A 401(k) is a popular type of tax-advantaged retirement plan that an employer can offer. And if you’re self-employed, you may choose a similar account called a solo 401(k). They allow you to contribute a portion of your paycheck or self-employment income and select investment options, such as mutual funds and exchange-traded funds (ETFs), to accelerate your account growth.
With either type of 401(k), you can usually choose a traditional or Roth account.
Traditional accounts give you an immediate benefit with tax-deductible contributions, which reduce your annual taxable income and tax liability. You defer paying income tax on contributions and account earnings until you take withdrawals in the future.
Roth accounts require you to make taxable contributions. However, your future withdrawals of contributions and investment earnings are entirely tax-free.
Unlike a Roth IRA, which has an income limit to qualify, there’s no income threshold to participate in a Roth 401(k) or Roth solo 401(k). Therefore, even high earners can participate in a workplace or self-employed Roth and reap the benefits.
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Differences between a 401(k) and a solo 401(k)
Now that you understand the 401(k) basics, let’s cover six main ways a regular and solo plan differ and answer Matt’s question.
Administration
If you’re a business owner, there’s a financial and administrative cost to offering your employees a 401(k) retirement plan. The brokerage firm you choose charges fees to set up and administer a plan as your custodian. Plus, employers have a fiduciary duty to act in the best interest of their workers and follow the federal Employee Retirement Income Security Act (ERISA).
The solo 401(k) was designed to be easier to administer and less expensive for the self-employed. Unless your plan exceeds $250,000 in assets, no filing requirements exist. But when your account exceeds that amount, you must file Form 5500-EZopens pdf file, a simple, two-page document.
Eligibility
You can only participate in a 401(k) when your employer offers one. While most large companies offer a retirement plan, it’s not required. They come with administrative costs that prevent many small businesses from offering a retirement plan.
You can only have a solo 401(k) if you’re self-employed with no full-time employees except a spouse or business partner. For instance, you might work part-time or full-time as a freelancer or contractor or have a side business like real estate, tutoring, photography, or writing.
The business owners and their spouses are considered owner-employees rather than employees but can also contribute to their own solo 401(k) plans. Interestingly, you contribute as both an employer and employee of your business, increasing the annual contribution limit, which we’ll cover next.
Matt, a solo 401(k) is an excellent choice if you’re a solopreneur with no plans to hire full-time staff. You can have one even if you work another job.
For instance, if you have a W-2 day job and a part-time side business with 1099 income, your business income makes you eligible for a solo 401(k) no matter how much or little you earn. However, you can’t contribute more than your self-employment earnings.
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Contribution limits
The contribution limits differ significantly between a regular and solo 401(k). As I mentioned, the solo rules allow you to contribute as if you were two people: an employer and an employee of your own business.
For 2023, those with a regular 401(k) can contribute up to $22,500 or $30,000 if they’re over 50. Your employer may make additional matching or profit-sharing contributions to your account, allowing you to exceed those limits. For 2024, the limits increase to $23,000 or $30,500.
If you have a solo 401(k), the annual contribution limits are much higher but depend on your business income. For 2023, the combined employer and employee contribution limit is up to $66,000 or $73,500 if you’re over 50. After age 50, you automatically qualify for an additional $7,500 catch-up contribution.
Let’s break down the solo 401(k) contribution rules. You can contribute up to $22,500 or $30,000 as your employee. Plus, as your employer, you can make an additional profit-sharing contribution of up to 25% of your income, up to the $66,000 or $73,500 annual maximum. So, the more you earn, the more you can contribute to a solo 401(k).
Note that if you have a regular 401(k) with another employer, you can also have a solo 401(k). However, the employee limits apply per person, not per plan. That means you can’t exceed the employee limit of $22,500 or $30,000 if you’re over 50 for 2023, no matter how many 401(k)s you have.
READ ALSO: Your complete guide to 401(k) retirement accounts
Investment options
With a regular 401(k), the plan rules, investment options, and fees are determined by your employer. Some brokerage firms may offer an extensive investment menu, and others may be slim.
As your own employer with a solo 401(k), you have more control over the investment options and fees. So, whether you want to purchase stock, mutual funds, ETFs, gold, or cryptocurrency in your retirement plan, you’ll find providers offering mainstream and alternative investments with varying fees. You could open a self-directed solo 401(k), allowing you to invest in almost anything tax-free, including real estate, tax liens, and private business funding.
Are you a freelancer who needs to start a retirement plan? Laura explains the rules, pros, and cons of four easy retirement account options that any freelancer or entrepreneur can use to create a comfortable, happy lifestyle in retirement.
Loans
Some regular and solo 401(k)s offer participants loans and hardship withdrawals, while others don’t. If you’re under age 59.5, a 401(k) withdrawal is subject to income taxes plus a 10% penalty.
