Sunday, August 28, 2005

Opening an Individual 401(k)

PFBlog is writing a series of posts regarding Tax Strategy for Self-Employment now that he and his wife will both have side income. We didn't go through anything as elaborate as his thought process, but we did do some research and decided to open an individual (aka "solo" or "self-employed") 401(k) this year for LaLa.

Background
For the past two years LaLa chose to contribute the maximum to a Traditional IRA and take the tax-deferral route. This was due to our desire to maximize cash on hand at the time by deferring taxes despite the potentially more lucrative longer term gains of chosing a Roth IRA instead.

Basically, in 2004, we used her income as a self-employed web and graphic designer to pay down our existing debt and engage in some "deferred purchasing" (admittedly not all necessary) while our household and daily expenses (as well as my 401k contributions) came solely out of my income. Hindsight is 20/20, but this year we finally got serious about using her income to help her "catch up" in her retirement savings.

The Individual 401(k)
I recalled reading an article at Bankrate about a year and a half ago on "individual 401(k)s" and given our goal of maximizing her contributions, this seemed the solution for her. With this type of account, she can defer up to $14,000 of her income as well as contribute up to 25% of her net profits (the profit sharing piece). The potential deterrents to this type of account are things like administration fees and "paperwork". Some custodians charge a fee to maintain this type of account and there is a fair amount of forms involved in establishing one since you are basically a company creating a 401(k).

Finding Fidelity
After shopping around at the usual discount brokers (Vanguard didn't offer it, T.RowePrice charged an under $5k per fund maintenance fee) LaLa decided on Fidelity's Self-Employed 401(k) since it had no setup or maintenance fees and the funds she wanted to buy did not incur transaction fees. We also really like their online interface and have experienced great customer service in the past.

They did a good job of helping us navigate the forms required to establish this account however it was quite a hassle to transfer in funds from a USAA Rollover IRA (short answer: disburse as a check and deposit within the 60 day limit). The other small niggle is that contributions must be made by check via snail mail unlike the ACH transfers available in our Roth and Rollover IRA accounts. But the small irritations greatly outweigh the benefits of the higher maximium contributions allowed, so we're all good.

The Future?
LaLa is happy with her choice of Fidelity for now since it allowed her quickly and inexpensively get to the point where she was socking away retirement savings. But ultimately we're interested in exploring some options not offered by Fidelity et al. For the future, we are interested in pursuing more self-directed IRA options such as investing in real estate, but we have a lot to learn and do before we're ready for that.

8 comments:

  1. 7 ways to eat for free. Thought you might enjoy this:

    http://www.okdork.com/move/weblog/2005/08/jewgality_ii.html

    let me know what you think:)

    ReplyDelete
  2. Hey, you are fast! Thank you for sharing your experience.

    MM @ PFBlog

    ReplyDelete
  3. Hi, I followed a link from fatpitchfinancials.com and didn't know there was a personal 401k. I like your "save-o-meter". Best of luck with your saving.
    -Phil

    ReplyDelete
  4. This is great!
    I wasn't aware you could have a free self-employed IRA at Fidelity!

    And my wife works there!

    Maybe they do not want employees to know that... or they may become contractors :)

    Money And Investing

    ReplyDelete
  5. I manage an account for my 90 year old Dad at Merrill Lynch and am impressed with their level of pro-active support; but as the account is over $1m it has their attention.

    I have my own accounts with Fidelity, find their fees to be within reason, Interent software tool excellent, phone responce excellent. I was very impressed that they have returned 13% year to date with an IRA account they manage for me. Fidelity wants long term accounts even if they are small; which is unlike many others (like ML mentioned above)

    I have recommended Edward Jones for my mother-in-law because there is a local rep that does a great deal of hand holding and that is more important for her than severly restricted offerings, modest to poor returns and limited training the reps get.

    There is not one company that it the right solution for everyone and you need to shop. Vangard and TIAA CREF are others I would suggest you consider as they traditionally have very low fees.

    ReplyDelete
  6. Larry, we're all set at Fidelity (my opinion of them matches yours). Vanguard didn't offer an individual 401k product (at least when we checked earlier this year) or we probably would have gone with them due to their very low fees.

