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What Is a Solo 401(k)?

Editorial Note: The content of this article is based on the author’s opinions and recommendations alone and is not intended to be a source of investment advice. It has not been previewed, commissioned or otherwise endorsed by any of our network partners.

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Self-employment comes with many perks, but you may think access to a 401(k) plan isn’t one of them. Considering the 401(k) is one of the most powerful and accessible investment accounts available to the American public, not having one can be a pretty big loss.

Good news, entrepreneurs: You can have your freelance cake and eat it too! There is such a thing as a solo 401(k), also known as a personal 401(k), individual 401(k), self-employed 401(k), or — our personal favorites — a solo-k or uni-k. Since the solo 401(k) rules are similar to those that govern traditional 401(k)s, you won’t miss out on the high contribution caps that come with combined employee-employer contributions.

So how does this unique solo retirement plan work, exactly? Who’s eligible, and how much can you contribute overall? Read on to learn more about this Goldilocks investment account for self-employed savers.

Solo 401(k) basics

A solo 401(k) is an investment plan designed to help you save for retirement by “deferring” a portion of your income and allowing it to grow tax-free on the market. This boosts your savings goal in a couple of key ways.

Investing your hard-earned cash takes advantage of the power of compound interest, turning even a small investment into a cushy nest egg down the line. In the short term, you’ll benefit from a tax advantage because 401(k) contributions don’t count toward your total taxable income. The exception to that rule is a Roth solo 401(k), wherein your contributions will be taxed today but won’t be subject to tax when you withdraw them later.

Any self-employed individual or sole proprietor is eligible to open a solo 401(k), and a wide variety of traditional 401(k) custodians also offer solo-k options.

If you’re familiar with the basic workings of a regular 401(k), you already know a whole lot about the solo-k too. According to the IRS, “These plans have the same rules and requirements as any other 401(k) plan.”

However, there are a few key differences in the nitty-gritty details for solopreneurs to keep in mind. Let’s take a look!

How much can you contribute to a solo 401(k)?

Like regular 401(k)s, solo 401(k)s come with generous contribution caps, making them an appealing option for those looking to aggressively save for retirement. You’ll be able to contribute up to 100% of your earned income, capping out at $19,500 — or $26,000 if you account for the $6,500 “catch-up contribution” available to investors aged 50 or over.

The total contribution cap — including “nonelective contributions,” i.e., the freelancer’s equivalent of employer contributions in a regular 401(k) — is much higher.

Your specific contribution cap must be determined using a “special calculation” based on your “earned income,” which, according to the IRS, is defined as your “net earnings from self-employment after deducting both one-half of your self-employment tax and contributions for yourself.” You can make these calculations using the rate table or worksheets in Chapter 5 of IRS Publication 560, “Retirement Plans for Small Business,” or feed your personal financial data into a contribution calculator, like this one from Fidelity.

No matter how much you earn, the overall contribution limits for a solo 401(k) match those of any other 401(k) plan. For 2020, that cap is $57,000 — or $63,500 for those eligible to make catch-up contributions.

There is one big caveat, however, which can catapult your retirement savings to the next level: the spousal exemption.

If you’re married and your spouse earns income from your business, he or she also can contribute up to the $19,500 elective deferral limit — and you can put in up to another 25% of your compensation as a profit-sharing contribution. That means your total contribution limit could effectively double from $57,000 to $114,000.

Solo 401(k) withdrawal rules

Now that we’re clear about how much money you can put into your solo-k, let’s talk about the most important part: taking it out again.

As is the case with a regular 401(k) plan, there are strict rules governing when you can (and must) make withdrawals, and there are penalties in place for those who withdraw their assets early.

In order to avoid taxes and fees, you must wait until you reach the age of 59 and a half before taking distributions from your solo 401(k) plan. You also may be able to access the money with impunity if you can demonstrate “immediate and heavy financial need,” per IRS rules.

If you do take out early withdrawals without meeting one of the exceptional circumstances, the money will count toward your total taxable income for that year — and will be subject to an additional 10% tax as a penalty. Of course, you’ll also be missing out on the opportunity to allow your money to grow.

