Tax Advantages of a Solo 401(k) for Small Business Owners

Author: Siân Killingsworth / 24 Aug 2023 / 401(k) Plan Information, Solo(k) Plan Information

As a small business owner, gig worker, or self-employed individual, you juggle many responsibilities. Among the essential but often neglected areas is retirement planning. A solo 401(k) could offer you tax advantages that not only secure your financial future but also bring immediate fiscal benefits.

A solo 401(k) is a retirement savings plan designed specifically for self-employed individuals, small business owners without full-time employees, and freelancers. It allows for both employee and employer contributions, providing a way to save a significant amount for retirement while benefiting from tax advantages.

Ubiquity offers two types of solo 401(k) plans:

1. Single(k)^®: This is a straightforward solo 401(k) option that provides the essential features for retirement saving and tax advantages. It’s designed for simplicity and ease of use, making it ideal for small business owners who want a hassle-free way to start securing their financial future.
2. Single(k) Plus^®: This version includes additional features and services, like record-keeping and more extensive investment options. It offers greater customization and is designed for those who want to take a more active role in managing their retirement funds.

Both plans offer the core benefits of a solo 401(k), including tax-deferred growth and dual contribution benefits, but the record-kept Single(k) Plus provides a more comprehensive set of features for those looking for an elevated retirement planning experience.

Here is a detailed breakdown of what you stand to gain from saving in a solo 401(k):

1. Tax-Deferred Growth

What it Means:

In a solo 401(k), the returns you earn from your investments are not taxed immediately. They are tax-deferred, meaning you pay taxes only when you start making withdrawals in retirement.

Example:

If you invest $10,000 and it grows to $15,000 over a couple of years, you don’t owe taxes on the $5,000 gain until you withdraw it. This allows your investments to compound more quickly because you’re not siphoning off gains to pay taxes yearly.

2. Dual Contribution Benefits

Employee Contributions:

You can wear two hats: that of the employer and the employee. As an employee, you can defer a portion of your income into the plan. This pre-tax contribution reduces your current taxable income. For 2023, the maximum you can contribute as an employee is $22,500. If you are over 50, you can add an extra $7,500 as a catch-up contribution.

Employer Contributions:

You can also contribute as the employer, up to 25% of your compensation. These contributions further reduce your business’s taxable income because they are deductible expenses.

3. Enhanced Tax Savings

Contributions to a solo 401(k) may reduce your overall taxable income.

Example:

If you make $100,000 a year and contribute $22,500 to your 401(k), you’re only taxed on $77,500. This could potentially drop you into a lower tax bracket, saving you a substantial sum when tax time comes.

4. Control Over Investments

You have broad discretion over your investment choices in a solo 401(k), including stocks, bonds, mutual funds, and real estate.

Example:

Suppose you have expertise in the real estate market. You could diversify your solo 401(k) by adding real estate investments, tailoring your portfolio according to your risk tolerance and knowledge base.

5. Administrative Simplicity

When you work with a reputable plan provider, setting up and maintaining a solo 401(k) is typically straightforward.

Example:

Many providers offer digital platforms where you can monitor investments, make changes, and get customer support, all without the complicated paperwork that some other retirement plans require.

6. Loan Provision Flexibility

You can borrow from your solo 401(k) for sudden financial needs or business investment opportunities.

Example:

If your business needs a new piece of equipment costing $20,000, you could borrow from your solo 401(k) to make the purchase, then repay the loan over an agreed period.

7. Tailored Contributions

Solo 401(k) plans accommodate fluctuating incomes, allowing you to adjust your contributions accordingly.

Example:

If you have a profitable year and make $120,000, you can maximize your contributions. In a less prosperous year where you earn $70,000, you can reduce your contributions without facing any penalties.

8. Retirement Savings Discipline

Automatic contributions and tax incentives encourage you to consistently fund your retirement account, instilling a savings discipline that can serve you well long-term.

9. Efficient Estate Planning

By naming beneficiaries for your solo 401(k), you ensure a smoother transition of your retirement funds to your loved ones, avoiding the time-consuming and often costly probate process.

Your Takeaway

The solo 401(k) offers multiple tax advantages uniquely suited to the financial realities of small business owners, gig workers, and self-employed professionals. With options for immediate tax relief and long-term investment growth, a solo 401(k) should be a strong contender when considering retirement plans for your business.

 

Please refer to Important Information for details.