Maximizing Your Retirement Savings with a Solo 401(k)

Are you a business owner with no employees, or perhaps a career freelancer? If so, a solo 401(k) could be a powerful tool to help you save for retirement. This type of retirement plan offers many of the same benefits as a traditional 401(k), but with some unique advantages tailored to self-employed individuals. In this blog, we’ll explore how a solo 401(k) works, its contribution limits, tax advantages, and whether it’s the right choice for you. And remember, for any mortgage service needs, O1ne Mortgage is here to help. Call us at 213-732-3074 to speak with one of our expert loan officers.

Understanding How a Solo 401(k) Works

A solo 401(k) is designed for business owners who have no employees, although a spouse who earns income from the business can also participate. This plan allows you to contribute as both the employee and the employer, which can significantly boost your retirement savings. The contributions you make as an employee are tax-deductible, and you won’t owe taxes until you make withdrawals in retirement. However, withdrawing funds before age 59½ typically results in a 10% early withdrawal penalty, and required minimum distributions (RMDs) begin at age 73.

Solo 401(k) Contribution Limits

For 2023, the contribution limits for a solo 401(k) are as follows:

• As the employee: You can contribute up to $22,500 of earned income. If you’re 50 or older, you can contribute an additional $7,500.
• As the employer: You can contribute up to 25% of your compensation. If your business isn’t structured as a corporation, you can calculate your earned income by taking your net earnings and subtracting half of your self-employment tax and contributions for yourself.

In total, contributions can’t exceed $66,000 in 2023, excluding catch-up contributions for those 50 or older. This includes both the elective deferrals you make as the employee and your contributions on the employer side.

Tax Advantages of a Solo 401(k)

One of the most attractive features of a solo 401(k) is its tax advantages:

• Employee contributions are tax-deductible: When you file your personal income tax return, contributions you made as an employee will reduce your taxable income.
• Employer contributions count as a business expense: For incorporated businesses, these contributions are considered a deductible business expense. For other business structures, they may qualify as a personal tax deduction.
• Your money grows on a tax-deferred basis: You won’t owe taxes on solo 401(k) funds until you begin taking distributions, allowing you to avoid paying taxes on investment gains along the way.
• Consider a solo Roth 401(k): Roth 401(k)s are funded with after-tax dollars, meaning contributions are not tax-deductible, but you can make tax-free withdrawals in retirement. Starting in April 2024, Roth 401(k)s will be exempt from required minimum distributions.

Is a Solo 401(k) a Good Idea?

If you’re self-employed and looking for a tax-friendly way to save for retirement, a solo 401(k) is definitely worth considering. This plan is especially beneficial if your spouse also earns income from the business, as it can help accelerate your family’s nest egg. Participants can contribute more compared to a traditional 401(k), and the tax benefits offer additional incentives.

However, not all business owners can contribute to a solo 401(k) plan. If you have employees who aren’t contract workers, you may need to explore other retirement savings options, such as:

• Traditional Individual Retirement Account (IRA): Traditional IRAs share some characteristics with 401(k)s, though contribution limits are lower. Contributions may be tax-deductible, and early withdrawal penalties and required minimum distributions apply.
• Roth IRA: With a Roth IRA, you’ll enjoy tax-free distributions in retirement, and there are no required minimum distributions. You can withdraw your contributions at any time, provided you’ve had the account for at least five years.
• SIMPLE 401(k): SIMPLE stands for Savings Incentive Match Plan for Employees. These 401(k)s are geared toward small businesses with fewer than 100 employees.

How to Open a Solo 401(k)

Opening a solo 401(k) involves a few key steps:

1. Compare solo 401(k) providers: Many investment brokerages offer solo 401(k)s. Shop around to find the provider that best fits your needs, considering fees, investment choices, and investor support resources.
2. Decide on the right type of solo 401(k): Choose between the tax benefits of a traditional solo 401(k) or a Roth. A Roth might make sense if you expect your tax bracket to be higher in retirement than it is now.
3. Open your account and select your investments: You’ll likely choose from a variety of mutual funds and exchange-traded funds (ETFs). If you’re unsure where to start, a financial advisor can provide personalized investment guidance. Some solo 401(k) providers also offer investment support.
4. Comply with IRS rules: Stay within the annual contribution limits. Employee contributions generally must be made by December 31 of a given tax year, while the deadline for employer contributions is typically the tax filing deadline, usually in mid-April of the following year. If your plan exceeds $250,000 in assets, you’ll likely need to file Form 5500-EZ annually.

The Bottom Line

A solo 401(k) plan can be an excellent way for self-employed workers to maximize their retirement savings. With several tax advantages and generous contribution limits, it can be especially attractive if your spouse also earns income from the business. As you plan for your financial future, maintaining strong credit is also crucial. Be sure to periodically check your free credit report and credit score from Experian.

For any mortgage service needs, O1ne Mortgage is here to assist you. Call us at 213-732-3074 to speak with one of our expert loan officers. We’re committed to helping you achieve your financial goals and secure a prosperous future.