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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. 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 $19,000 — or $25,000 if you account for the $6,000 “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 2019, that cap is $56,000 — or $62,000 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 $19,000 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 $56,000 to $112,000.

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 2019 (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.

Jamie Cattanach
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Jamie Cattanach is a writer at MagnifyMoney. You can email Jamie here

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What Is the Fiduciary Rule?

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

When a professional agrees to become a fiduciary and abide by fiduciary duty, it means they have agreed to put the interests of their clients ahead of their own. For financial advisors managing your life savings, this seems like an obvious requirement. But right now, it’s not.

Today, financial advisors may choose to be a fiduciary or not. However, the fiduciary rule could change that very soon. Both federal and state regulators are reviewing different fiduciary rules that would set tougher requirements regarding how advisors can invest your money.

This is not the first time regulators have tried to pass a fiduciary rule. Read on for our coverage of the past and present status of the fiduciary rule, plus a look at what might be coming in the future.

How would a fiduciary rule impact financial planning?

Not all financial advisors work as fiduciaries, which means they don’t have to put your interests first when they recommend products. Depending on their qualifications, an advisor may only need to follow a suitability standard instead of a fiduciary standard. Under the suitability standard, a financial advisor can suggest products and investments that fit your needs but aren’t necessarily the very best option available for you.

A classic example would be an advisor who offers two investment funds that are similar in performance and both fit your needs, but one charges a higher fee and gives the advisor a larger commission. A fiduciary would need to recommend the low-cost option, whereas a suitability advisor could recommend the higher-priced one.

If an industry-wide fiduciary rule was passed, it would prevent conflicts of interest like this. For more information on how fiduciary duty works for the industry, as well as what advisors already work as fiduciaries, check out this guide.

Why is a fiduciary rule needed now?

The fiduciary rule is needed more now than ever. Americans today are far more involved in managing their retirement investments than was the case in generations past, when people were much more likely to have had employer-managed pensions. Employer-sponsored pensions fall under the scope of the Employee Retirement Income Security Act of 1974 (ERISA), a government rule that requires the person supervising the pension to have fiduciary duty for employees covered by the plan.

But ERISA does not apply to personal financial advisors, which creates a fiduciary gap. This is why there has been a push by both federal and state regulators to change the rules and protect investors who need to be involved in managing their own retirement savings.

Nicholas Hofer, a financial advisor and CFP from Boston, sees this shift as a good thing. “There is no question that being held to a fiduciary standard is important,” he said. “If firms are not willing to put their client’s interests first, the entire financial advisory industry is in jeopardy.”

Implementing the fiduciary rule could also help the industry as a whole, according to Harold Pollack, a University of Chicago professor and financial author.

“The rule helps consumers distinguish sales pitches from unbiased advice,” said Pollack. “If you’re charging consumers $250 per hour for genuinely valuable advice, it is hard to compete with a nominally free or cheap financially-conflicted competitor whose business model is to steer her consumers into unwise or overpriced investments.”

Are there downsides to a fiduciary rule?

While a standard fiduciary rule can seem like an overall good thing, past proposals have faced their share of criticism. Since many firms and advisors work under a looser standard, a stricter ethical code could hurt their profits and reputation.

“Firms that rely on fees and commissions for profits could face fallout if their clients have not been fully informed about their business model,” said Hofer. As a result, not all advisors are happy about the change.

Though you may not be that concerned about an advisor’s profit margins, this could lead to firms increasing other fees or tightening up their standards for what kind of clients they’d accept, as smaller accounts may no longer earn enough to cover overhead costs. For example, an advisor may set a limit where they only accept clients with at least $250,000 of assets, meaning middle and lower-class investors could be priced out of the financial advisor market.

Having a strict fiduciary rule could also limit what kind of investments are available, as everyone would be shoe-horned into the supposedly “best” low-cost approach. Investors who want to try something different would potentially struggle to find advisors willing to meet their express preferences.

Finally, what counts as the best investment isn’t always clear, something the SEC Chairman Jay Clayton pointed out in a recent speech on the subject: “Many different options may in fact be in the retail investor’s best interest, and what is the “best” product is likely only to be known in hindsight.” But despite these concerns, government regulators have decided to press forward with a few fiduciary rules.

