When “solopreneurs” decide to go into business on their own, there are many things they may have happily left behind in the corporate world, but a 401(k) shouldn’t be one of them.
Many self-employed individuals may think they’re too small for a 401(k) or that starting a plan just for them is too pricey or confusing, but these business owners are able to take advantage of distinctive tax benefits, and can make tax-deferred contributions as both an employer and employee.
If you are thinking about ways to reduce your 2014 business and personal taxes and plan for retirement, you may want to consider starting an Individual 401(k) plan (also known as a Solo 401(k)) by the December 31 government deadline. You will still have until your 2015 tax deadline to make employer contributions (that’s March 17 if you are an S-Corp or C-Corp and April 15 if you are an LLC, 1099 or Sole-Proprietor).
Here are some of the benefits a Solo 401(k) may offer the self-employed. Remember, you should talk through any retirement and business planning decisions with a financial consultant and tax advisor.
Benefit #1 – You Can Shelter More Money
With a Solo 401(k), a business owner is able to make tax-deferred business contributions totaling $52,000 if they are under 50 years old or $57,500 if they are 50 or older (depending on their income), with the potential to shelter more money than with other retirement vehicles such as IRAs.
To reach that cap, you can profit-share up to 20 percent of net schedule C if you are an LLC or up to 25% of W-2 compensation if your business is an S-corp. You can also make personal contributions as an employee of up to $17,500 ($23,000 if you’re over 50) to help reach the maximum contribution amount.
While the same limits hold true in employer plans, reaching the $52,000 cap can be more difficult since the company contributions go to all participating employees, so the cost to do so can add up quicker (versus just paying yourself as a self-employed business from company profits).
“Individual 401(k) plans offer the self-employed tremendous flexibility in managing taxes and planning for retirement. Compared to other retirement savings tools like IRAs, Solo 401(k)s offer high personal and business tax deferral limits, and also offers Roth 401(k) options for owners looking for after-tax benefits,” says Stuart Robertson, head of ShareBuilder 401k, a 401(k) plan provider that specializes in online-managed, ETF-based 401(k) plans for small to medium-sized businesses.
Benefit #2 – You Can Support Multiple Owners and Spouses
A solo 401(k) is also an option for businesses with more than one owner. The tax-deferral benefits are also available to multiple owners and spouses who derive income from the business. But if you hire employees who don’t hold an ownership stake in the company, you’ll need to convert to a 401(k) plan designed for employees.
Benefit # 3 – You Can Avoid Complex Regulations
One reason 401(k) plans are often considered confusing is because most are subject to nondiscrimination testing that prove a plan benefits all employees, not just owners and highly compensated employees. These tests can be very complex and can add up to lot of managerial headaches.
But since a Solo 401(k) only covers owners and possibly spouses, this testing does not apply, making these plans markedly less complex.
“Overall, setting up and managing an Individual 401(k) plan is a lot simpler than most business owners realize,” says Robertson. “Our plans can be set up online and should not take a lot of time to manage.”
Deadlines for Solo 401(k) Plans
December 31 is fast approaching, so if you want maximize your tax-deferred income for 2014 and begin 2015 ready to save for retirement, don’t wait.
ShareBuilder401k can walk you through the set-up process, and will discount set up costs by $75 between December 8 and December 14. If you start a plan with $250,000 or more at any time, there is no charge).
Once your plan is established, you have until your tax deadline to make business contributions for the 2014 calendar year. The deadline for making personal contributions is December 31, 2014.
And remember, you may have great plans to grow your business, hire employees and perhaps eventually sell. But in the meantime, an Individual 401(k) may help you plan for your retirement, and reduce your business and personal tax obligations at the same time.
This should not be construed as tax or financial planning advice. You should always confer with your accountant or financial consultant before making a decision about retirement planning for yourself or your company.
Spark Business and ShareBuilder Advisors, LLC are separate but affiliated legal entities and are each responsible for their own products and services.
** Advisory services are provided by ShareBuilder Advisors, LLC, an SEC registered investment advisor and a subsidiary of Capital One Financial Corporation.
401(k) plans are: not FDIC insured • Not bank guaranteed • May lose value
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