Self-Employed Should Choose Solo 401(k)

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By Greg Plechner

BOSTON (TheStreet) -- If you've learned the many advantages of a Roth IRA and the importance of saving, even during these economically challenging times, it's worth hearing about a lesser-known plan: the solo 401(k), possibly the best way for a young business owner or self-employed person to save for retirement.

With the job market weak over the past couple of years, many of you may have chosen to start your own business or become self-employed. If so, the solo 401(k), also known as the individual 401(k), is a plan worth looking into if your goal is to maximize your retirement savings.

If you have a sole proprietorship, partnership, LLC or corporation, you would qualify for a solo 401(k) as long as you have with no employees other than yourself or a spouse. For a young married couple, this is a tremendous advantage, and the potential for retirement savings is significant.

The biggest advantage of the solo 401(k) is the contribution limits, which are generally much higher than other qualified retirement plans, such as a Simple IRA or SEP IRA, due to the way the contribution amount is calculated. Similar to a regular 401(k), you can elect to defer up to $16,500 of your pretax income to the plan ($22,000 if you are 50 or older). In addition, as the employer of the company, you can make a profit-sharing contribution based upon a percentage of your earnings, for a total maximum contribution of $49,000 annually (or $54,500 if age 50 or older).

Let's say you are a sole owner of an incorporated business with net earnings of $25,000 and self-employment income of $23,249. In this case, you would be able defer the maximum of $16,500 to a solo 401(k). You also would be able to make a profit-sharing contribution of up to 20% of your self-employment income, or $4,650. The result would be a total annual contribution of $21,150 for retirement savings. Compare this with what you'd be able to defer with other retirement plans. Using the same scenario, you would be able to contribute only $12,177 to a Simple IRA, $4,650 to a SEP and only $2,420 to a defined benefit plan.

Certainly, for leaner years when you might need the additional cash, you likely will not contribute the maximum allowed and, under this plan, may elect the contribution amount each year. Solo 401(k) plans also usually permit loans, generally up to a maximum of $50,000 -- an attractive feature for a young person or couple wanting to start saving for retirement but preferring to keep some funds available for emergency use. In addition to these benefits, solo 401(k) plans are fairly easy and cost-effective to set up and administer through a provider, such as Vanguard and Fidelity.

Bottom line: For a self-employed professional or individual business owner, it's worth considering a solo 401(k) as an easy, effective and flexible way to maximize your retirement savings while you're young.

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