If your regular or solo 401(k) allows loans, the IRS allows you to borrow up to 50% of your account value up to a lifetime limit of $50,000. You can use the funds for any purpose but must repay yourself at a set interest rate for up to five years.
If you don’t repay a regular or solo 401(k) loan on time, it could be considered an early withdrawal, subject to income taxes, plus an additional 10% early withdrawal penalty. However, if you pay it on time, a 401(k) loan is tax-free, regardless of age.
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Legal protections
I mentioned that ERISA, a federal law, protects regular 401(k)s. It sets minimum standards for employers that offer retirement plans and the administrators who manage them. It protects plan participants and their beneficiaries’ interests in workplace retirement plans.
Additionally, a powerful but lesser-known benefit ERISA offers workplace retirement plans is protection from creditors. Let’s say you have money in a regular 401(k) but lose your job and can’t pay your car loan. The car lender can attempt to get repayment from you in various ways, but not by tapping your 401(k). There are exceptions like owing federal tax debts, criminal penalties, or an ex-spouse under a Qualified Domestic Relations Order.
But a solo 401(k) isn’t covered under ERISA because they aren’t considered an employee benefit plan. Since they only cover business owners and their spouses, a solo 401(k) doesn’t enjoy the same legal protections as a regular 401(k) protected by ERISA.
Therefore, if you’re considering a rollover from an old 401(k) to a solo 401(k), be aware that you wouldn’t enjoy the same legal protections from potential creditors.
This article originally appeared on QuickandDirtyTips.com and was syndicated by MediaFeed.org.
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4 ways to protect yourself from forced retirement
While younger workers might have the luxury of finding new jobs with higher wages, the pandemic pushed many older workers to retire, according to a new study by The New School Schwartz Center for Economic Policy Analysis.
Out of 3.8 million older workers who lost their jobs in April 2020, 400,000 workers were retired involuntarily a year later, the study finds. Further, since March 2020, the size of the retired population between ages 55 and 74 has expanded beyond its normal level by 1.1 million people. The Schwartz Center used unemployment data to reach its conclusions.
“Those who retired left involuntarily,” says research associate Barbara Schuster. “People who could stay in their job made a choice to hold onto their job.”
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Older workers who were pushed out of their jobs the first month of the pandemic found it difficult to find another job.
“The combination of the shock and uncertainty brought about by the pandemic plus the accompanying recession caused many of these unemployed older workers to give up, thinking there was no way they would ever get hired again, so their unemployment turned into retirement,” says Carol Fishman Cohen, CEO and co-founder of iRelaunch, a career reentry sourcing, consulting and training company.
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Although there is a low unemployment rate, older workers still find it more difficult than younger workers to find a new job, and often a new position will pay less than their previous role, says Teresa Ghilarducci, director of the Schwartz Center.
“When you’re that close to retirement and you lose a few years of earning, you also lose crucial pension and retirement contributions,” she says. Combine that with rising inflation and younger retirees may need to draw on their retirement savings to pay for food and gas, she says.
In fact, younger retirees are in danger of falling from the middle class into poverty. Early retirement, especially when it’s unplanned, can lead to economic challenges. Here’s how to protect your retirement savings.
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Only 7% of retirees wait until age 70 to claim Social Security. But those who wait until 70 will be eligible for around 32% more in monthly benefits, depending on when they were born.
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One of the easiest ways to manage an unexpected retirement is to learn to live with a little less space. The U.S. housing market is red hot right now so if you own a home, consider selling it and buying a smaller house or condo, says Nick Covyeau, certified financial planner and founder of Swell Financial Partners in California. “If you have built up equity in your house, you can sell at a profit, buy a smaller house with cash and still have money left over to extend your retirement,” he says.
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Residents in nine states — Alaska, Florida, Nevada, New Hampshire, South Dakota, Tennessee, Texas, Washington and Wyoming — pay no income taxes. If you’re planning to sell your home, you might want to consider moving to one of those states to further stretch your retirement funds, Covyeau says.
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It is possible for older workers to return to the workplace, Cohen says. Many of the people iRelaunch works with decided to return to work either because retirement wasn’t for them or they faced unanticipated financial pressures, she says. If you want to return to work, it’s important to show your value to any potential employer. “Part of the onus is on the older workers themselves, who need to put in the effort to become subject matter experts in their fields all over again and get very focused on where they can add the most value at an employer,” Cohen says.
If you don’t want to restart your career, you could take a part-time job that aligns with an interest or hobby, perhaps at a library, bookstore or home improvement store, Covyeau says. A 30-hour-a-week job can be particularly helpful if you’re two or three years from your planned retirement age and want to delay claiming Social Security, he says.
This article originally appeared on Policygenius.com and was syndicated by MediaFeed.org.
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