Solo 401(k) - The best way to max your contributions to a deductible retirement account
The Solo 401 (k) is a relatively new self-employed retirement plan that gives flexibility of contribution and highest contribution limits but requires some amount of detailed paperwork. Changes in tax laws have altered the Solo 401 (k) in several ways. Today, the plan offers bigger deductible annual contributions helping you consolidate a big tax-deferred retirement account balance while keeping your annual income tax bill low. It is an ideal plan for the self-employed who have no employees. You have an exception there if the only other employee is your spouse.
How to set up a Solo 401(k) account?
You could set up a Solo 401(k) account with the help of any financial institution. You could opt for the traditional or Roth structure depending upon whether you want tax-deferred growth or tax-free growth. The paperwork would include filling up an application, forms for company information and agreements, etc.
What are the advantages of a Solo 401(k) plan?
The main advantage of this Plan is that the limit on deductible contributions is high all the way to even 100 per cent of the net earnings up to $16,500 ($22,000 if you are older than 50). You can also contribute another component or the profit-sharing amount of up to 25 per cent of your compensation income or 20% of your self-employment income. However, if you have employees then you are required to contribute to their account as well which requires paperwork and is better done with the help of a professional tax consultant.
Can you take a loan against your Solo 401 (k) account?
One of the most popular reasons why self-employed people go for the Solo 401(k) is the option to take pre-retirement loans. This option is set up with the help of a form. Most businesses also qualify for a tax credit of up to $500 to take care of up to 50 per cent of the cost of setting up and administering the account in the first three years. People who have a business and a day job could also contribute to their regular retirement account at their workplace and to their solo 401(k) account.
Most businesses that qualify for a Solo 401 (k) plan also qualify to take a tax credit of up to $500 to cover up to half the cost of setting up and administering the plan in each of its first three years.
What is the penalty on early withdrawals?
If you withdraw money from the account before the age of 59 years and six months then you have to pay a 10 per cent penalty. However, there are some exceptions which include: permanent disability of account owner, death of account owner, for non-reimbursed medical expenses (if expenses are in excess of 7.5% of your adjusted gross income), for first-time home purchase, for higher education costs and medical insurance premium.
What is the last date for setting up a Solo 401(k)?
A Solo 401(k) must be established by the end of the tax year which is December 31. The last date for funding the Plan depends upon how the business has been set up - incorporated or unincorporated. Also, every component of the Plan contribution could have a separate last date. The last date varies from the ending of the tax year to the extended due date of the tax return.