW)
Historical Stock Chart
From Apr 2023 to Apr 2024