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If you’re looking to boost your investment buying power or save for retirement exponentially faster, a Solo 401(k) (also known as an Individual 401(k) or Self-Employed 401(k)) offers an opportunity not available with other accounts.
The account, designed for savers who are self-employed or a sole proprietor (including those who have an LLC), could help you super-charge your investing and claim larger tax deductions. Your business entity would be the sponsor of the plan, and it allows you as the employer and the employee to make contributions and salary deferrals into the account much higher than most other retirement plans.
However, the Solo (k) plan includes a couple of caveats, and it’s important to know the guidelines before getting started.
What to know about the Solo 401(k) plan
Solo 401(k) contribution limits: 10x your retirement account
With a Solo 401(k) you could contribute nearly 10 times the amount you can with an IRA.
The contribution limit for a Traditional or Roth IRA in 2020 and 2021 is $6,000, or $7,000 if you’re age 50 and older.
With an Individual (k), the employee (you) may defer 100 percent of your earned income, up to $19,500 per year, $26,000 if you’re 50 and older in 2020 and 2021.
The employer (also you) may provide a profit sharing contribution of up to 25 percent of your income (20 percent for unincorporated entities).
For 2020, that’s a total contribution possibility of $57,000 if you’re under 50, or a whopping $63,500 if you’re 50 or older!
10x your tax deductions, too
Higher contribution limits mean you’re able to claim higher tax deductions. That’s a potential $57,000 tax deduction if you’re under 50 and maxed out your contributions!
One important note, though: unlike IRAs and other accounts, the account must be established and employee salary deferrals must be made by December 31 to count for that tax year.
Additional tax advantages: Roth Solo 401(k)
The Solo (k) has the added option of a Roth component. You can choose to make after-tax deferrals, which means future withdrawals are tax-free.
Plus, unlike a Roth IRA, there are no income restrictions associated with a Roth Solo 401(k).
Boost your investment buying power
The power of a self-directed Solo 401(k) is that you’re not limited to stock, bond, and mutual fund investments. This greatly expands your investment options to include real estate, private equity, precious metals, and much more. Self-directed investing is possible with custodians, such as Equity Trust, who are equipped to handle the unique recordkeeping requirements.
Suppose you want to purchase a rental property with your retirement account. If you’re contributing as much as $57,000 into your account each year ($63,500 for those 50 and older), think of how much quicker you’ll be able to accrue enough for the purchase than if you were contributing $6,000 or $7,000 to a self-directed IRA each year.