Why It Might Pay to Go Solo

Wells Fargo

Why It Might Pay to Go Solo

If you’re looking for a good retirement plan, especially one that can help you maximize tax-deductible retirement contributions, it might pay to look at a solo 401(k). Typically, if you’re self-employed or own a small business and have no other full-time employees (with the exception of the owner’s spouse), the first plans to consider have been simplified employee pensions (SEPs) and savings incentive match plans for employees (SIMPLE) IRA plans. They’re both solid plans because they’re fairly simple and don’t cost much to administer.

But depending on your goals, a 401(k) plan may offer a better combination of benefits. A solo 401(k) plan is a standard 401(k) plan combined with a profit-sharing plan. (It’s not a different kind of 401(k) plan, but one that takes advantage of the relaxed rules that apply when the only people who participate in the plan are the owner and his or her spouse.) If you have full-time employees age 21 or older (other than your spouse) or part-time employees who work more than 1,000 hours a year, you’re not eligible for a solo 401(k).

A solo 401(k) also offers the same flexibility as a standard 401(k), as you can choose to invest pre-tax money or go for a Roth plan, which allows you to invest after-tax dollars.

In terms of maximizing contributions to your solo 401(k), you can invest as much as $15,500 as an employee for 2007. As an owner, you’re allowed to contribute an additional 25% of your compensation, up to a total of $45,000. And there is no minimum contribution, so you don’t have to worry about not adding to the fund during lean years. So if you and your spouse are both in the solo 401(k), you could save up to $90,000 per year. If you’re age 50 or older, you can add another $5,000 each in catch-up contributions this year.

With a standard 401(k), you can only invest up to the $15,500 limit and the catch-up contribution. In the case of a SEP IRA, you can invest only 25% of your business income up to $45,000. That may seem to compare favorably to a solo 401(k), unless 25% of your business income doesn’t get you to the $45,000 maximum, at which point, you truly miss the benefit of the $15,500 employee contribution. In addition, there is no $5,000 catch-up contribution opportunity.

Solo 401(k)s mean more paperwork than SEP IRAs and once your account reaches $100,000 or more, you need to file a special tax return, but those disadvantages are small compared with the potential benefits.

Talk to your accountant or financial advisor before entering into any retirement plan. To find out more about solo and other 401(k)s, check out 401khelpcenter.com and, for information about plans in general, read IRS Publication 560 (2006), Retirement Plans for Small Business.
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