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Need a Better Way to Save for Your Retirement? Consider the Solo 401(K)

Retirement plans are a key benefit most people look for when seeking employment. But what happens when you work for yourself? When you strike out on your own, you hope to increase your income, increase your work flexibility, and experience the luxury of answering to no one; however, when you leave your employer, you leave behind the security of traditional retirement investment plans, such as corporate 401(k)s.

Sole proprietors often rely on IRAs as the method of savings for retirement when they first start out. But the amount of money one can contribute to an IRA is limited, which doesn’t work well if your business brings in a large amount of cash.

As your business grows, your investments should increase too. If you’re a sole proprietor (meaning you don’t have any employees), and you want to focus more attention on long-term retirement savings, you should look at the personal or Solo 401(k). These plans are geared toward business owners who want to shelter a large amount of their income.

If you are a sole proprietor and you want a new way to save for your retirement, consider the following points to determine whether a Solo 401(k) might be the right plan for you.

How Can You Save More With a Solo 401(k)?

The greatest benefit of the Solo 401(k) is the larger amount of money you can save tax-deferred. You can defer up to one hundred percent of your income through salary deferral on a pretax basis, as long as you do not exceed $15,000 for 2006. For example, say you are a sole proprietor of an interior design business that you run out of your home, and your spouse works outside the home and earns enough money to support you both. Then you can contribute your entire income to your solo 401(k), up to $15,000. Owners over 50 years old can save an additional $5,000 each year as a catch-up contribution.

Also, you can make a business-based contribution of up to 25 percent of your compensation if your business is incorporated; 20 percent if it is not incorporated. The total combined contribution for a Solo 401(k) is $44,000. And over age 50, the total combined contribution is $49,000.

Who Will Benefit the Most from the Solo 401(k)?

Business owners who have high cash-generating businesses can benefit the most. And those who run business that aren’t salable can benefit even more. For example, if you run a consulting business that you can’t sell when you are ready to retire, then you obviously need to save for your retirement. Rather than reinvesting all your excess income back into your business, you can consider putting some of that money away, and the Solo 401(k) may be your best option for doing so.

For those sole proprietors who don’t make much money in their business, the Solo 401(k) probably won’t be better than other plans. If your income is very high, say $200,000 or more, a SEP IRA or Profit Sharing Plan can be equally beneficial.

Do Solo 401(k)s Offer Investment Options?

Business owners have a greater number of business choices with a Solo 401(k) than they do with other savings plans. Any asset classes that are available through your Solo 401(k) custodian can be selected for your plan. You can choose from individual stocks, bonds, mutual funds—even gold coins. In a typical 401(k), you are usually limited to mutual funds. However, all the investment expenses must be paid by the Solo 401(k), and all the investment profits and interest must go back into the plan.

As the business owner, you are typically the sole plan trustee, and you can direct the investments of the plan to suit your personal preferences and needs. For example, a business owner who is nearing retirement age might choose more stable investment options than a person in his or her 20s.

What Are the Risks?

Many business owners are concerned about putting all their money into a Solo 401(k) because they fear they won’t be able to access it in an emergency. But, just like corporate 401(k)s, loans are allowed on Solo 401(k)s. You can borrow up to 50 percent ($50,000 maximum) of your account’s value if the investment company managing plan allows it; however, you must pay the loan back over a predetermined time (typically five years) with interest, per plan provisions.

If you want to withdraw money from your Solo 401(k) permanently, and not roll over to an IRA, income tax penalties are possible. Most withdrawals are taken in times of financial hardship or in an emergency, such as to pay medical expenses or to avoid a foreclosure. And, if you are under age 59 1/2, you may still owe income taxes on the amount withdrawn and additional early withdrawal penalties.

Is The Solo 401(k) Right for You?

Many employees of large corporations have been able to save for retirement in their company’s 401(k) plan. Now many sole proprietors and some partnerships are able to save using the same vehicle with the Solo or personal 401(k).

The greatest benefit of the Solo 401(k) is the ability to save more in a tax-advantaged method. Plus it offers more control and choice of investments than other retirement savings plans. In case of emergency, you can borrow from your Solo 401(k), just as you can from a corporate 401(k). The only restriction to this plan is that you cannot have any employees working for you, other than your spouse.

The deadline for establishing a Solo 401(k) for many businesses is Dec. 31 of that tax year. Use this information to weigh the pros and cons of the Solo 401(k) for you and your business. If you think a Solo 401(k) might be right for you, consult with your investment advisor and CPA to see if a Solo 4014(k) is the best way for you to save for your retirement.

About the Author

Doug Charney is a senior vice president-investments with Wachovia. He also is president of The Charney Investment Group, located in Harrisburg, Pa. His client base extends all over the United States. A graduate of Penn State University, Charney has more than 10 years of experience with Dean Witter and Wachovia Securities. He has been included in the Investment Consulting Red Carpet Club and been named to Wachovia Securities Senior Leadership Council.


Wachovia Securities does not render tax or legal advice. Please consult with your tax or legal advisor before making any transactions, which may cause a taxable event. Asset Allocation cannot eliminate the risk of fluctuating prices and uncertain returns.

The accompanying information was prepared by or obtained from sources that Wachovia Securities believe to be reliable, but Wachovia Securities does not guarantee its accuracy or completeness. The material has been prepared solely for information purposes and is not a solicitation to participate in any investment strategy.

Investments in securities and insurance products are not FDIC insured/not bank guaranteed/may lose value.

Wachovia Securities, LLC, member NYSE//SIPC, a registered broker-dealer and separate non-bank affiliate of Wachovia Corporation.

For More Information

Call Doug Charney at (888) 529.2973 to learn more about retirement options for small businesses.

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