Solo Retirement Plan Options

 

If you’re a sole proprietor, independent contractor, freelancer, or solopreneur with no employees, you still have the ability to save for your retirement above and beyond what IRAs and Roth IRAs permit. This is important because you can’t rely on a sale of your business to provide financial security in retirement. Essentially, you can use any type of retirement plan that would be possible if you were a big company with employees. Thus, you can have a profit-sharing plan or a defined benefit (pension) plan. All plans offer similar tax advantages. Here are some options well-suited for those who work alone:

SIMPLE IRAs

For a SIMPLE IRA, as a self-employed individual you can make both the employer and employee contributions to the plan, even though you’re neither an employer nor an employee. For 2014, you can make a salary reduction contribution up to $12,000 (plus another $2,500 if you’re at least 50 years old by year’s end); this is the so-called employee contribution.

In addition, you can make the so-called employer contribution of either:

• A 100% match to the salary reduction contribution up to 3% of net earnings from self-employment, or
• A non-elective contribution of 2% of net earnings from self-employment (taking into account no more than $260,000 of such earnings).

Key dates:

• The SIMPLE IRA must be opened (paperwork signed) by October 1 of the year of the plan (e.g., October 1, 2014, in order to make contributions for 2014).
• The salary reduction contribution must be contributed to the plan no later than January 30th (30 days after the end of the tax year).
• The employer contribution can be made up to the due date of your return, including extensions.

FAQs from the IRS provide more information about SIMPLE IRAs.

Solo 401(k)s

If you can afford to save more that is allowed in a SIMPLE IRA, you can use a 401(k) plan even though you’re the only plan participant. Again, you can make both the employee contribution (up to $17,500, plus $5,500 if at least 50 years old by year end) and an employer contribution (no more than $52,000 minus the basis employee elective deferral contribution).

The advantages of the solo 401(k) are the ability to add the most to a retirement plan (other than possibly a defined benefit plan) and the option of using a designated Roth account (regardless of your income or eligibility for a Roth IRA) for after-tax savings to create tax-free retirement income.
The disadvantage: You must file an annual report with the Department of Labor by July 31 after the close of the plan year (e.g., July 31, 2015, for the 2014 plan) unless you are exempt from filing (see the instructions to Form 5500-EZ). This filing is not required for SIMPLE IRAs or SEPs.

 

SEPs

You can use a Simplified Employee Pension (SEP) plan even though you’re not an employee and the plan does not provide a pension. There’s a single contribution based on your net earnings from self-employment.


Key date:
The plan can be set up and funded up to the extended due date of your tax return. Thus, if you didn’t have any qualified retirement plan in place by the end of the year, you can wait until you review your tax situation for the year to sign the paperwork and add a contribution to the plan.
FAQs from the IRS provide more information about SEPs.

 

Conclusion

The sooner you start to save money in a retirement plan, the more you’ll have available to you in your later years. Unclear about which plan is best for you? Talk with a tax or financial advisor.

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How to Retire Early on a 401k With No Penalty

Normally, if you withdraw money against your 401k retirement plan before the age of 59 1/2, you pay both income tax on the withdrawal and a 10 percent penalty. However, if you're looking to retire early on a 401k with no penalty, you can sidestep it by drawing out the money in what will be considered "substantially equal payments" spread over the remainder of your life.          

Suggestions

1. Divide the amount of equity built up in your 401k by the number of years remaining in your life expectancy. For example, if you are 50 years old and have $250,000 in your 401k, your life expectancy will have approximately 25 years remaining, for a penalty-free withdrawal of $10,000 per annum.
2. Visit your bank or financial advisor to discuss setting up an annuity plan that would see you withdraw the required amount of money each year.
3.  Continue to receive your annuity without adjusting the amount you are paid each year, unless it is absolutely necessary. If your payments drop below your established threshold, the Internal Revenue Service will come looking for the 10 percent fee you're trying to avoid.
4. Retire on your 401k early by waiting until you're as close to the age of 59 1/2 as possible. Not only will that increase the amount of your annuity, it will also make it easier for you to adjust the amount of the annual payment downward with no penalty. IRS regulations state you will face the 10 percent penalty if you adjust the amount of the annual payment within the first 5 years of your plan, but you are exempt from this technicality after the age of 59 1/2.
5. Factor marriage into the equation. If a married couple decides to withdraw annual payments together and one spouse passes away, the rules change. If the deceased was aged 59 1/2 or younger, or if the payments had been taken for at least 5 years, the surviving member of the couple is entitled to readjust the payments with no penalty.

Tips

• "Substantially equal payments" is not the only way the Internal Revenue Service will permit you to take money from your 401k with no penalty. If you have significant medical expenses, want to make a down payment on your first home or suffer a disability, you might also qualify for penalty-free withdrawal of your 401k equity.
• Remember that life expectancies are determined according to actuarial tables if you plan to use your 401k to retire early. Your remaining life expectancy is determined by the financial institution, not by you.
• You must draw money from your 401k every year, or your previous drawings may become subject to the 10 percent penalty, as well as income tax arrears.

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How to Calculate a Cash Out of a 401(k)

401k retirement plans are an employer-sponsored benefit that allow you to save money for retirement. Given the time to grow, 401k plans can provide you with financial security in your retirement years. However, sometimes circumstances require you to access your 401k funds to take care of emergencies such as medical treatment or to save your home from foreclosure. If you need to cash out your 401k, several factors can influence how much cash you will actually get.

Instructions

1. Obtain your current 401k balance by contacting your 401k Plan Administrator or by accessing your account through your plan's website.
2. Add the balance of any 401k loans that you may currently have out. How the loan is treated during a cash-out varies by plan. Some plans instantly include the loan proceeds as part of your 401k balance for purposes of calculating taxes and penalties. If you lose or quit your job, the loan may be considered due in full immediately. If you have not repaid the loan in 60 days, it will then be considered taxable income, subject to the same taxes and penalties as the remainder of your 401k balance.
3.   Subtract 10% of the full balance (including loan distributions) of your 401k account. Early withdrawals are instantly hit with a 10% penalty by the IRS unless you can qualify for a hardship or other penalty-free type of early withdrawal.
4. Calculate the amount of federal tax that will be withheld on the full balance of your 401k account. The tax will be based upon your IRS Income Tax bracket, which is based upon your annual income.
5. Calculate the amount of state tax to be withheld from your full 401k account balance. You can find your state's income tax rate by contacting the state department of taxation where you reside.
6. Subtract any administrative fees from the remaining balance. You can find out exactly what fees apply by contacting your plan administrator or by reading your 401k Summary of Benefits statement.
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Tips

•  If at all possible consider other alternatives, such as home equity or 401k loans, to avoid paying massive penalties on your 401k distribution.

• If you have been the victim of a natural disaster and a Federal Disaster Declaration has been issued for your area, you may qualify for a hardship withdrawal. IRS Publication 575 contains current information about this 401k penalty exemption. 

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