The Bogleheads' Guide to Retirement Planning by Taylor Larimore, Richard A. Ferri, Mel Lindauer, Laura F. Dogu, John C. Bogle
Tags: nonfiction, Non-Fiction, Business & Economics, Business, Business & Money, Investing, Personal Finance, Financial, Retirement, Retirement Planning
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accounts will be covered in another chapter, the employer-based retirement accounts for a self-employed person essentially function as big IRAs. There are four types of IRAs that a self-employed investor might consider: a solo 401(k), a Roth solo 401(k), a SEP-IRA, and a SIMPLE IRA.
Solo 401(k)
The 401(k)s first came on the scene in 1978, when section 401(k) of the tax code was written. They were popular with employers because they cost less money than traditional defined contribution plans, and they were popular with employees because of the matching funds and the control offered to employees over their financial future. But they did not serve self-employed individuals very well. It wasn’t until 2001 that changes were made to benefit the self-employed, and, thus, the birth of the solo (or self-employed) 401(k).
As with a traditional IRA, you must have U.S. taxable compensation, but the advantage is that there is no income limit for contributions, and there is a much higher contribution limit. In fact, it is possible to shelter up to $49K in 2009, $54.5K if you are 50 years old or older. Of course, to put that much away, you must have sufficient income. To max out a solo 401(k), your pretax profit must be at least $205K in 2009. You can defer your first $16,500 into the solo 401(k) as the employee’s contribution, but additional money comes as the employer’s contribution. This amount is limited to 20 percent of your net business income (including the employer’s contribution but not the employee contribution) after subtracting half of your self-employment tax.
The withdrawal rules are exactly the same as with a traditional IRA, except you can borrow up to $50,000 (or 50 percent, whichever is less) of the amount. Borrowing from a 401(k) isn’t a good idea because the borrowed money is no longer growing, but at least the interest you pay goes to you instead of a bank. A solo 401(k) can also be rolled over into a traditional IRA, should you so desire, although there is really not a huge advantage to doing so (unless you plan a Roth IRA conversion), because solo 401(k) fees are so low, especially at companies such as Vanguard, Fidelity, and www.401kbrokers.com .
Roth Solo 401(k)
This option became available in 2006. Like a Roth IRA, the Roth portion of the solo Roth 401(k) is an after-tax contribution, which then grows tax-free and allows for tax-free withdrawals in retirement. The employer contribution, however, is always traditional, meaning it has an up-front tax deduction and is taxed upon withdrawal in retirement. The income limits and contributions limits are otherwise exactly the same as with a solo 401(k), although you are effectively sheltering more money by using the solo Roth 401(k) than with the traditional solo 401(k). Vanguard, the mutual fund company favored by Bogleheads for its low costs, recently added the Roth option to its solo 401(k).
SEP-IRA
Prior to the advent of the solo 401(k), this account was the best way for a self-employed high-income earner to shelter income from taxes in a traditional manner. The maximum contributions are exactly the same as with the Solo 401(k) for a high-income earner, except that they come from the employer, not the employee. The result is that you actually need a higher income to max out a SEP-IRA than a Solo 401(k). In 2009, you need an income of $255K, $50K more than with a solo 401(k). When you also consider that SEP-IRAs have no Roth option, smaller catch-up contributions, and no option to take out a loan, there really is very little reason to choose a SEP-IRA over a Solo 401(k). SEP-IRAs used to be more available and significantly cheaper than a solo 401(k) plan, but that is really no longer the case, with companies such as www.401kbrokers.com and Vanguard entering the fray. A SEP-IRA can always be rolled over into a solo 401(k), of course, should you change your mind or want to switch from an existing SEP-IRA.
SIMPLE IRA
SIMPLE stands for Savings Incentive
Solo 401(k)
The 401(k)s first came on the scene in 1978, when section 401(k) of the tax code was written. They were popular with employers because they cost less money than traditional defined contribution plans, and they were popular with employees because of the matching funds and the control offered to employees over their financial future. But they did not serve self-employed individuals very well. It wasn’t until 2001 that changes were made to benefit the self-employed, and, thus, the birth of the solo (or self-employed) 401(k).
As with a traditional IRA, you must have U.S. taxable compensation, but the advantage is that there is no income limit for contributions, and there is a much higher contribution limit. In fact, it is possible to shelter up to $49K in 2009, $54.5K if you are 50 years old or older. Of course, to put that much away, you must have sufficient income. To max out a solo 401(k), your pretax profit must be at least $205K in 2009. You can defer your first $16,500 into the solo 401(k) as the employee’s contribution, but additional money comes as the employer’s contribution. This amount is limited to 20 percent of your net business income (including the employer’s contribution but not the employee contribution) after subtracting half of your self-employment tax.
The withdrawal rules are exactly the same as with a traditional IRA, except you can borrow up to $50,000 (or 50 percent, whichever is less) of the amount. Borrowing from a 401(k) isn’t a good idea because the borrowed money is no longer growing, but at least the interest you pay goes to you instead of a bank. A solo 401(k) can also be rolled over into a traditional IRA, should you so desire, although there is really not a huge advantage to doing so (unless you plan a Roth IRA conversion), because solo 401(k) fees are so low, especially at companies such as Vanguard, Fidelity, and www.401kbrokers.com .
Roth Solo 401(k)
This option became available in 2006. Like a Roth IRA, the Roth portion of the solo Roth 401(k) is an after-tax contribution, which then grows tax-free and allows for tax-free withdrawals in retirement. The employer contribution, however, is always traditional, meaning it has an up-front tax deduction and is taxed upon withdrawal in retirement. The income limits and contributions limits are otherwise exactly the same as with a solo 401(k), although you are effectively sheltering more money by using the solo Roth 401(k) than with the traditional solo 401(k). Vanguard, the mutual fund company favored by Bogleheads for its low costs, recently added the Roth option to its solo 401(k).
SEP-IRA
Prior to the advent of the solo 401(k), this account was the best way for a self-employed high-income earner to shelter income from taxes in a traditional manner. The maximum contributions are exactly the same as with the Solo 401(k) for a high-income earner, except that they come from the employer, not the employee. The result is that you actually need a higher income to max out a SEP-IRA than a Solo 401(k). In 2009, you need an income of $255K, $50K more than with a solo 401(k). When you also consider that SEP-IRAs have no Roth option, smaller catch-up contributions, and no option to take out a loan, there really is very little reason to choose a SEP-IRA over a Solo 401(k). SEP-IRAs used to be more available and significantly cheaper than a solo 401(k) plan, but that is really no longer the case, with companies such as www.401kbrokers.com and Vanguard entering the fray. A SEP-IRA can always be rolled over into a solo 401(k), of course, should you change your mind or want to switch from an existing SEP-IRA.
SIMPLE IRA
SIMPLE stands for Savings Incentive
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