As a busy small business owner (as well as likely being the main caretaker for your children), you may not be aware yet of a powerful tool that can help you enormously with your tax burden and saving for retirement.
I’m talking about a Solo 401(k), also known as an Individual 401(k).
What are the benefits of a solo 401(k)?
- It’s easy to set up and open. Do you have 20 minutes, an EIN or TIN, and a phone?
- You don’t need a financial advisor or some kind of magical finance knowledge. You can easily set it up yourself.
- It’s cheap. Like, $20 a year.
- You get to pick the fund or funds you want to use. More about this later, but it really is a big advantage.
- You get to save money for retirement AND reduce your taxable income for the year.
- You can choose if you want to contribute pre-tax or after-tax (as a Roth), even in the same year.
- And the best part…you get to contribute money as an employer AND an employee. This lets you add up your savings fast. For instance, in 2019, the individual limit for contributing to an IRA is $6000. But with a Solo 401(k), you can contribute up to $6000 as an employee, and then contribute up to the limit of $19,000 as an employer. This is a big opportunity for retirement savings. And don’t forget that you’re also reducing your taxable income figure by whatever you contributed.
You’re eligible to open a Solo 401(k) if:
- you are self-employed, or a partner in a business where the only employees are you and your spouse
- you claim some self-employment income on your tax return (even if you also have a full-time job)
- and you have a TIN or an EIN for your LLC, S corp, or C corp.
Overcoming your fear with information
I’m summarizing the benefits and eligibility requirements. The IRS explains everything in clear and plain terms here.
I’m not endorsing any company, and certainly not getting any compensation from any company. After my research, I chose to work with Vanguard, because of their reputation for low fees and fair treatment for clients, and I’ve been really pleased with their responsiveness, style of customer service–helpful but super unpushy, and fees. Here’s the info on their Solo 401(k) plan if you want to look into it.
Now, a lot of people get all woozy at the mention of 401(k)’s or retirement in general. I did that for a long time, too. It’s easy to be scared. But I learned that it’s almost as easy just to deal with it, and it’s way more satisfying and empowering.
A while ago, in my financial dark ages, I called one of my other investment companies. I was nobly (but ignorantly) trying to find out what fees I was paying. The representative told me that because of the account setup, I was paying zero dollars in fees. Great, I thought, but there’s no way you’re just managing this money for me for free. I know I’m paying something. But I didn’t know what to ask. So I hung up unfulfilled. This month, after reading Grant Sabatier’s excellent book Financial Freedom, I called that company back.
“What’s the expense ratio for that fund?” I asked the representative.
And then she told me, my jaw dropped, and I initatied the transfer of my funds to a much lower-cost company, potentially saving me hundreds of thousands of dollars down the line.
A little about expense ratios
I’m not giving financial advice here, but if you don’t know what fund you want for your 401(k), you can just say “I want a stock market index fund” or “I want an international stock market index fund” and you’re looking at a nonthreatening little expense ratio under 0.05%. You can even just say “I want a fund with a low expense ratio.”
If you had a 401k from a corporate job in the past, you were not in control of either fees or expense ratios–and they add up significantly and insidiously.) If you want some comparison, call up the company that holds your old corporate 401(k) and ask them what the expense ratios are for the funds that make up your holdings. When I did this, calling three different companies (Lincoln, Principal, and Invesco), I got a range from 1.16% to 0.11%. But the ones with low expense ratios were always mixed into variety packs with more expensive ones, much as the Frosted Flakes and Corn Pops mini cereal boxes were always packaged with the All-Bran and Corn Flakes.
You can also ask the representative you talk with whether they make a commission, if you’re feeling concerned. You can also ask about sales loads and any other fees, if you’re considering an actively managed fund (after reading Jack Bogle’s The Little Book of Common Sense Investing, 10th Anniversary Edition, I’m certainly not).
I wish you luck in your financial adventures.
And as a final note, you might be surprised at how your body responds when you reduce your financial stress. The mind is the body and the body is the mind. Stress impacts the posture and the breath. The breath impacts your stress response. And around and around it goes.
One final book recommendation, Sunday Times Top Ten Bestseller (London) The Inflamed Mind, by University of Cambridge’s Edward Bullmore. Short story: the Cartesian divide between the mind and the body is outdated and inaccurate. Inflammation in the body as a result of various physical traumas and illnesses also causes depression, research shows. Caution, the book relies on some old-timey sexist examples, but the presentation of this new research was compelling enough for me to continue reading.