5 Reasons To Consider A Solo 401(k)

You might think of building a retirement portfolio in the same way you do about working out or eating right, meaning even though you know you should, you might not do it. According to The National Retirement Risk Index, most Americans are not saving enough to retire comfortably, and about half don’t have any retirement savings. How much money you’ll need to require may depend on various factors, such as your location, lifestyle, and expenses. There are many options out there to help you grow your savings to prepare for retirement, including a solo 401(k) plan.

If you’re a small business owner and don’t employ anyone full-time, the solo 401(k) might be the perfect fit to grow your retirement savings with healthy contribution limits that can positively alter your taxable income. This plan is similar to employer-sponsored 401(k) plans, but it’s designed for self-employed workers. Your small business must generate a profit to qualify for a solo 401(k), and you must establish the solo 401(k) before the end of the year to garner any tax benefits. 

If your small business fits this profile, the solo 401(k) could be an excellent way to save for retirement while giving you a nice tax deduction. To help you better understand these plans and the benefits they provide, our team at 3D Partners Wealth Advisors put together this list of five reasons to consider a solo 401(k).

Increase Tax Savings

Retirement Jar full of money

Image by aag_photos licensed under CC BY-SA 2.0

The 2021 contribution limits for a solo 401(k) are $58,000 per year and increase to $64,500 annually if you are 50 or older, up from $57,000 and $63,500 in 2020. This limit is per person, so your spouse can also contribute up to an additional maximum amount. As a comparison, the limits for an IRA are $6,000, with an allowable $7,000 for those 50 and older. 

The contribution limits alone are a huge advantage, allowing you to put more away and reduce your taxable income significantly. Also, the business itself can do an employer match of up to 25% of the contribution, further reducing the taxable income amount.

Ability to Self Direct

The second reason to consider a solo 401(k) has to do with the allowable instruments in which you can invest. With limited exceptions, you can invest your solo 401(k) in any type of investment you would like. You are not bound by the options provided by the financial firm that houses your investment, as you would with a standard IRA or 401(k). A solo 401(k) allows you to focus your investment strategy on whatever you feel comfortable with and are most knowledgeable about for investing your money.

You can use this to think outside the box with your investment choices. You could choose to lend out your money and earn interest on the repayment. If you’re well-versed in real estate, you could purchase a rental property or invest in a development property. If you’re knowledgeable about a particular industry sector and interested in investing in a startup, that’s also an option. When you explore all your options, it quickly becomes apparent why the ability to self-direct is a big reason to invest in a solo 401(k).

Avoid Third-Party Custodians

Many retirement investments, such as an IRA, require that a third party act as a custodian of the investment account. However, a solo 401(k) has no such requirement, and the solo 401(k) owner can act as their own trustee. There are self-directed IRA options, but even those require processing through the third-party custodian of the IRA. This requirement often creates delays and, in some cases, has caused clients to miss out on opportunities. On the other hand, with you acting as your own trustee and custodian, you don’t have these delays because you’re responsible for processing all transactions.

There is no delay or any additional expense associated with using third-party custodians. With a solo 401(k), you’ll have a checking account associated with the solo 401(k). You have complete control of that account, allowing you to write checks and electronically send funds for investments and related expenses. Keep in mind that this freedom comes with responsibilities, so make sure you fully understand the regulations regarding self-directing your solo 401(k).

Access Personal Loans

An IRA does not allow you to use your retirement account for personal reasons unless you meet a specific set of circumstances first. Because of those requirements, accessing your IRA for a personal reason might not be a practical option. On the other hand, a solo 401(k) allows you to take up $50,000 or half of the value, whichever is less, and use that amount for whatever you want.

A solo 401(k) still needs to be drawn up using a 401(k) compliant loan note and must be paid in a maximum of five years, with payments occurring no less than once per quarter. Your solo 401(k) is still a pretty good option for quick access to capital, especially compared to an IRA.

Bypass UDFI Tax

Another downside to an IRA versus a solo 401(k) is that when you use borrowed money to leverage your investment in an IRA, any income received becomes subject to the unrelated debt-financed income tax or UDFI. For example, if you use an IRA to purchase a rental property for $200,000, but 25% or $50,000 came from a non-recourse loan, 25% of any income garnered from that rental property would be taxed under UDFI.

A solo 401(k) isn’t subject to the UDFI tax. All the money you made from your rental property in the example above would be exempt from this tax. Not paying this additional tax makes a solo 401(k) even more appealing to investors.

Contact 3D Wealth Advisors in Honolulu, HI to Learn More About Solo 401(k)s

When you’re ready to examine your investment portfolio options, plan for your retirement, or just learn more about investing your money, turn to the knowledgeable team here at 3D Wealth Advisors. One of our team members would be happy to answer any questions or get you set up for a second opinion. You can reach us at 808-707-8068 or through our secure online contact us form to learn more.