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A Simple Guide to 401(k) Accounts

A Simple Guide to 401(k) Accounts
Key Points
  • The 401(k) is the most popular retirement plan offered by employers
  • Saving money for retirement now prepares you for your future
  • It’s best to start saving early, but it’s never too late to start

401(k) accounts can be scary and confusing for many people, especially if you do not know exactly what they are. We’ve created a simple guide to 401(k) accounts and cover what it’s all about.

What Is A 401(k) Plan?

To put it into very simple terms, a 401(k) account is quite similar to that of a savings account. You put a certain amount of money into it on a regular basis, to begin building it up. However, instead of taking it out on a rainy day, the money is saved for when you are ready and eligible to retire.

Because it is so similar to a regular savings account, many people ask why they cannot just simply use a savings account to do the same thing. There is one big reason as to why having a 401(k) account is so important.

In the USA, everybody is expected to pay income taxes. However, by putting some of your earnings into a 401(k), it helps to defer some of your income until later on in your life. Any money that you put into your account is not taxed (right now). Thus, the more money that you feed into your account this year, the less you are going to pay in income taxes. A savings account does not work like this, you will still have to pay the same amount taxes.

However, just because you do not pay tax on this money right now, it does not mean you never will. When you take this money out in retirement, you will have to pay a certain amount of taxes on it.

Some employers are even offering matching funds for any and all employees who contribute to the company’s 401(k) plan. So, you need to double check if this is something that your own employer is offering and take advantage of it. Even matching a small percentage is like putting free money into your account for retirement.

How Do You Withdraw Money From Your 401(k)?

Once you retire, you are able to then begin withdrawing the money from your 401(k) account. There are quite a few different ways that you can withdraw this money, you just need to decide which is the easiest and most convenient for you. For example, you can access the money through a direct deposit every other week or every month, or you can receive it through a check in the mail. It is entirely up to you.

It is important to note the exact amount of money that is in your account before anything is withdrawn. That way you can then withdraw around 4% of that value every year. Which, more often than not will give you a reasonable amount of money in your bank. Even after the taxes have been taken, which is also something that you do not have to worry about because the majority of the time the company, that your account is with, will have them handled for you.

A Solo 401(k) For Entrepreneurs

A Solo 401(k) plan is a 401(k) qualified retirement plan that was designed for self-employed individuals and small business owners with no full-time employees, excluding a business partner and/or spouse. Much like the typical 401(k) plan, this unique plan encourages individuals to save for retirement in a tax-advantaged environment. When participants contribute funds into the Solo 401(k), taxes on the funds will be deferred until the participant takes a qualified distribution.

The Solo 401(k) is an IRS-approved plan that has the same rules and requirements as a traditional employer-sponsored 401(k). However, the Solo 401(k) allows participants to make annual contributions to the plan as both an employee and employer, which ultimately increases the yearly maximum contribution limit.

Also known as a Self-Employed 401(k) or Individual 401(k), individuals can benefit even if they generate a portion of their total income through self-employment activities, such as a freelance gig. 

The Solo 401(k) plan is perfect for:

  • Sole proprietors
  • Consultants
  • Independent contractors, such as a realtor, doctor, accountant, attorney, dentist, or sales agent.
  • A sole proprietorship, LLC, Partnership or Corporation

Benefits of “Going Solo”

There are many reasons why it is considered the most attractive retirement solution for the self-employed. Additionally, it’s beneficial for small business owners with no full-time employees.

Related: Is a Solo 401(k) Worth it?

High Contributions

Under the 2024 Solo 401(k) contribution rules, if you’re under the age of 50, you can make a maximum employee deferral contribution in the amount of $23,000. If you are at least age 50, that limit is increased to $30,500 thanks to the catch-up contributions.

You can make this in pretax, or in a Roth 401(k) plan (after-tax).

On the profit sharing side, the business can make a 25% (20% in the case of a sole proprietorship or single member LLC) contribution up to the combined maximum limit. The total amount you can contribute in 2024 is $69,000 ($76,500 if you are age 50+).

Tax-Free Loan for any Purpose

If your plan allows for it, you’re eligible to borrow up to $50,000 or 50% of your account value (whichever is less) for any purpose. This includes paying personal expenses such as:

  • Credit card bills
  • Mortgage payments
  • Personal or business investments
  • A car
  • Vacation

Virtually, you can use it for anything.

You must pay the loan back over a five-year period at least quarterly at a minimum interest rate of at least Prime. Notably, you have the option of selecting a higher interest rate. Since the payments go back to your plan, you can continue to reap the rewards of the 401(k). Also, there is no pre-payment penalty.

