On Friday, I will be discussing the solo 401(k) with MomsMakingaMillion hosts Gina and Kat. Gina has been curious about how someone who has not had access to a 401(k) at their place of employment can invest for retirement. This is the first of a three part series on the topic.
Kat: If the entrepreneurial spirit is truly alive and if the Moms listening to this show are an example, then chances are you have given some thought to opening your own business.
Now we all know that more than the business plan is needed. More than just that great idea; the one that you know is just what some consumer somewhere cannot live without. More than just that spirit of being your own boss. More than the freedom to call the shots, be the builder of your own destiny.
Being in business for yourself is a huge risk that is likely to impact your retirement. Paul, you have some thoughts on this?
Paul: I do. Those of use running our businesses know that relying on your skills day in and day out will sap the very lifeblood out of you, leaving you thrillingly exhausted at the end of each day. It is great and terrifying, all at the same time.
And many of us will fund that venture with money that may not come directly from your previous employer’s 401(k) – at least I hope is hasn’t – but from money you could have put away for that future.
Kat: Is using your 401(k) to begin a business a good idea?
Paul: Not really. But people do it anyway. Some folks borrow, use saved money, look to friends and family for help. But if you did tap those retirement funds, there are ways to recoup those lost dollars quickly.
But you have got to act fast. Right from the beginning.
Kat: What is one the first things you should do?
Paul: First, pay yourself a salary. A surprising amount of start-ups do not see this a necessary expense. It is understandable. They think that if they take money from the business rather than plowing dollars back into it, they are hurting the business. You put profits back in; a salary is an expense.
And just like when you had that other “regular” job, the one with the 401(k), you should account for a pre-tax retirement contribution.
Kat: Sounds good. What now?
Paul: There are several ways to get going. First, we will discuss the easiest one to set up. And in future segments, we will talk about other plans to think about as your business grows.
The solo 401(k) is for a sole proprietor, a business of one. It was created for people with great ideas, folks like you Your business can have a spouse for an employee but generally, the self-employed, the entrepreneur, the small business owner must go it alone. The good thing about solo 401(k): simplicity.
Kat: Now there’s an idea worth noting. Simplicity.
Paul: It has to be simple to use and easy to maintain. After all, you have enough to deal with. You may contribute up to $13,000 of you tax-deferred income with a bonus incentive (thrown in for good measure) allowing you to add up to 25% of profit from your business as well. You might be living on tuna and crackers, but this type of plan can allow the start-up business owner the advantage of playing 401(k) catch-up in a relatively short time. The contribution limit is $41,000.
The relaxed rules that come with a solo 401(k) offer you the ability to decrease your contribution or suspend it altogether. By try not to. Because other rules in the plan might come in handy during some rough spots in your business’s future. Known as hardship withdrawals, these loans against your solo 401(k) often have more favorable terms than those plans administered by larger enterprises. You might, at some point in time consider rolling over your previous 401(k) into your new plan. We discusses rollovers last week.
Kat: There are a few drawbacks to the to the solo 401(k).
Paul: First, you need to find a plan administrator. Typically, these might be mutual fund managers but not always. The fund families are generally less expensive (trust and equity companies can charge anywhere from $400 upward to set up the account, and an additional percentage or fixed fee on the balance of the account) costing about ten dollars to set-up the account and 0.25% against the account balance, it may on the surface seem like a no-brainer to chose these folks. But the funds they offer you may add additional costs to the account in the way of fees and some fund families, like Fidelity who wants $10,000 upfront to begin investing with any fund.
I have a list of plan administrators which I will post on the blog after the show.
You should also consider your business’s growth potential. If its quick, and you anticipate hiring employees, setting this kind of plan up may be a waste of time. Once your solo 401(k) is set up and your business grows, you will need to transition to a traditional 401(k) sooner than you would have liked to – or had the time to.
If you do anything, keep this in mind: this is a taxable event and should have the stamp of approval on it from someone who is a professional. Find a good one through references or very good friends.
Tomorrow: What if you get a job after opening a solo 401(k)?
Related posts:
Hearing what other are going through and comparing it to my own, I’m not doing as bad as I thought.