Like most retirement plans, the solo-k is subject to required minimum distributions. In general, you’ll need to make your first withdrawal by April 1 of the year following the year in which you turn 70 and a half.

Other retirement accounts to consider

If you’re working for yourself, there are a number of alternatives to the solo 401(k) when it comes to saving for retirement.

An individual retirement arrangement (IRA), is an investment account that allows any individual to save for retirement, regardless of their employment situation. IRAs come in both traditional and Roth varieties. They are easy to set up and available through a wide range of financial institutions.

IRAs provide many of the same tax benefits as 401(k) plans. For instance, traditional IRA contributions may be fully or partially tax-deductible, depending on your circumstances, and while contributions to a Roth IRA are taxed, they are then available for tax-free withdrawal upon retirement.

However, IRAs carry a much lower contribution cap than 401(k) plans — just $6,000 for 2020 (or $7,000 if you’re aged 50 or over).

Another popular option for self-employed individuals is the simplified employee pension (SEP) plan. In a SEP plan, contributions are made by the business only, which means you won’t get a tax break on your personal income. The contributions will, however, count as a business expense, and they are deductible up to 25% of employee compensation.

Although SEP plans carry higher contribution limits than IRAs, the “25% of compensation” clause may drive the limit lower than it would be for a solo-k plan, depending on your income. SEP plans also don’t allow catch-up contributions for savers close to the age of retirement, and there’s no Roth option available.

Whether you work for yourself or someone else, saving for retirement is the foundation of any solid financial roadmap. For those who choose to strike their own path, a solo 401(k) plan is an excellent option for paving the road to retirement.

Advertiser Disclosure: The products that appear on this site may be from companies from which MagnifyMoney receives compensation. This compensation may impact how and where products appear on this site (including, for example, the order in which they appear). MagnifyMoney does not include all financial institutions or all products offered available in the marketplace.

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Asset Management vs Wealth Management: What’s the Difference?

Editorial Note: The content of this article is based on the author’s opinions and recommendations alone and is not intended to be a source of investment advice. It has not been previewed, commissioned or otherwise endorsed by any of our network partners.

Asset management and wealth management may seem like interchangeable terms, but they are quite different in practice. Asset management is when you hire someone to direct your investments, while wealth management is advice that addresses every aspect of your financial life, from cash flow to goal planning to insurance coverage. Whether you need one or the other will depend on your situation and stage in life.

What is asset management?

Asset management is the practice of advising and managing investments. If you hire a financial professional to manage your assets, that’s their only focus: the performance of your portfolio, evaluation of your risk and the allocation of assets in investments.

“Ultimately, it’s understanding a client’s goals and developing, implementing and managing a set asset allocation to help a client reach those goals,” said Trevor Scotto, a financial planner in Walnut Creek, Calif.

An asset manager can help you design your portfolio, monitor it over time and distribute the assets as needed. “When someone needs to start distributing assets from their portfolio, an asset manager will help them structure the most intelligent and tax-efficient process,” said Alex Caswell, a financial planner in San Francisco.

What services does asset management offer?

Typically, an asset manager will offer the following:

  • Risk assessment
  • Portfolio design
  • Investment rebalancing
  • Tax minimization strategies
  • Monitoring of investments and investment options
  • Asset distribution

What sort of clients does an asset manager serve?

A typical client for an asset manager might be someone just starting out in their career who needs guidance on setting up their portfolio, or someone with a simpler financial situation in general. They might not have the wealth or complicated money scenario that lends itself to more involved wealth planning.

“On the other side of the spectrum is more of a do-it-yourselfer,” Scotto said. This kind of client might want to manage the rest of their financial lives themselves, along with a bit of investment guidance.

What is wealth management?

Wealth management takes a big-picture view of your finances, from estate planning to insurance coverage. Wealth management includes asset management — but instead of just focusing on your investment portfolio, a wealth manager will take all the other facets of your financial life into account.

The benefit of wealth management, among other things, is that wealth managers consider and advise on other parts of your finances, and those parts can be just as crucial as your investments.

“When clients come in and they’ve really had their financial dreams broken, it usually wasn’t because they messed up on investments,” said Robert DeHollander, a financial planner in Greenville, S.C. “It was usually because they missed something on the financial defense side, especially insurance.”