True “Checkbook Control”

One of the most popular aspects of the “Solo K” is that it does not require you to hire a bank or trust company to serve as trustee of the Plan.

This differs from an IRA, which requires a financial institution to serve as trustee and custodian of the IRA. You can open the plan account at any local bank or credit union and the plan participant can serve as trustee of the plan.

This flexibility allows the plan participant (you) to gain “checkbook control” over your retirement funds. In essence, all assets of the plan will be under the sole authority of the you, the 401(k) participant.

It allows you to eliminate the expense and delays that come with an IRA custodian. This enables you to act quickly when the right investment opportunity presents itself.

Unlocking a World of Opportunity

You can invest in almost any type of investment opportunity that you discover, including:

  1. Real Estate (rentals, foreclosures, raw land, tax liens etc.)
  2. Private Businesses
  3. Precious Metals
  4. Hard Money
  5. Peer to Peer Lending
  6. Cryptos
  7. Traditional Assets, such as stocks and mutual funds

The only investments you cannot make with 401(k) funds are life insurance, collectibles, and any transaction involving a disqualified person.

Use Non-Recourse Leverage Tax Free

When an IRA buys real estate that is leveraged with non-recourse mortgage financing, it creates Unrelated Debt Financed Income (a type of Unrelated Business Taxable Income) on which taxes must be paid pursuant to Internal Revenue Code Section 514.

The Solo 401(k) is exempt from UDFI. In other words, unlike an IRA, IRC 514(c)(9), allows a 401(k) plan to use non-recourse leverage to make a real estate acquisition without tax or penalty.

Hands down, the Solo 401(k) is the best plan for the real estate investor.

Roth 401(k) Options

You have the option, assuming your plan documents allow for it, of contributing to a Roth 401(k). Akin to the popular Roth IRA, you can make after-tax contributions to your Solo 401(k) plan. There is no upfront tax-break, however, all qualified distributions from the plan are tax free during retirement.

To be qualified, the Roth must be open for at least five years, and you must be at least age 59 1/2. At that point, all distributions from the Roth, including earnings, are not treated as taxable income.

It’s important to point out that not all Solo contributions can be made via a Roth. Only the employee contribution can. Contributions as the employer (profit sharing) cannot be made as a Roth.

If you have pretax funds in your Solo 401(k), you do have the option of converting them to Roth. The amount converted will be treated as taxable income during the year in which they are converted. Make sure you can pay the taxes before converting.

Simple Plan Administration

The plan is easy to operate and effortless to administer. There is generally no annual filing requirement unless the assets in your plan exceed $250,000. In that case, you will need to file a short information return with the IRS (Form 5500-EZ, due July 31).

Offset the Cost of Your Plan with a Tax Deduction

By paying for your Solo 401(k) with business funds, you will be eligible to claim a deduction for the cost of the plan, including annual maintenance fees.

The deduction for the cost associated with the plan and ongoing maintenance will help reduce your business’s income tax liability. In effect, this will offset the cost of adopting the plan itself

The retirement tax professionals at IRA Financial will help you take advantage of the available business tax deduction for adopting a Solo 401(k) plan.

Asset & Creditor Protection

In the case of a bankruptcy, the general exemption found in sec­tion 522 of the Bankruptcy Code, 11 U.S.C. §522, provides an unlimited exemption for retirement assets exempt from taxation for Section 401(a) (tax qualified retirement plans—pen­sions, profit-sharing and section 401(k) plans). Thus, ERISA qualified plans as well as Self-Directed 401(k) plans are given full bankruptcy exemption.

Outside of bankruptcy, state law will govern whether Solo 401(k) plan assets are safe from creditors. Most states will provide protection from creditors outside of the bankruptcy context.

Your Solo 401(k) at IRA Financial

IRA Financial will take care of setting up your plan. The entire process can be handled in a number of ways, but the fastest and easiest is via our app. This typically takes between 2-10 days to complete. Timing largely depends on your current retirement asset custodian and how quickly they move funds to the new plan.

Our tax and ERISA professionals are on-site greatly reducing the setup time and cost. Most importantly, each client of IRA Financial receives a retirement tax professional to help with the establishment of the Plan.

Get in Touch

Do you still have questions regarding the Solo 401(k) retirement plan? Contact IRA Financial directly at 800-472-0646. Or you can fill out a contact form to the right to get in touch with one of our specialists to answer any questions.


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