Why All Solopreneurs Ought to Contemplate Opening a Solo 401k

Right now, I’ve a really informative article from Paul Kim of Ocho all about the advantages of getting a solo 401k, how a lot you may contribute every year, and the way a solo 401k works. Since lots of my readers are self-employed, I assumed this might be the proper matter to cowl at present, as saving for retirement is so necessary! Take pleasure in Paul’s article beneath.

A solo 401k is likely one of the strongest wealth-building instruments for self-employed people. It comes with the very best contribution limits of any retirement plan, tax-free compounding, the flexibility to spend money on any asset class, and extra.

I’ve been self-employed for many of my skilled life – 9 years to be actual. In my early 20s, I found the potential of making a living on-line, taught myself the right way to construct blogs, realized search engine optimization, and have been making an ideal residing rising content material companies for almost a decade.

Just lately, I joined the workforce at Ocho as a full-time worker, and many individuals have requested me why I might ditch working for myself to turn into an worker.

I’ve two solutions for them:

First, the founding father of Ocho, Ankur Nagpal, constructed and grew his final firm, Teachable, to a $250 million enterprise in only a few years. With the ability to work alongside him, together with the proficient founding workforce he recruited, is a tremendous alternative. And after almost a decade of solopreneurship, I crave working as a part of a bunch to attain a higher objective.

Second, what Ocho is constructing is one thing I passionately needed to exist for a really very long time – a supercharged, intuitive solo 401k plan for self-employed individuals like me.

I had heard of a solo 401k earlier than becoming a member of Ocho, however like many individuals I’ve talked to, ultimately dismissed the concept after realizing how complicated (and costly) it may be to arrange and keep a self-directed account. Main banks solely provided a cookie-cutter model of the plan with none of the nice options, and not one of the different third-party suppliers appeared promising sufficient to belief with my retirement financial savings.

At Ocho, we launched our self-directed solo 401k plan with checkbook management. And we fully reimagined the enroll circulate and consumer expertise to make it as intuitive and accessible as attainable.

In the event you’re a enterprise proprietor or self-employed (ie. you run a weblog, freelance, or are a creator), I’d like to share some the reason why it’s best to look into getting a solo 401k.

Even in the event you don’t care about retirement financial savings proper now, the tax advantages of getting an account can doubtlessly prevent tens of 1000’s of {dollars} every year.

Associated content material:

What’s a solo 401k?

What’s a solo 401k? I’ll speak extra about this in only a bit however, briefly, it’s a particular form of 401k plan designed particularly for enterprise house owners and self-employed individuals. It presents the very best contribution limits, a giant Roth account, and the flexibility to spend money on any asset class with tax-free compounding.

In contrast to a standard 401k, you don’t want an employer to sponsor a plan as a way to take part.

As a enterprise proprietor or self-employed particular person, you may arrange an account and begin making contributions by yourself.

How do you qualify for a solo 401k?

To be eligible for a solo 401k, all you want are two issues:

1. Any kind of enterprise exercise.
2. No full-time W-2 staff that work over 1,000 hours per yr in your small business (excluding your partner).

There aren’t any earnings limits (all earnings ranges are eligible whether or not you make a couple of hundred per week or have a seven-figure enterprise), and any kind of enterprise entity qualifies. Nevertheless, you can not have any full-time staff aside from your partner. You may nonetheless work with contractors and freelancers, however W-2 staff that work over 1,000 hours per yr that aren’t your partner will disqualify you from a solo 401k.

What’s so particular a couple of solo 401k?

A solo 401k provides you extra management and adaptability than every other retirement plan. Let’s do a fast run by way of of all the advantages and options.

A fast be aware earlier than we dive in: Not all plan suppliers will provide these options with their plans. In the event you’re wanting to join a solo 401k, ensure you do your analysis and find a provider that gives the advantages that you just’re searching for.

1. Highest contribution limits

A solo 401k has the very best contribution limits of any retirement plan on the market. For 2022, you may contribute as much as $61,000 or $67,500 in the event you’re at the very least 50 years of age. For 2023, you may contribute as much as $66,000 or $73,500 in the event you’re at the very least 50 years of age.

For comparability, a standard 401k plan has a contribution restrict of $20,500 for 2022 and $22,500 for 2023. And a conventional or Roth IRA has a contribution restrict of simply $6,000 for 2022 and $6,500 for 2023.

2. Put money into any asset class

If you make investments by way of a standard 401k that you just obtain out of your employer, your funding choices are normally restricted to round a dozen mutual funds which might be pre-selected by your organization.

With a conventional or Roth IRA, you get a wider vary of funding choices, however you’re nonetheless restricted to only conventional belongings like shares, bonds, ETFs, and mutual funds.

