To the Men and Women Who Want to
Quit Working One Day: The Solo 401k Plan

Solo 401k or IRA

One of the most important lessons my father taught me about managing money was investing for retirement. Following his advice, I opened an IRA at age 21 and have been investing ever since. When I first started investing, I was eligible for an IRA, but I was working for Colgate-Palmolive and we did not have a 401(k) plan. It wasn't until about a year later that Colgate-Palmolive had a 401k plan.

At that point, I was barely earning enough money to invest in both plans . I had to decide which investment plan was the best for me. Since there was not a company match to my 401k, I chose to invest in an IRA. 

Later when I started my own Company, I began a Solo 401(k) plan, and I have the option of investing in an IRA plan as well. I face the same question a lot of people face: where should I invest my retirement funds – in a Solo 401(k) plan, or in an IRA? Let’s take a look at the pros and cons of both accounts, then you can use this information to make the best decision based on your needs. 

Solo 401(k ) vs IRA – Finding the Best Retirement Plan for You 

Solo 401(k) Plans: There are a variety of employer sponsored retirement plans, including 401k, 403b, 457, 401a Plans, and Thrift Savings Plan. For simplicity, we will use the type--Solo 401(k). Please see the site for more information on related plans.

For tax purposes, Solo 401k plans have one similarity to Traditional IRAs – contributions are deposited before income  taxes  which can lower your adjusted gross income (AGI), giving you a tax break immediately. The invested money will be taxed when taken later or at retirement age. There are small penalties for early withdrawals.

You also have the opportunity of investing in a Solo Roth 401(k), which can be setup at the same time as a regular Solo 401(k). The maximum annual 401k contribution amount is the same--one amount for both traditional and  / or Roth 401k plans .. up to $18,000 for 2016.

The first distinct benefit in favor of Solo 401(k) plans is the amount of contributions you can make in a year. For 2016 you can deposit up to $18,000 pre-tax and / or Roth from your income. Plus there is a optional company match or profit sharing contribution, which is essentially free tax deductible money for you . My Solo 401(k) has a discretionary employer profit sharing contribution based on a percentage of my income. It's great, it's tax deductible money, and I take advantage of every penny of it!

Individual Retirement Arrangement:- IRA: There are two main types of Individual Retirement Accounts: Traditional and Roth. 

IRA: An IRA is an account set up at a financial institution that allows an individual to save for retirement with tax-free growth or on a tax-deferred basis. 

For people who are looking for relief from today's tax bill, making a contribution to a traditional IRA offers a welcome tax deduction. With a traditional IRA, investors must stop making contributions when they turn 70 1/2 years old, at which point they are forced to take distributions and begin paying taxes on that money. 

For both IRAs: These are individual investments, meaning there are no company contributions of any kind. There may be certain tax or eligibility restrictions for Traditional or Roth IRAs based on your income, filing, and marital status. The IRA contribution limits can also vary based on age and other factors. 

Traditional IRA: The main benefit of a Traditional IRA is that the money can be fully or partially deductible, depending on your situation. The contribution limit for  2016 is $5,500, or $6,500 if you're age 50 or older. You can't make regular contributions to a traditional IRA in the year you reach 70½ and older.

Regular IRA deposits are invested before taxes are removed, which will affect your AGI, resulting in an immediate tax break. The invested money will be taxed when withdrawn at retirement age, and there are penalties for early withdrawal (with certain exceptions). 

Roth IRA: Roth IRAs are not deductible contributions, which means you use post-tax money to fund your account.  

Roth IRA contributions may also be limited based on your filing status and income. 

However, the distributions made during retirement age are tax exempt, which is the main reason people invest in a Roth IRA. As with the Traditional IRA, early withdrawals may incur stiff penalties. 

The Roth IRA has no required minimum distributions. That means you can live to 150 without ever tapping your Roth IRA. Furthermore, anyone with earned income can keep adding to their Roth IRA account regardless of age. If you're earning an income at age 90 and want to save for the future, just do it: You can continue to contribute until you stop working or kick the bucket, whichever comes first.

For both IRAs: These are individual investments, meaning there are no company contributions of any kind. There may be certain tax or eligibility restrictions for Traditional or Roth IRAs based on your income, filing, and marital status. The IRA contribution limits can also vary based on age and other factors. 

Pros and Cons of 401(k) Plans and IRAs

Solo 401(k): The biggest benefit of a Solo 401k plan is the larger up to $18,000 contribution and the possibility of having an employer contribution. Free money is something not to pass up, specifically when it will increase over time. The Solo 401k also allows for loans up to $50,000 and permits withdrawals while you are still employed. 
Further, Solo 401k plans, with the exception of collectibles,you have an almost unlimited selection of investments to choose from or may have lower investment fees as you are investing on your own. As your own trustee and custodian, you can invest in almost anything without paying for a trustee or custodian like you are required with an IRA. Unlike a Self Directed IRA, when a Solo 401k plan uses nonrecourse leverage to purchase real estate that is leveraged, it is exempt from paying any Unrelated Business Income (UBTI) tax on any gain generated.
There is no early distribution 10% penalty on Solo 401k plans due to separation from service for those age 55 and older.

All investment responsibility is in your hands. You decide where to invest and how much to invest.  The advantage of managing your investments is the flexibility of deciding where to invest: Real estate, gold, mutual funds, stocks, bonds, life insurance, ETFs, etc. the possibilities are huge. The other benefits of Solo 401(k) plans include controlling your tax options by investing in a Roth Solo(k) for tax free withdrawals, or investing in a Traditional Solo 401k to lower your AGI and existing tax obligations.

IRAs:, all investment obligations lie with the individual. This can be overwhelming for some people, but there is always the option of paying someone to manage your funds. 
One of the advantages of an IRA is having access to a wide range of investments. When selecting investments, it's usually a good idea to think carefully about your own circumstances. Are you getting close to retirement and more targeted on investing for income? Or possibly your needs are focused towards investing for growth? Reviewing your goals can help you select the right type of investment.

IRAs require outside trustees and custodians that charge fees to allow you to choose from individual securities, such as stocks, bonds, certificates of deposit (CDs), mutual funds, exchange-traded funds (ETFs), or a managed option, where the asset allocation is done for you. Y
ou cannot purchase collectibles like antiques, art, jewelry, baseball cards, comic books, etc. or life insurance contracts.
You will FIND that you cannot purchase sub-chapter “S” corporation stock because the sub-“S” corporation is prohibited from having an IRA as a shareholder. 
The withdrawal of funds from the IRA before age 59 1/2 is subject to a 10% penalty.

Which to Choose?

Only one of these types of retirement plans involves the possibility of the most contributions and therefore the greater amount of funds working for you and the greater tax deductions– the Solo 401(k) plan. With your Solo 401(k) you can have a match or profit sharing contribution. It is probably in your best interest to invest in a Solo 401(k) plan to the point of receiving the maximum company contribution. It is hard to pass up tax deductible money!

After you have put in enough money to get the maximum contribution, I would consider investing in a Roth IRA if you are eligible. Roth IRAs are beneficial because you will be able to withdraw this money tax free in retirement. Doing this diversifies your future tax liabilities by having a taxable and non-taxable retirement funds.

On a personal level, I max out my Solo 401(k) year at year end when my earned income is determined.Then I contribute to my Roth IRA. I contribute enough to get the maximum benefit. My goal is to increase it until I can max out both my IRA and my Solo 401k plan. My goal is to funnel as much money as possible into my retirement.