The Obama Administration fiduciary rule

The Obama Administration first proposed an industry-wide fiduciary rule back in 2016. This law would have applied to any financial advisor selling products or giving advice for a retirement plan, like a 401k or an individual retirement account (IRA). It didn’t apply to financial advisors giving investment recommendations for a regular brokerage account, though.

Some ways advisors would have needed to meet the fiduciary standard under this rule included:

  • Putting the client’s interests first for investment recommendations.
  • Avoiding potential conflicts of interest for commission and fees.
  • Properly disclosing how they are compensated, such as whether they are fee-only or fee-based.
  • Being transparent about why they were proposing different options.

When the current administration took charge in 2017, it moved to review the rule as part of its drive to reduce government regulations. While the Department of Labor initial continued implementing the Obama Administration’s rule, industry groups sued the government and a federal court ultimately struck the law down in 2018.

The Securities and Exchange Commission (SEC) fiduciary rule

After the cancellation of the Obama administration’s fiduciary rule, the SEC decided to take its own look at implementing a fiduciary rule. In June of 2019, the SEC proposed an update to its regulations for advisors depending on the services they offer: Broker-dealers, who make money selling products and investments, versus advisors, who make money charging for advice.

Before the new proposed ruling, firms that registered with the SEC, known as Registered Investment Advisors (RIAs), had to follow a fiduciary standard. Broker-dealers could just follow a suitability standard for recommending products.

The SEC ruling would toughen the standards for broker-dealers — now they need to make recommendations in the “best interest” of clients. While not as strong as a fiduciary duty, it is tougher than the suitability standard. Brokers must be able to justify the risks, costs and benefits of a recommendation to prove it’s in a client’s best interest. Both types of financial advisors would also need to provide a standardized disclosure form explaining their fees, services and potential conflicts of interest.

The proposed SEC fiduciary rule is not as strong as the Obama fiduciary rule, which would have put the fiduciary standard on broker-dealers selling products for retirement accounts The SEC fiduciary rule is currently scheduled to launch in June 2020.

The Department of Labor (DOL) fiduciary rule

The DOL has not given up on launching its own fiduciary rule. While it has yet to formally propose anything, Secretary of Labor Alexander Acosta has said the DOL is studying the SEC ruling to guide a new DOL fiduciary standard.

The Obama DOL fiduciary rule was tougher than the SEC regulations, as it covered broker-dealers selling products. Any additional DOL fiduciary rule could further tighten standards for the industry. But while the government is making some moves, Pollack is still disappointed that the DOL let the Obama fiduciary rule die in court.

“I favor the strongest possible fiduciary standards,” he said. “To the extent that SEC and DOL rules are weaker than the Obama administration sought to impose, I regret these departures.”

State fiduciary rules

With the federal fiduciary rule up in the air, several state governments decided to pick up the slack and launch their own regulations for advisors operating within their borders.

New York has passed tougher standards for life insurance and annuities, so advisors selling these products need to meet a best interest standard. Nevada, New Jersey and Massachusetts are also reviewing or preparing to launch laws that would make a fiduciary standard apply for broker-dealers and investment advisors in their states. Maryland considered a similar law, but the bill didn’t pass.

This creates a tricky landscape because the way your financial advisor can make recommendations may depend on where you live.

The fiduciary rule: What’s next?

Creating an overarching fiduciary rule for investment advisors will not be easy but Eric Roberge, CFP® and founder of Beyond Your Hammock, thinks the industry badly needs one as there’s too much confusion regarding who offers what.

“I don’t think there’s anything inherently wrong with professionals who sell products, but what we do need in the industry, for the benefit of the people who need professional services, is more transparency,” he said. “Without a standard fiduciary rule, consumers have a very hard time distinguishing who is there to provide objective, in-your-best-interest advice — and someone who is a more of a salesperson with the financial incentive to sell products.”

Hopefully, the future fiduciary rules can achieve these goals so consumers can feel more confident in taking recommendations from financial advisors. In the meantime, since this is not yet the industry standard, make checking whether an advisor is a fiduciary one of the questions you ask before signing up.

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.

David Rodeck
David Rodeck |

David Rodeck is a writer at MagnifyMoney. You can email David here

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Is It Ever a Good Idea to Max Out Your 401(k)?

