The solo route to retirement: Adopting an individual 401(k)

One of the nations' new popular 'workplaces': the Dean and DeLuca coffee shop in New York City.
Waring Abbott | Getty Images
One of the nations' new popular 'workplaces': the Dean and DeLuca coffee shop in New York City.

When many of America's 15 million self-employed workers think about retirement planning, fear and confusion are often abound. Freelancers and owner-only businesses frequently think they're too small for a 401(k), or believe that starting a plan is too pricey. In actuality, setting up and managing an Individual 401(k) can be simple and straightforward, and newer digitally enabled providers even allow owners to quote and set up a plan online.

If you're looking for ways to reduce your 2016 tax bill and plan for retirement, starting an Individual 401(k) plan may be a smart move before yearend. But remember, it's always a good idea to talk with a trusted financial consultant and tax advisor before moving ahead with any retirement or business planning decisions.

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Here are three ways Solo 401(k)s can benefit owner-only businesses.

1. You get up to $53,000 in tax-deferred investments per year.

With an Individual 401(k), business owners can make tax-deferred contributions totaling $53,000 if they are under the age of 50 – a figure that jumps to $59,000 once the contributor turns 50 or older (depending on income). That's significant and could even drop you down a tax bracket while also putting away a meaningful amount for retirement.

With the self-employment rate among workers age 65 years and up reaching 15.5 percent last year, this threshold offers the potential to shelter much more money than other retirement vehicles (including the IRA's upper limit of $5,500-$6,500) and may help you catch up on retirement goals if you've fallen behind.

Solopreneurs can reach their Individual 401(k) cap by profit-sharing up to 20 percent of net reported income if they operate an LLC, or 25 percent of W-2 compensation if the business is incorporated. Individuals can also make personal contributions as an employee of up to $18,000 ($24,000 once they're 50 or older) to help them reach the maximum contribution amount.

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This same limit holds true in employer plans, but in that case, company contributions go to all participating employees, making it costlier and more difficult to reach the $53,000 limit. Since you are both the employer and employee in an Individual 401(k), you have the flexibility to pay yourself and contribute as an employee, an employer or both.

2. Individual 401(k)s can include multiple owners and spouses.

Individual 401(k)s may be a good fit for businesses with more than one owner. The tax-deferral benefits are available to multiple owners and spouses who derive income from the business, ensuring partnerships and collective owners can also leverage these vehicles.

But once a business hires employees who do not hold an ownership stake (or less than five percent) in the company, it's required to convert the plan to an employee-based 401(k).

3. You can avoid some complex regulations.

One reason that 401(k) plans are often considered complex and confusing is a government requirement that subjects them to nondiscrimination and other tests that confirm a 401(k) plan benefits all enrolled employees, not just a niche group of owners or highly compensated employees. Since Individual 401(k)s only cover owners and their spouses, there is no conflict of interest and this added testing does not apply.

Deadlines for individual 401(k)s are yearend.

The deadline for Individual 401(k) plan adoption is fast approaching, so if you want to maximize tax-deferred income and retirement contributions for 2016 don't wait. You must purchase your plan by December 31 and you'll have until your tax deadline to make employer contributions. Typically, you have until March 15, 2017 to make contributions if you run an S-Corp and C-Corp, and until April 18, 2017 if you are an LLC, sole proprietor or have a 1099.

You may have great plans to expand your business, hire employees and perhaps even cash out down the road. In the meantime, an Individual 401(k) can help you plan for your future retirement goals while also reducing today's tax obligations.

—By Stuart Robertson, president of Capital One Advisors 401k Services.