A wealth manager may also help coordinate planning with all the financial professionals in your life, such as your accountant, insurance agent and estate attorney. “Most of the time, what we find is that none of those advisors are actually talking to each other, and things can get missed,” Scotto said. “There’s so much more value the client can have if all the advisors are aligned.”

What services does wealth management offer?

Wealth management will differ from firm to firm, but in general, you can expect to find many of the following on a wealth manager’s list:

  • Analysis of cash flow and debt management
  • Tax planning
  • Retirement planning and goal setting
  • Social Security analysis
  • Estate planning
  • Legacy planning
  • Insurance analysis (life, health, property, disability, long-term care)
  • Investment management
  • Coordination of all your advisors (CPA, estate attorney, etc.)

What sort of clients does a wealth manager serve?

Wealth management clients are typically further along in their financial affairs — whether that’s higher on the career ladder or with a higher net worth. They also may be people with more complex financial situations, such as business owners, people approaching retirement or those in the midst of a life event that has money in motion.

“That might be a birth, a death or an inheritance,” DeHollander said. “They need a professional to look over their shoulder and give them advice.”

Wealth management can also be helpful for someone coming out of a divorce or having just lost a spouse. “It’s a very emotional time, and you need somebody to be your advocate to help put everything in place,” Scotto said.

The common thread for wealth management clients is that they’ve realized there’s more to their financial security than their investment portfolio. “Investing assets is a necessary part of creating financial security, but by far, it’s not the sole driver,” said Erika Safran, a financial planner in New York City.

Differences between asset and wealth management

In thinking about asset management vs wealth management, it’s useful to imagine that asset management is one piece of the wealth management pie. While wealth management includes asset management, it also includes guidance on your overall financial picture, from whether you have the right amount of life insurance to whether you have the right powers of attorney drawn up.

In general, either kind of manager can be registered as a broker/dealer or as an investment advisor, and either kind of manager may carry fiduciary responsibility, or they may only need to offer recommendations that are “suitable” for your portfolio.

Another difference tends to be in fee structure: Asset managers commonly charge a percentage of assets to manage your investments, or they’re paid on commission by the products they recommend. Some may also offer an hourly rate.

Wealth managers may charge a percentage of assets, but there may be an additional fee — a flat rate or hourly rate — for the evaluation of your financial picture and for recommendations. This may be a fee that’s charged once, or annually, or every time you have them revisit your situation.

 Asset managementWealth management
DescriptionCovers your investment portfolios onlyEncompasses all aspects of your financial life
FocusInvestments, risk assessment, portfolio strategy, asset allocation and distributionInvestments, insurance, estate planning, retirement planning, education planning, legacy planning, charitable giving, tax planning
CompensationUsually a percentage of the assets under management or commissions from the financial products they include in client portfolios, although some are fee-basedMight be a percentage of assets under management and/or a flat or hourly fee for wealth management services charged annually or as needed

The tricky part about differentiating asset management from wealth management is that a lot of firms use wealth management language to describe their asset management functions. Many “wealth managers” are really just asset managers.

“My experience has typically been that you can’t put a blanket statement on these terminologies,” Scotto said. “I’ve seen people who work at banks who call themselves wealth managers. It’s very confusing to the end investor.”

Which is right for you?

The decision to go for asset management versus wealth management is a personal one and depends on your goals and circumstances. If you’re a newer investor and just looking for a kickstart to get your portfolio going, an asset manager may be the right call. If you’re looking for more overall guidance or you have a more complex money situation, a wealth manager can help.

How to choose a wealth manager

It’s important to put some time and research into choosing a wealth manager because that person will be advising you on every aspect of your financial life. “At the end of the day, you need to feel really comfortable with the person you’re working with because ultimately, one of the roles of the advisor is keeping the client from making costly mistakes,” Scotto said. “You have to have so much trust in your advisor.”

To that end, ask friends and co-workers if they’ve worked with an advisor they recommend. “The best way to do it is through a referral, if you know someone you trust who’s had an experience and can give you the name of somebody,” DeHollander said. Talk to at least three advisors before committing. Ask a lot of questions, and make sure it’s a good fit.