With a solo 401k, you may spend money on any asset class. Along with conventional belongings, it’s also possible to make various investments into belongings like cryptocurrencies, NFTs, actual property, treasured metals, and personal fairness.

3. Tax-free compounding

As with most different retirement plans, a solo 401k comes with tax-free compounding. If you promote belongings and make a revenue, you don’t pay any capital positive aspects tax. As an alternative, 100% of the earnings go straight again into your account, the place it could possibly get reinvested.

This additionally applies in the event you resolve to spend money on one thing like an funding property, which is feasible by way of a self-directed solo 401k plan that enables various investments. All rental earnings you obtain from tenants can be tax-free, and in the event you resolve to promote your property sooner or later, all earnings would additionally go straight again into your solo 401k account, fully tax-free.

4. Roth possibility

If you join a solo 401k, many premium plan suppliers will give you two totally different accounts.

1. A standard (pre-tax) solo 401k account.
2. A Roth (post-tax) solo 401k account.

These work equally to a conventional and Roth IRA. In the event you’re unfamiliar with how these work, right here’s a fast breakdown of the 2 forms of accounts.

With a conventional retirement account, you contribute with pre-tax {dollars} (earnings that you just haven’t paid taxes on but). The quantity you contribute to your account will get deducted out of your taxable earnings for the yr. Nevertheless, withdrawals in retirement can be taxed as common earnings.

With a Roth retirement account, you contribute with post-tax {dollars} (earnings that you just’ve already paid taxes on). You don’t get any tax breaks for making contributions, however your withdrawals in retirement are fully tax-free.

Instance: Let’s say that you just earned $80,000 this yr and resolve to contribute $20,000 into your solo 401k. In the event you contribute that cash into a conventional solo 401k, it will get deducted out of your taxable earnings and also you solely should pay taxes on $60,000 of earnings fairly than $80,000. Nevertheless, in the event you contribute $20,000 right into a Roth solo 401k, your taxable earnings continues to be the total $80,000.

Now let’s fake that the $20,000 contribution will get invested and, over the subsequent few years, grows to a worth of $200,000. If it was invested by way of a conventional solo 401k, you’ll should pay earnings taxes once you resolve to make a withdrawal of your funds in retirement. Nevertheless, if it was invested by way of a Roth solo 401k, since you already paid taxes in your contribution, your withdrawals in retirement can be fully tax-free.

5. Mega backdoor Roth

In the event you love Roth accounts, the solo 401k has one other function that permits you to contribute much more cash right into a Roth solo 401k than is usually allowed.

Usually with a solo 401k, you may contribute as much as $22,500 right into a Roth account for 2023. In the event you’re at the very least 50 years of age, you may contribute as much as $30,000. With a mega backdoor Roth solo 401k, you have got the flexibility to contribute as much as the solo 401k contribution restrict solely into your Roth account. As an alternative of with the ability to contribute simply $22,500, you may contribute as much as $66,000 ($73,500 if age 50+) into your Roth solo 401k for 2023.

6. The biggest attainable tax deduction

Due to its excessive flexibility, you have got full management over what kind of contribution you wish to make into your solo 401k plan every year.

You may allocate a few of your funds to pre-tax and the remaining to Roth, you are able to do a mega backdoor and put the whole quantity right into a Roth solo 401k, or you may even resolve to not contribute to a Roth account in any respect for the yr. 

In the event you resolve to contribute every little thing to a conventional solo 401k, it’s attainable to get a tax deduction of as much as $66,000 ($73,500 if age 50+) for 2023.

7. Rollovers

You may rollover belongings from every other retirement account, besides a Roth IRA, right into a solo 401k plan. When you’ve got belongings in one other retirement account, rolling it over to a solo 401k instantly provides you entry to extra funding choices.

As an example, when you’ve got $50,000 sitting in your conventional IRA, you may roll it over tax-free right into a solo 401k and make investments the cash into various belongings.

There aren’t any limits on how a lot you may rollover into your solo 401k, and rollovers don’t have an effect on your annual contribution limits. For instance, in the event you resolve to rollover $50,000 into your solo 401k this yr, you’ll nonetheless have the total contribution restrict of $66,000 remaining.

Solo 401k Contributions defined

Contributions to a solo 401k work a little bit in a different way than different retirement plans. Because you’re the proprietor of your small business, you get to contribute as each the employer and the worker. All sides has barely totally different guidelines and limits. Let’s undergo them beneath.

Worker contributions: As an worker of your small business, you may contribute as much as 100% of your compensation as much as $22,500 for 2023. In the event you’re at the very least 50 years of age, you additionally get a further $7,500 in catch-up contributions, bringing your whole contribution restrict to $30,000.

