Self-employed retirement plan alternative: The solo 401(k)
Solo 401(k) plans are an attractive retirement savings option for self-employed individuals and small business owners. This article provides a detailed comparison of solo 401(k)s, SEP IRAs, SIMPLE IRAs, and Roth 401(k)s, focusing on eligibility, contribution limits, and advantages.
Eligibility
- Solo 401(k): To be eligible, you must run a business with no employees, except for your spouse. You will also need your Employer Identification Number (EIN).
- SEP IRA: Any size business, including self-employed individuals, can use a SEP IRA.
- SIMPLE IRA: Small businesses with up to 100 employees and employees who have earned at least $5,000 in the prior year are eligible.
- Roth 401(k): Any employer 401(k) plan that offers a Roth option, including self-employed individuals with a solo 401(k) setup, can contribute to a Roth 401(k).
Contribution Limits (2025)
- Solo 401(k): You can contribute up to $70,000 combined as an employee and employer, with an additional $7,500 catch-up if you're over 50.
- SEP IRA: Employer-only contributions are capped at $70,000 or 25% of compensation, whichever is less.
- SIMPLE IRA: Employee salary deferrals are limited to $16,500, with an additional $3,500 catch-up for those over 50. Employers must contribute a percentage of employee salaries, with a minimum of 3% for all employees.
- Roth 401(k): Contribution limits are similar to solo 401(k)s, with employee deferrals of up to $22,500, plus an additional $7,500 catch-up for those over 50.
Advantages
- Solo 401(k): Offers the highest contribution flexibility, catch-up, loan options, Roth option, and investment diversity. It's ideal for high earners wanting max deferrals and loan features.
- SEP IRA: Simplest to administer, making it a good choice for businesses with variable income.
- SIMPLE IRA: Has low administrative burden but lower limits.
- Roth 401(k): Provides tax-free withdrawals if tax rates are expected to rise.
Setting Up a Solo 401(k)
To open a solo 401(k), you'll need to pick a broker, with some offering fee-free plans like Fidelity and Charles Schwab. Be prepared for more paperwork than a typical brokerage account, as you may need to get a tax ID from the IRS. Once your account is set up, you can begin making contributions and choosing your investments, with the ability to manage the investments yourself or use investment advice services provided by the broker.
Penalties and Drawbacks
The solo 401(k) has penalties for early withdrawals before retirement age (59 1/2), and taking out a loan against your account is generally discouraged due to potential drawbacks. It's also worth noting that once your account exceeds $250,000 in assets at the end of the year, you'll need to start filing a special form with the IRS each year.
Consult a Financial Advisor
It's always recommended to consult with a financial advisor to help you achieve your financial goals. With the right planning and understanding of these retirement savings options, you can make informed decisions to secure your financial future.
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- Managing your personal-finance can benefit significantly from understanding retirement savings options like solo 401(k)s.
- With a solo 401(k), you can contribute up to $70,000 per year, making it an attractive choice for high earners seeking max deferrals and loan features.
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