Some questions to ask:

  • How do you define wealth management?
  • Who are your typical clients?
  • How are you compensated?
  • Is any of your compensation based on selling products?
  • What is your money philosophy?
  • What licenses do you hold?
  • What financial planning designations or certifications do you hold?
  • What are your areas of specialization?
  • Will I work with you, or someone else in your company?
  • What kind of services can I expect?
  • Are you required to act as a fiduciary?

(This last question is important. As a fiduciary, an advisor is required to put a client’s interests above their own.)

How to choose an asset manager

The process of choosing an asset manager is a lot like choosing a wealth manager, except your range of focus is narrower. As with a wealth manager, it’s still recommended that you speak to at least three advisors before choosing one, and references are a great place to start. You can ask the same questions of asset managers as you would of wealth managers. (But ask them how they’d define asset management.)

Do RIAs offer asset management services or wealth management?

Registered investment advisors (RIAs) may offer both asset management services and wealth management services. It’s important to talk to them about the services they offer so that you understand the scope of their work.

“It’s a case by case basis, firm by firm, advisor by advisor,” Scotto said. “The one thing to point out is that RIAs, as independent firms, are required to uphold fiduciary standards, and if you’re a Certified Financial Professional (CFP), you’re also supposed to uphold the fiduciary standard of care. If there’s any doubt, find an independent investment advisory firm with CFPs on staff, and you’ll be in good shape.”

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Investing

Should I Open an IRA with My Bank?

Editorial Note: The content of this article is based on the author’s opinions and recommendations alone and is not intended to be a source of investment advice. It has not been previewed, commissioned or otherwise endorsed by any of our network partners.

Opening an individual retirement account (IRA) with a credit union or a bank might be a good call, depending on your risk tolerance and investing goals. If you’re an extremely conservative investor, you’re very close to retirement or already retired, a bank IRA might be right for you. But for most retirement savers, the optimal place to invest is a brokerage IRA.

When should I open an IRA with my bank?

For most people, bank individual retirement accounts are not the best place to grow their retirement funds. Bank IRAs offer very limited, low-yield investment options, typically savings accounts or certificates of deposit (CDs). However, they do offer a few advantages for some retirement savers.

Bank IRAs are ultra-safe investments. If you open one at a Federal Deposit Insurance Corporation (FDIC)-accredited institution, the funds you save in an IRA savings account or IRA CD receive deposit insurance up to the legal limit. Even if the bank were to fail, you wouldn’t lose the funds saved in your IRA. This is the right place to park your retirement cash if you’re super risk-averse.

There are tax strategies you can take advantage of with a bank IRA. If your tax preparer tells you on April 14 that you need to make an IRA contribution to get the most out of your tax return and you have money in your bank savings account, you can open an IRA savings account at that bank and move funds into the IRA in no time.

Keep in mind that bank IRA savings accounts and CDs traditionally offer very low rates of return. Most investors need a higher return on their retirement savings to meet their goals. The best place to get those higher returns is to open an IRA at a brokerage.

Should I open a bank IRA savings account?

A bank IRA savings account offers you a tax-advantaged way to save for retirement by stashing cash in a savings account in either a traditional IRA or Roth IRA. With a traditional IRA, your contributions may be tax deductible, and you’ll be taxed on all withdrawals. With a Roth IRA, your deductions are post-tax, and your withdrawals — including earnings — are tax free.

You may also be able to open other types of IRAs at a bank or credit union, such as a SEP IRA or SIMPLE IRA, which are accounts for self-employed people. And in some cases, you may be able to open a Coverdell Education Savings Account (formerly known as an Education IRA).

An IRA savings account pays interest, and the money accrues until you can withdraw it at age 59 1/2 or older. That said, interest rates are typically lower than the returns you could get in the stock market.

Top bank IRA savings account rates

Account

Minimum opening deposit

APY

Latino Community Credit Union IRA Share Account (Traditional, Roth, SEP)

$25

3.05%

Communitywide FCU IRA

$2,000

2.00%

Signature Federal Credit Union IRA Savings (Traditional, Roth, CESA)

$0

2.00%

“We are in a period of low interest rates, and the outlook of those rates going up doesn’t look favorable,” said Thomas Rindahl, a certified financial planner in Tempe, Ariz. “Someone using savings or traditional CDs is facing the very real risk of losing purchasing power over time.”