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

The earlier you start saving for retirement and the more you contribute, the better. But should you max out your 401(k)? Whether maxing out your 401(k) is a good idea really depends on your personal financial situation.

The maximum amount you can contribute to your 401(k) is currently $19,000 a year if you are under age 50, and $25,000 if you are 50 or older. Once contributed, this money usually can’t be withdrawn until age 59½ without incurring penalties.

If you stash away this money now, you’ll be giving up part of your income and possibly making it more challenging to achieve other financial goals, such as saving up to buy a house or paying off your student loan debt. Still, you want to make sure you have enough cash saved to retire when you want to.

Should I max out my 401(k)?

There are a number of exceptional reasons to consider maxing out your workplace retirement account if you’re financially able.

As a baseline, you should at least make sure you’re saving enough to secure your entire employer match, if your workplace offers one. This match is a specific amount of “free money,” usually offered as a percentage of your own contribution, that your employer might offer to incentivize you to save for retirement.

But reaching your retirement goals may require contributing beyond your employer match. Alex Caswell, a financial advisor at RHS Financial, said three main reasons that people usually aim to maximize their 401(k) include:

  • Saving enough to actually retire one day
  • Reducing taxable income to save on taxes
  • Growing wealth on a tax-advantaged basis

Additionally, most people drastically underestimate how much they’ll need to retire one day, and many forget that retirement could last up to 30 years or even longer, Caswell said.

“Somehow you will need to make a fraction of your annual income grow and accumulate to the point where it can provide for you fully every year,” he said. “When you think about it from this perspective, it becomes very clear how important it is to contribute as much as you can.”

With all this being said, stashing $19,000 in your 401(k) each year can be easier said than done. While saving for retirement should be a financial priority, it shouldn’t necessarily come at the expense of other important financial goals, like building up an adequate emergency fund or paying off high interest debt.

You also don’t necessarily have to do all of your retirement saving in your 401(k) plan — especially if it has high fees or limited investment options.

Financial goals to complete before you max out your 401(k)

Depending on your salary and financial situation, it may make sense to check off some important to-dos before you start maxing out your 401(k). If you’ve already crossed all of these off your financial to-do list, that could also be a sign that you’re well-positioned to max out your 401(k).

Here are some of the most important goals you should consider when weighing whether you can realistically afford to max out your 401(k).

Building up an adequate emergency fund

Roger Whitney, host of the podcast Retirement Answer Man, says that it’s important to build up an emergency fund before you start maxing out your retirement fund. “Think of an emergency fund as the financial airbag of your life,” he said.

Having an emergency fund can give you financial options when anything unexpected comes up and help you keep your long-term assets for the long term. If you don’t have an emergency fund, you may be forced to deplete your resources if you face a job loss or a financial emergency.

How much should you save? Caswell suggests saving three to six months of expenses in a “safe and liquid bank account,” such as a high-yield savings account.

Paying off high-interest debt

You may also want to consider paying off high-interest debt before you max out your 401(k) entirely, advised financial planner Brandon Renfro.

If you have high-interest credit card debt, for example, it may be a good idea to go ahead and get that paid off first, he said. That’s because the average credit card interest rate is nearly 17% as of the date of publishing, meaning you’ll pay a lot in interest each month if you carry this debt over the long term instead of prioritizing paying it off.

Purchasing an adequate amount of life insurance

Make sure you have enough life insurance coverage to provide for your family if you were to suddenly pass away.

This shouldn’t be too difficult considering how inexpensive term life insurance coverage can be. Still, if you’re stretching yourself too thin to max out your 401(k), it might be tough to add another monthly bill.

Purchasing enough disability insurance coverage in case you’re unable to work

The importance of disability insurance is also worth taking into consideration when deciding whether to max out your 401(k). You should purchase enough disability insurance to provide coverage if you wind up being unable to work for six months or longer, said financial planner Ryan Inman.

Remember that your 401(k) funds can’t be used to replace your income if you cannot work for some reason without paying a hefty penalty. Disability coverage, on the other hand, can help you pay your bills and living expenses until you can get back to work.

Saving money in a health savings account, or HSA

According to financial advisor Matthew Kircher, health savings accounts (HSAs) offer one of the best tax-advantaged ways to save for high-income individuals.

“This is the only triple-tax-free option available that provides an upfront tax-deduction, tax-deferred growth and tax-free distributions,” he said.

