Advanced Strategies for Your Solo 401(k)

In my last article I discussed the basics of a solo 401(k). To review, if you’re an independent contractor you have several choices for establishing your own retirement plan. Probably the most common one is a SEP IRA, but a solo 401(k) operates similar to an employer sponsored 401(k) but on a much smaller scale. With a solo 401(k) there are more rules to follow, you have to calculate your maximum contribution annually (which is based on multiple factors), and there may be two types of contributions (employer and employee).

So why should this be a retirement plan you should consider?

Advanced strategies

First, since you can open an account at almost any custodian, you’re not limited to just a few mutual funds. I’ve looked at many employer sponsored retirement plans, and most of the mutual fund choices just plain suck. They’re loaded with high fee funds and limited choices. With a solo 401(k), you have wide open choices that you control.

Second, you can designate your employee contribution as Roth 401(k) contributions. This means that you won’t get a tax deduction for these contributions, but the gains grow tax free and withdrawals are tax free. It’s like contributing to a Roth IRA (with some additional rules) regardless of the income you make. Note that while Roth IRA contributions are limited to $5,000 if you’re under age 50, the Roth 401(k) is limit is much higher — $17,000.

Since most physicians can’t contribute directly to a Roth IRA anyway, this becomes our way of taking advantage of the Roth tax structure. When you retire or stop practicing medicine, you can then rollover the Roth 401(k) portion into a Roth IRA and let it continue to grow tax free.

Third, if you work part time as a physician, then the solo 401(k) allows you to sock away more money than a SEP IRA. Suppose you’re a 52-year-old sole proprietor, work eight to nine shifts per month and make $150,000 in net annual income. You can contribute $22,500 as an employee contribution ($17,000 plus $5,500 catch up over age 50) and then an additional $30,000 as an employer contribution for a total of $52,500. With a SEP IRA, the employee contributions don’t exist so you’re limited to $30,000.

There are also other benefits, such as providing a bit better asset protection over IRAs. Also you can shelter money in a 401(k) structure so you can convert IRAs to Roth IRAs. You can also take loans from a solo 401(k) (though not recommended) whereas IRAs generally don’t allow loans.

The downsides

While the benefits are big, there are some downsides you should know:

- There is extra time and effort associated with opening a solo 401(k)

- Once the plan assets reach $250,000 you will need to file an annual IRS form showing the plan’s assets. If you fail to file this form, you could potentially face hefty penalties

- As plan assets grow, you may need a third-party administrator, resulting in an additional annual fee

As I’ve hopefully laid out, I think the benefits of having a solo 401(k) outweigh the downsides and provide a wonderful opportunity for you to save for your retirement.