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How To Get Started With An Individual 401(k)
A 401(k) is simply a company-sponsored retirement plan. Usually, a company will keep a portion of an employee’s paycheck and invest it for them so that they’re prepared for retirement. This is generally offered by the company as a perk to their employees.
So what do you do if you’re self-employed or a full-time freelancer? That’s where individual 401(k)s come in.
An individual 401(k), which is also be known as a solo 401(k), is a one-participant 401(k) plan. Essentially, it’s meant specifically for business owners who have no employees (if your company is set up as a sole-proprietorship or a single-owner LLC/S-Corp, this means you). This means that even though you’re a freelancer or business of one, you can still enjoy the tax advantages of company-sponsored retirement plans.
For an individual 401(k), the total contribution cannot exceed $57,000 for 2020. This means that if the employee contributes $10,000 then the employer can only contribute up to $47,000. The standard contribution amounts for individual retirement plans in 2020 are as follows:
- Employee Salary Deferral - defer your salary up to $19,500 (or $26,000 if you’re over age 50, same limits applies for 2021)
- Employer Contributions (Profit Sharing) – For sole-proprietorship and single-member LLC, you can contribute up to 20% of your net earnings after self employment deduction. For a C corp., S corp., or LLC, you can contribute up to 25% of the salary you pay yourself. In either cases, this cannot exceed more than the 401(k) contribution limit of $57,000 in 2020. ($58,000 in 2021)
How to Set Up an Individual 401(k)
A key thing to remember is that as the owner of your own business, you are viewed as both an employee and an employer. Additionally, how you contribute to your retirement plan is on how your company is structured (Corporation, LLC, etc.).
Lucky for you, our retirement calculator can help you determine how much you should contribute.
Additionally, this plan is probably best for you if you don’t plan on having any employees besides your spouse. However, by adding your spouse you can double the amount that you’re allowed to contribute to $114,000 total ($57,000 * 2 = $114,000).
Now that we’ve explored why individual 401(k)s are a good idea, let’s look at where you can get started.
Steps to Open an Account
The deadline to open an account and make contributions is your tax filing deadline.1 This means to benefit from the tax-advantages for tax year 2020, you can open and make contributions up to April 15, 2021. For those with a corporation entity status, this can be as late as September 15, 2021 with appropriate tax extension filing.
- Head to the provider’s site and fill out details such as date of birth, Social Security number (SSN) and business info (EIN and address).
- Fund your individual 401(k). You can rollover money directly from your previous retirement account electronically or start making a contribution.
- Transfer funds from your business checking account to make it a business contribution and treat it as a business expense
- Transfer funds from your personal checking account or take it out of your salary through your payroll provider to make it a personal contribution.
- Review the investment options and select the ones that are right for you.
Tip: call the provider’s retirement advisors, they are incredibly helpful and can walk you through any input fields that are not clear.
Use our retirement calculator to view the tax amount you can avoid with an individual 401(k) contribution.
Popular Financial Institutions to Consider
Generally speaking, most major banking/lending institutions will have an option for getting started with an Individual 401(k). If you’re already satisfied with the banking institution that you use, it’s probably worth asking if they offer individual 401(k). This way you can keep everything under one roof. However, if you’re looking for a few other places to get started we’ve highlighted a few of the most popular below:
|Company||Fees||Investment Options||Unique Features|
|Charles Schwab||No fees||Mutual funds, ETFs, Managed accounts||Online educational resources on investing. Reports and investing advice from outside advisors. But does not allow 401(k) loans|
|Solo 401k||$399 setup fee, $99/year maintainence||Stocks, ETFs, crypto, real estate||Extensive support in investing in alternative investments (cryptocurrency, real estate, commodity), easy 401(k) loans process|
|Ubiquity||No setup, and $75/month maintainence, or $900/year||20,000 Mutual Fund options||Simple interface and easy to reach support in opening up your account, allow for mega-backdoor Roth [^footnoteInfo]|
|Merrill Edge||0.52% asset-based fee & $3 monthly record-keeping fee,- Employer fees include $100 for setup, plus $20+ per month||Mutual Funds and ETFs||Online educational resources on investing. Access to local financial advisors|
Pros and Cons of an Individual 401k
|Highest contribution limits compared to other retirement accounts||There’s more paperwork involved in setup, but usually there is no annual filing requirements until the plan exceeds $250,000.|
|You’ll have the ability to borrow up to $50,000 against the value of your 401(k). This isn’t a feature with IRAs.||Depending on the financial institution, there may be higher annual fees for servicing unique features|
|The ability to contribute both as an employee and the employer to maximize tax deductions|
You can include a Roth component to your individual 401(k), which are made on an after-tax basis. Thus any investment gains in the future are not taxed.
A Few Additional Advantages
- Full control over where your money is invested (you can choose the right opportunities based on your retirement goals).
- It’s easy to administer payment for investments and related expenses are tax deductible business expenses.
- Investment income is deposited directly to the 401(k) trust account.
- No 3rd party review of paperwork is required.
- Generally, there are no processing or transaction fees for your investments.
- Employer contribution is also counted as a business expense. This means that you can further reduce your corporate effective tax.
To review the most recent information by the IRS, details are available at Publication 560.
Opening an Individual 401(k) is a great way to start your retirement journey if you’ve been operating as a full-time freelancer or business owner of 1. This remains one of the most popular options for freelancers and solo-preneurs who have incorporated. We have helped many of our users open an individual 401(k) up, and we’re happy to help you! Contact us if you want to talk through balancing your business earnings and retirement savings to maximize tax refunds.
Additionally, our last recommendation when considering Individual 401(k)s would be to check if the financial institution offers mega backdoor Roth 2 or after-tax contributions by the IRS. A mega backdoor Roth allows you to contribute more to reach the total 401k contribution limit ($57,000 in 2020). To better understand how this works with sample scenarios, check out this detailed guide by Ubiquity.
- The SECURE Act passed in 2019 has changed the deadline for opening an individual 401k from end of the calendar year to tax filing deadline, including tax extension deadline. Note that contributions for corporations will still need to be documented by the end of the calendar year, but actual money transfers can occur up to the tax extension deadline. ↑
- A financial planning method described to contribute after-tax money into your traditional retirement account, then moving it into your Roth account so it is not taxable at withdrawal. ↑
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