The key to maximizing the HSA is to pay all actual medical expenses out of pocket, with the idea that you keep adding to and growing your account. You do have to have a high-deductible health plan to qualify for an HSA, however.

In 2020, this means a deductible of at least $1,400 for individuals (up from $1,350 in 2019) or at least $2,800 for a family (up from $2,700 in 2019). Maximum out-of-pocket amounts also apply to high deductible plans, and in 2020, your maximum out-of-pocket amount can be no more than $6,900 for individuals ($6,750 in 2019) or $13,800 for families ($13,500 in 2019).

While individuals and families could contribute up to $3,500 and $7,000 to HSA accounts in 2019, respectively, those figures will rise to $3,550 for individuals and $7,100 for families in 2020.

Save up to purchase your first home

Depending on your situation, you may want to prioritize homeownership. If you’re spending a lot of money on rent right now, for example, being able to purchase a place of your own could help you stop renting and start building equity.

“If homeownership is a goal of yours, you may want to get that taken care of before you start maxing out your 401(k),” Renfro said.

When you should max out your 401(k)

While you’ll want to balance your other financial goals, there are situations in which maxing out your 401(k) might be a good idea. You may want to consider maxing out your 401(k) if:

  • You earn a lot and want to reduce your tax bill. Terms may apply.
  • You want to give compound interest a chance to help your money grow, tax-deferred.
  • You’ve achieved some of the important non-retirement goals we’ve outlined above.

In addition to making sure you have enough saved to retire, the tax benefits of maxing out your 401(k) are real.

“Contribution to a regular 401(k) doesn’t get counted toward your income,” Caswell said. “If you are in a high tax bracket, every dollar you manage to protect from taxes will increase the power of that money to grow your wealth. At an annual contribution limit of $19,000, maxing out your 401(k) is one of the most powerful ways to reduce your tax bill.”

And, as we noted, don’t forget about the advantages of letting your money grow in a 401(k). All investments in your 401(k) grow tax-free.

“All the gains, dividends and interest you will incur year after year will be tax-free,” Caswell said. “This is unlike a regular brokerage account where you will receive a 1099 at the end of every year and be saddled with a tax bill.”

Other options besides maxing out your 401(k)

Whether or not you decide to max out your 401(k), there are plenty of other investment options to consider that can also help you to retire on your own terms. You may consider saving for retirement in other places as well, especially if your company’s 401(k) plan carries high fees or lackluster investment options.

Invest in a Roth IRA

According to Renfro, another retirement account option you may want to consider is a Roth IRA, which lets you invest for retirement with after-tax dollars. One strategy is to save enough in your 401(k) to get the employer match and then put anything you want to save above that amount in a Roth IRA, said Renfro.

“Saving in a Roth IRA in addition to a 401(k) can diversify your tax liability and help lower your overall tax rate when considered over multiple years,” Renfro said.

In 2019, most people can contribute up to $6,000 to a Roth IRA. If you’re age 50 or older, you can contribute up to $7,000.

Contribute to a traditional IRA

If you have the option to contribute to a traditional IRA, you may consider it before maxing out your 401(k). While 401(k) accounts are a great savings vehicle, they can be restricted in their investment options,.

“If you are looking for more control of your investment strategy, then you may consider saving in an IRA once you have taken full advantage of the 401(k) match,” Caswell said.

Note that the same contribution limits apply to traditional IRAs as Roth IRAs, and that the limit applies to both accounts combined.

Open a brokerage account

If you’ve already maxed out tax-advantaged retirement savings accounts like your 401(k), you can also consider opening a taxable brokerage account with any firm that offers one, such as Vanguard, Fidelity or Schwab.

Inman says that, while a taxable investment account won’t provide any tax savings, “it will provide another pool of assets to provide you with income in retirement.”

The bottom line

At the end of the day, having enough income in retirement is the underlying goal anyway, right? By contributing to a 401(k), simultaneously pursuing other financial goals and letting time and compound interest do their work, you should be well on your way to a secure financial future. Whether you decide that maxing out your 401(k) is a good idea to get there ultimately depends on your financial situation and other financial goals.

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.

Holly Johnson
Holly Johnson |

Holly Johnson is a writer at MagnifyMoney. You can email Holly here