If you’re a customer at that bank, opening an account may be as easy as logging in online, checking a few boxes and funding the account with a deposit from your bank account. If you’re not a bank customer, you may need to enter your personal information, choose an account and set up a funding deposit.

Should I open a bank IRA CD?

A bank IRA certificate of deposit offers another tax-advantaged retirement savings vehicle — but with slightly higher interest rates, because you agree to keep your cash in the certificate of deposit for the length of the CD’s term, whether that’s six months, one year or five years. Generally, the longer the term, the higher the interest rate.

As with IRA savings accounts, you can open various types of IRA CDs, including a traditional IRA, Roth IRA, or SEP or SIMPLE IRA.

If you’re a bank customer, opening an account may require logging in, confirming your information and funding the account with a deposit from your bank account. If you’re not a bank customer, you may have to enter your personal information, choose an account type and set up a deposit from your bank.

Top bank IRA CD account rates

Institution

Term

APY

BethPage FCU

3 months

1.60%

INOVA FCU

6 months

1.75%

Paramount Bank

12 months

2.25%

INOVA FCU

18 months

2.00%

MAC Federal Credit Union

2 years

2.80%

America’s Credit Union

3 years

2.53%

Credit Union of the Rockies

4 years

2.60%

American 1 Credit Union

5 years

2.78%

Evansville Teachers FCU

6+ years

2.25%

Most retirement savers should open an IRA with a broker

Although bank IRAs offer a safe place to put your retirement cash, they’re not the ideal savings vehicle for most investors. Because you’re investing your retirement cash for the long-term — and hoping to eventually have enough to comfortably stop working — you need higher returns than you’ll get at a bank. This is why you probably want to open an IRA at a brokerage.

“I think of the bank as the place where you have your emergency funds — and I don’t particularly care about low returns on emergency funds, but the IRA is meant to be a long-term investment,” said Chip Simon, a certified financial planner in Poughkeepsie, N.Y. “You probably want to have something that’s going to be steered toward some growth over time.”

For this, you’ll need a brokerage IRA, where you have a much wider array of investments and greater potential to grow your savings. You can build a diversified portfolio from a mix of stocks, bonds, mutual funds, ETFs and other investment vehicles, giving you the opportunity to earn a healthy return and fatten your nest egg over time.

Brokerage IRAs offer higher returns

Consider that since 1928, the S&P 500 has had an average annual return of 11.57%. Historically, non-savings account assets have performed more favorably than savings accounts over the last 15 years:

  • U.S. large-cap stocks: 8.22%
  • U.S. mid-cap stocks: 8.09%
  • U.S. small-cap stocks: 7.93%
  • Long-term bonds: 6.38%

Here’s how it breaks down:

If a 35-year-old deposited $1,000 into an IRA and added $1,000 each year until age 65, here’s how the two accounts would compare:

Account

Assumed annual return

Balance at age 65

Bank IRA savings account

2.00%

$48,163

Well-diversified stock portfolio in a brokerage IRA

7.00%

$112,019

Still feeling ultra conservative? Brokerage IRAs also have conservative investment options, such as bonds and money market funds.

“Oftentimes, what we find is that we can find a better money market than what our client is earning at the bank,” said Monica Dwyer, a certified financial planner in West Chester, Ohio.

Brokerage accounts have the advantage of being a good place to consolidate your savings over time. If you have a 401(k) from an old job, for instance, you can open a rollover IRA at the same brokerage where you have your Roth or traditional IRA (or both), a taxable account and/or a health savings account. Plus, brokerage accounts offer SIPC insurance on up to $500,000, often with secondary insurance on amounts above that.

Brokerage accounts are also easy to roll IRAs into and out of, versus a bank IRA. At a bank, the process can be more cumbersome, and the easiest way is often to take a direct withdrawal.

Advertiser Disclosure: The products that appear on this site may be from companies from which MagnifyMoney receives compensation. This compensation may impact how and where products appear on this site (including, for example, the order in which they appear). MagnifyMoney does not include all financial institutions or all products offered available in the marketplace.