Employer contributions: Because the employer, you may contribute as much as 25% of your compensation if your small business is included, and as much as 20% of your compensation if your small business just isn’t included.

The whole worker and employer contributions should not exceed the annual solo 401k contribution limit, which is $66,000 for 2023 ($73,500 if age 50+). Worker contributions could be made as pre-tax or Roth (or each), however employer contributions can solely be made as pre-tax.

How do withdrawals work with a solo 401k?

Withdrawals from a solo 401k work equally to different retirement plans. You can begin making withdrawals out of your account when you attain the age of 59½.

Withdrawals made earlier than turning the age of 59½ are topic to a ten% early distribution penalty plus earnings taxes on the quantity withdrawn.

For instance, in the event you make an early withdrawal of $10,000 earlier than you flip 59½ years previous, you’ll should pay $1,000 in penalties plus earnings taxes on the $10,000 withdrawn quantity.

Conventional vs Roth withdrawals

After the age of 59½, withdrawals don’t get hit with the ten% penalty.

Nevertheless, relying on the kind of account you withdraw from, you should still should pay earnings taxes.

Certified distributions from a conventional solo 401k are taxed as common earnings, and the quantity in taxes relies on your tax bracket and tax charges on the time of withdrawal. Certified distributions from a Roth solo 401k are tax-free.

Solo 401k vs different retirement plans

Let’s check out how a solo 401k compares with different standard retirement plans just like the IRA, SEP IRA, and 401k.

Solo 401k vs SEP IRA

The closest comparability to a solo 401k is the SEP IRA. Each retirement accounts are designed for enterprise house owners they usually have the identical contribution limits. Nevertheless, there are some main variations to pay attention to in the event you’re attempting to resolve between the 2.

• Roth possibility: A solo 401k has a Roth possibility whereas a SEP IRA solely comes with a pre-tax conventional possibility. All contributions to a SEP IRA have to be made as pre-tax contributions.
• Catch-up contributions: The solo 401k and SEP IRA have the identical contribution restrict of $66,000 for 2023. Nevertheless, a solo 401k has catch-up contributions whereas a SEP IRA doesn’t. In the event you’re at the very least 50 years of age, a solo 401k means that you can contribute as much as $7,500 extra in 2023, bringing your whole contribution restrict to $73,500.
• Funding decisions: A solo 401k permits you to spend money on each conventional and various belongings, whilst you can solely make conventional investments with a SEP IRA. Put one other approach, a SEP IRA solely permits you to spend money on issues like shares, bonds, mutual funds, and ETFs, whereas a solo 401k additionally permits you to spend money on various belongings like cryptocurrencies, NFTs, actual property, and personal fairness.
• Workers: SEP IRA house owners are allowed to have full-time staff, whereas with a solo 401k, you’re not allowed to have any full-time W-2 staff that work over 1,000 hours in your small business (excluding your partner). The caveat is that SEP IRA house owners should make equal share contributions for each eligible worker of their enterprise. For instance, in the event you resolve to contribute 15% of your compensation into your SEP IRA, you’re obligated to additionally contribute 15% of each eligible worker’s compensation into their SEP IRAs as effectively.

Solo 401k vs 401k

A 401k plan is an employer-sponsored retirement plan.

As a way to take part in a 401k, you should work at an organization that gives one to their staff.

Then again, a solo 401k is for particular person enterprise house owners and could be opened with out an employer. Listed below are a number of the main variations between a solo 401k and 401k.

• Funding choices: A 401k sometimes solely permits you to spend money on round a dozen mutual funds which might be pre-selected out of your employer. You may’t select particular person shares of corporations you want, you may’t spend money on your favourite ETFs, and you’ll’t spend money on various belongings. Compared, a solo 401k permits you to spend money on any asset class, whether or not it’s conventional belongings or various investments like crypto, actual property, and personal fairness.
• Contribution limits: As an worker, you may solely contribute as much as $22,500 right into a 401k plan, or as much as $30,000 in the event you’re at the very least 50 years of age. Nevertheless, with a solo 401k, since you may contribute as each the worker and the employer, your contribution restrict is 3x increased at $66,000 for 2023, or $73,500 in the event you’re at the very least 50 years of age.
• Rollovers: Most 401k plans don’t will let you rollover your 401k belongings into one other retirement account whilst you’re nonetheless employed on the firm. With a solo 401k, you may rollover your funds into every other retirement account everytime you need.
• Roth possibility: Whereas some employers do provide a Roth possibility as a part of their 401k plan, most plans solely provide a conventional 401k account. With a 401k, whether or not you have got a Roth possibility or not is solely as much as your employer. With a solo 401k, you get the liberty to decide on a plan supplier that gives the advantages you’re searching for, just like the Roth account.