    I agree with your point about ML as well. My stepfather works for ML in publishing so we did investigate their options, but as you point out without large assets we...er..."weren't welcome" ;)

    ReplyDelete
  7. Great blog on the Individual 401k. After I read your blog I did some searching and found this site for accountants that compared a SEP IRA and Individual 401k (Solo 401k) and then read the website it recommends www.individual401k.com

    http://www.taxalmanac.org/index.php/SEP_IRA_versus_Solo_401k_/_Individual_401k

    Introduction:

    Are you still recommending a SEP IRA as a retirement plan to your self employed clients? I'm guilty of that too until I learned about how some of my clients could benefit from the Individual 401k (sometimes called a Solo 401k) as an alternative to a SEP IRA. A SEP IRA is a good choice for some self employed clients, but in other situations an Individual 401k provides a larger contribution / tax deduction versus a SEP IRA

    About the Topic:

    Individual 401k / Solo 401k plans are available to sole props, LLC and S and C corps. The advantage is in how the contributions are calculated. Also, a client that has an Individual 401k can have a loan, something they can not have in a SEP IRA. For example, I have had a client that left an employer and had a 401k, rolled over their 401k into an Individual 401k and then borrowed $50,000 to finance the startup of his business. There are no income or credit qualifications of getting the loan and interest is paid back into their own 401k.

    Contributions SEP IRA versus Individual 401k / Solo 401k

    In the example below the client is age 55 will have $100,000 net income in 2006 as a sole prop.

    SEP IRA - max contribution would be $18,587

    Individual 401k - max contribution would be $20,000 + $18,587 = $38,587.

    Before I knew of the benefits of the Individual 401k I would have recommended a SEP IRA and would have left a $20,000 tax deduction on the table.

    Not every client can make a contribution greater than the $18,587 permitted in a SEP IRA in this example, but for those clients that can an Individual 401k is clearly more advantageous. Also, a very interesting point is the benefits can be doubled for a husband and wife both working for the business and each with 100k net income would be able to contribute a total of $77,174 to an Individual 401k.

    Summary:

    An Individual 401k may provide your clients with a greater tax deduction and retirement contribution when compared to a SEP IRA. Also, an Individual 401k allows a loan that can provide a financial cushion or can help finance the startup of the business. I have had clients setup retirement account at this firm and have become knowledgeable about these retirement plans by reading the information on http://www.individual401k.com

    ReplyDelete
  8. Great blog on the Individual 401k was was a big time help! After I read your blog I did some searching and found this info comparing a SEP IRA and Individual 401k (Solo 401k) and then read the website it recommends www.individual401k.com

    http://www.taxalmanac.org/index.php/SEP_IRA_versus_Solo_401k_/_Individual_401k

    Introduction:

    Are you still recommending a SEP IRA as a retirement plan to your self employed clients? I'm guilty of that too until I learned about how some of my clients could benefit from the Individual 401k (sometimes called a Solo 401k) as an alternative to a SEP IRA. A SEP IRA is a good choice for some self employed clients, but in other situations an Individual 401k provides a larger contribution / tax deduction versus a SEP IRA

    About the Topic:

    Individual 401k / Solo 401k plans are available to sole props, LLC and S and C corps. The advantage is in how the contributions are calculated. Also, a client that has an Individual 401k can have a loan, something they can not have in a SEP IRA. For example, I have had a client that left an employer and had a 401k, rolled over their 401k into an Individual 401k and then borrowed $50,000 to finance the startup of his business. There are no income or credit qualifications of getting the loan and interest is paid back into their own 401k.

    Contributions SEP IRA versus Individual 401k / Solo 401k

    In the example below the client is age 55 will have $100,000 net income in 2006 as a sole prop.

    SEP IRA - max contribution would be $18,587

    Individual 401k - max contribution would be $20,000 + $18,587 = $38,587.

    Before I knew of the benefits of the Individual 401k I would have recommended a SEP IRA and would have left a $20,000 tax deduction on the table.

    Not every client can make a contribution greater than the $18,587 permitted in a SEP IRA in this example, but for those clients that can an Individual 401k is clearly more advantageous. Also, a very interesting point is the benefits can be doubled for a husband and wife both working for the business and each with 100k net income would be able to contribute a total of $77,174 to an Individual 401k.

    Summary:

    An Individual 401k may provide your clients with a greater tax deduction and retirement contribution when compared to a SEP IRA. Also, an Individual 401k allows a loan that can provide a financial cushion or can help finance the startup of the business. I have had clients setup retirement account at this firm and have become knowledgeable about these retirement plans by reading the information on http://www.individual401k.com

    ReplyDelete

Related Posts Plugin for WordPress, Blogger...