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A Simple Guide to 401(k) Accounts

A Guide to Your 401k Account
6 Minute Read
Key Points
  • A 401(k) is a type of retirement account
  • Saving money for retirement prepares you for your future
  • It’s never too late to start saving

401(k) accounts can be scary and confusing for many people, especially if you do not know exactly what they are. A simple guide to 401(k) accounts, we will 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, meaning that 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 of income 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 companies 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 spouse. Much like the traditional 401(k), 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. 

An Individual 401k 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

There are many reasons why the Individual 401k Plan is considered the most attractive retirement solution for the self-employed. Additionally, it’s beneficial for small business owners with no full-time employees.

There are many reasons why the Individual 401k Plan 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 2021 Solo 401k contribution rules, if you’re under the age of 50, you can make a maximum employee deferral contribution in the amount of $19,500. If you are over the age of 50, you can make a maximum employee deferral contribution of $26,000.

You can make this in pre-tax, or in an individual Roth 401k 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) profit sharing contribution up to a combined maximum. This includes the employee deferral of $56,000.

Tax-Free Loan for any Purpose

With an Individual 401k Plan, you’re eligible to borrow up to $50,000 or 50% of their 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 prime interest rate. Notably, you have the option of selecting a higher interest rate. There is no pre-payment penalty.

True “Checkbook Control”

One of the most popular aspects of the Individual 401k Plan 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. See, in the case of an Individual 401k Plan, 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 Individual 401k Plan will be under the sole authority of the 401k participant.

An Individual 401k plan 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

With an Individual 401k, you will be able to 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 as well as stock and mutual funds

The income and gains from these investments will flow back into your Individual 401k Plan tax-free!

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.

An Individual 401k plan is generally exempt from UDFI. In other words, unlike an IRA, Internal Revenue Code Section 514(c)(9), allows an Individual 401k plan to use non-recourse leverage to make a real estate acquisition without tax or penalty.

Individual Roth 401k Contributions

The Individual 401k Plan contains a built in Roth sub-account. You can contribute to an Individual Roth 401k without any income restrictions.

An Individual 401k Plan will allow you to make pre-tax and/or after-tax (Roth) employee deferral contributions to your Plan.

The Roth 401k, as many IRA holders know, is the equivalent of a Roth IRA, where you contribute after-tax funds. As a result, you don’t have to pay taxes at the time you take out a distribution.

An Individual Roth 401k is exactly like a Roth 401k, however it is for individuals who earn self-employment income.

Individual Roth 401(k) Conversion

The Individual 401k Plan allows the conversion of pre-tax 401K funds to an after-tax Roth sub-account in the Individual 401k Plan. However, the participant must pay income tax on the amount that he or she converts.

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 exceeds $250,000. In that case, you will need to file a short information return with the IRS (Form 5500-EZ).

Offset the Cost of Your Plan with a Tax Deduction

By paying for your Solo 401k 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 Solo 401k Plan and ongoing maintenance will help reduce your business’s income tax liability. In effect, this will offset the cost of adopting a self-directed Solo 401k Plan.

The retirement tax professionals at the IRA Financial Group will help you take advantage of the available business tax deduction for adopting a Solo 401k 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 Individual Solo 401k Plan assets are safe from creditors. Most states will provide protection for Individual Solo 401k Plan assets from creditors outside of the bankruptcy context.

Your Individual 401k At IRA Financial Group

IRA Financial Group will take care of setting up your entire Plan. We can handle the process by phone, email, fax, or mail. 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 Individual 401k Plan account.

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

Get in Touch

Do you still have questions regarding the Individual 401k retirement plan? Contact IRA Financial Group directly at 800-472-0646. Or you can fill out the form to get in touch with our IRA specialists to answer any questions.

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[10:44 PM] Valerie Marszalek-Boik