Solo 401k vs IRA

The principle distinction between a solo 401k and an IRA is {that a} solo 401k is just for enterprise house owners whereas any particular person with earned earnings can contribute to an IRA. Listed below are the principle variations between the 2 plans.

• Contribution limits: The contribution restrict of a solo 401k is 10x increased than the contribution restrict of a conventional or Roth IRA. A solo 401k has a restrict of $66,000 for 2023 ($73,500 if age 50+), whereas an IRA has a restrict of simply $6,500 for 2023 ($7,500 if age 50+).
• Funding choices: An IRA solely permits you to spend money on conventional belongings like particular person shares, bonds, mutual funds, and ETFs. A solo 401k permits you to spend money on each conventional belongings and various belongings. Technically, it’s also possible to spend money on various belongings by way of an IRA by way of a self-directed IRA. Nevertheless, these accounts sometimes don’t provide you with one thing referred to as checkbook management (defined additional down beneath), which is essential if you wish to spend money on various belongings.
• Revenue limits: IRAs have earnings limits that prohibit contributions or tax deductions in case your earnings is simply too excessive. For instance, with a Roth IRA, you can not contribute in any respect in case your modified adjusted gross earnings (MAGI) is over $153,000 for 2023. With a conventional IRA, you may nonetheless contribute in case your earnings is simply too excessive, however you gained’t get any tax deductions on your contributions in case your MAGI is over $83,000 for 2023.

How does checkbook management work?

At Ocho, we intentionally launched our solo 401k plan to come back with one thing referred to as checkbook management. Earlier than we log off, I needed to share a little bit bit about it since many individuals I’ve spoken with have by no means heard of it earlier than.

Checkbook management means precisely what it seems like: You get management over your solo 401k account’s checkbook. Basically, you have got full management over your solo 401k’s financial institution and funding accounts and might write checks and wire funds immediately once you wish to make an funding.

Right here’s the way it works

If you join a solo 401k plan, you get a separate financial institution and brokerage account on your solo 401k belief. Because the trustee of your plan, you get checkbook management over these accounts and might write checks immediately once you wish to make an funding. 

For instance, if you wish to purchase crypto, you’d open a brand new account with an alternate utilizing your solo 401k plan belief because the proprietor, and fund your account utilizing your solo 401k checking account. If you wish to spend money on a startup, you’d merely write a examine out of your solo 401k plan belief checking account.

With different self-directed solo 401k plan suppliers, they’ll create the solo 401k plan docs for you, however it’s essential to discover a third celebration financial institution and brokerage and ask them to just accept the docs and open your accounts for you.

With Ocho, we now have built-in brokerage accounts they usually’re created as a default a part of your account immediately once you enroll. You may fund your accounts by way of your dashboard, make investments into conventional belongings by way of our funding platform, or wire funds and write checks immediately.

Checkbook management provides you full freedom to spend money on no matter asset class you need, with out having to undergo a plan custodian to approve your buy and wire the funds for you. It’s one of the vital highly effective options of a self-directed solo 401k plan.

Conclusion

A solo 401k is likely one of the strongest wealth-building instruments for enterprise house owners and self-employed people. It comes with the very best contribution limits of any retirement plan, a mega-sized Roth account, tax-free compounding, and the flexibility to spend money on any asset class.

To qualify, all you want is any kind of enterprise or self-employment exercise, with no full-time W-2 staff that work over 1,000 hours per yr in your small business. All enterprise entities are eligible, whether or not you use as a sole proprietorship, LLC, partnership, s-corporation, or c-corporation.

Surprisingly although, whereas being one of the vital versatile retirement plans on the market, it’s lesser recognized than different plans just like the 401k or IRA. The reason being, establishing a solo 401k has at all times been a fancy course of, and requires studying by way of and signing dozens of pages of paperwork and utility kinds.

At Ocho, we fully redesigned the signup course of from the bottom up. What used to take hours or days now takes only a few clicks and can all be done through our website in below 10 minutes. 

That was a protracted learn! In the event you’re nonetheless right here with me, superior and thanks for studying to the top. In the event you’re serious about studying extra about establishing a solo 401k, I’d be more than pleased to reply any questions beneath and even assist information you thru our utility course of in the event you resolve to enroll.

Writer bio: Paul Kim is a cash nerd and finance blogger. Earlier than becoming a member of the workforce at Ocho to work on content material and schooling, he constructed two totally different finance media manufacturers from zero to over one million readers per yr. In his spare time, he likes listening to cash podcasts at 2x velocity whereas climbing together with his canine, Elliot.

Are you saving for retirement? What questions do you have got about solo 401ks?