If you are self-employed and have a desire to shelter more of your income from taxes, then you may know about retirement plans for small-business owners such as SEP IRA and SIMPLE IRA. But have you heard about Individual 401k (also know as Solo 401k)?
Individual 401 k Plan is unique and designed explicitly for small, owner only business. It offers powerful features that are not found in conventional IRA or 401(k). It is flexible and tax efficient retirement solution that will open up a world of investment opportunity with unlimited potential. Use your retirement account to invest in Real Estate, Notes, Tax Deeds, Tax Liens and much more. The IRS rules allow you to play the roles of both employer and employee in a Solo 401(k) Plan, allowing you to contribute more to the plan than you could to a SEP IRA.
Let’s take a look at some of the features of Solo 401(k) Plan that make it so appealing and popular among self-employed business owners.
Checkbook Control without Custodian Fees:
In a Solo 401(k) Plan, you can serve as trustee of the Plan, which gives you “checkbook control” over the Plan’s assets. Making an investment with a Solo 401(k) Plan is as easy as writing a check. Another significant benefit of the Solo 401(k) is that it does not require the participant to hire a bank or trust company to serve as trustee. This allows the participant to serve in the trustee role. This means that all assets of the Solo 401(k) trust are under the sole authority of the Solo 401(k) participant. A Solo 401(k) plan allows you to eliminate the expenses and delays associated with an IRA custodian, enabling you to act quickly when the right investment opportunity presents itself.
High Contribution Limits:
While an IRA only allows a $5,000 contribution limit ($6,000 for those over age 50), the Solo 401(k) annual contribution limits are significantly higher: up to $55,500, that’s nearly 10 times more compared with an IRA! Also, if your spouse generates compensation from the business, he or she can make contributions to the Plan.
While you have the option to shelter large portion of your income, contributions to a Solo 401(k) plan are completely discretionary. You always have the option to try to contribute as much as legally possible, but you always have the option of reducing or even suspending plan contributions if necessary. In other words, you have the ability to make contributions to your Solo 401(k) Plan, but are not required to do so.
With an IRAs, those who earn high incomes are disallowed from contributing to a Roth IRA. The Solo 401(k) plan contains a built-in Roth Sub-Account which gives you the ability make Roth type contributions (after tax) and is significantly greater than with an IRA without any income restrictions (for 2012 Roth Solo 401(k) maximum contribution is $22,500). This allows you to grow your investments tax-free!
While an IRA offers no participant loan feature, the Solo 401(k) allows participants to borrow up to $50,000 or 50% of their account value (whichever is less) for any purpose at a low interest rate (the lowest interest rate is Prime which is 3.25% as of January 1, 2012). This offers a Solo 401(k) Plan participant the ability to access up to $50,000 for use for any purpose, including paying personal debt or funding a business.
Exempt from UDFI:
When an IRA buys real estate that is leveraged with mortgage financing, it creates Unrelated Debt Financed Income (“UDFI”) – a type of Unrelated Business Taxable Income (also known as “UBTI”) on which taxes must be paid. The UBTI tax is approximately 35%. With a Solo 401(k) plan, you can use leverage without being subject to the UDFI rules and UBTI tax. This exemption provides significant tax advantages for using a Solo 401(k) Plan versus an IRA to purchase leveraged real estate.
Cost Effective Administration:
Generally, Solo 401(k) plans are easy to operate. There is no annual filing requirement unless your Solo 401(k) plan exceeds $250,000 in assets, in which case you will need to file a short information return with the IRS (Form 5500-EZ).