When America’s 15 million self-employed workers[1] contemplate retirement planning, confusion and misperceptions can arise. This year’s Spark 401k Small Business Retirement Planning Index found that more than half (57 percent) of the self-employed are not confident they are saving enough for retirement.
Freelancers and owner-only businesses often believe they are too small for a 401(k) or are simply unaware they can even start a solo 401(k) for themselves. In fact, the survey uncovered that 67 percent of owner-only businesses without a 401(k) think their business is too small to access a 401(k) plan. However, whether a business consists of one owner or 100 or more employees, there are affordable and accessible retirement plan options to fit any business.
Establishing an Individual 401(k), also known as a Solo 401(k) – a qualified retirement plan for employers with no full-time employees other than the business owner(s) – can be a straightforward process, as digital offerings allow business owners to receive a quote and set up a plan online. These plans are typically inexpensive and offer great saving and tax benefits. It’s always a good idea to speak with a trusted financial planner and/or tax advisor before making any significant retirement or business planning decisions.
For those looking to reduce their 2017 tax bills while planning for retirement, an Individual 401(k) plan may be a smart move. Here are three ways an Individual 401(k) can benefit owner-only businesses.
1. Business owners can contribute up to $54,000 in tax-deferred investments each year.
According to the survey, nearly a quarter (22 percent) of solopreneurs without a plan say they would consider offering a 401(k) if tax benefits existed – and many SBOs can reap tax breaks for contributions.
Under an Individual 401(k), you are both the employee and the employer. This means you can contribute the $18,000 per year maximum as an employee ($24,000 if 50 years plus) and/or profit share tax-deferred to yourself as the employer up to the $54,000 limit. Once the contributor hits the big 5-0, this threshold jumps to $60,000 (depending on income), a significant sum that could even drop someone down a tax bracket while empowering them to put away a meaningful amount towards retirement.
The self-employment rate among workers aged 65 years and older hit 15.5% in 20151; the aforesaid threshold helps a large fraction of the U.S. population shelter more money than other notable retirement vehicles such as IRAs (which carry an upper limit of $5,500-$6,500). Plus, unlike Roth IRAs, the Roth 401(k) feature is available to solopreneurs no matter their earned income. This can help them hedge future taxes if they choose to use it.
For those who have fallen behind on their retirement goals and are looking to catch up in the latter stages of their working life, solopreneurs can also reach their Individual 401(k) cap by profit-sharing up to 20 percent of net reported income if they operate an LLC, or 25 percent of W-2 compensation if the business is incorporated.
2. Individual 401(k)s can include multiple owners and spouses.
Individual 401(k)s are also an organic fit for businesses with more than one owner. The tax-deferral benefits available to multiple owners and their spouses who derive income from the business ensure that partnerships and collective owners are also well-positioned to leverage these vehicles for retirement saving. Once a business does hire an employee(s), it becomes mandatory to convert the plan to an employee-based 401(k).
3. You can get access to your 401(k) money in an emergency
Some owners are concerned they won’t be able to access their retirement money in case of an emergency. This isn’t true with a 401(k) plan. For those under 59 ½ years of age, there is 10 percent early withdrawal penalty on top of your tax rate for distributions of tax-deferred 401(k) and IRA savings. However, with a 401(k), you can choose to take a 401(k) loan instead, without early withdrawal penalty and no tax implications either. You may loan yourself half of your 401(k) balance up to the $50,000 limit. Do beware that by taking out this money it can impact how much you can save for retirement, and if you terminate your plan for any reason before the loan is paid back, the unpaid balance is typically due within 60 days. Any unpaid balance will be taxed plus the 10% penalty will apply if you are under 59 ½ years of age.
Next Steps
You may have great plans to expand your business, hire employees and perhaps even cash out down the road. In the meantime, an Individual 401(k) can help you plan for your future retirement goals while also reducing today’s tax obligations.
Applications for Individual 401(k)s ahead of the of the 2018 tax year are due by the end of the business fiscal year (December 31), giving business owners plenty of time to ensure they maximize tax-deferred income and retirement contributions for 2018.
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.
Investment products are offered by Capital One Investing, LLC, a registered broker-dealer and Member FINRA/SIPC. Investment advisory services are provided by Capital One Advisors, LLC, an SEC-registered investment advisor. Insurance products are offered through Capital One Agency, LLC.
All are subsidiaries of Capital One Financial Corporation.
ShareBuilder 401k and Spark 401k are marketing names for Capital One Advisors, LLC.
© 2017 Capital One. All rights reserved.
[1] US Bureau of Labor Statistics, Self-employment In The United States, March 2016
