How the Solo 401K Works

Self-employed individuals worry about retirement as much as employees. It can likewise cause anxiety for them especially as they approach their senior years. Hence, retirement plans were designed for the self-employed and small businesses owners with no employees.   These retirement plans are the SEP IRAs and the Solo 401k otherwise known as the Solo K or Uni-K.   For small business establishments with no employees, the spouse can also contribute to the Solo 401K as long as he derives income from the business.

And just like the IRAs the Solo 401K for the self-employed has two versions, the traditional and the Roth.  The same principles that govern the IRA are also those that govern these versions. The tax benefits are realized when you make your contributions in the traditional Solo 401K.  However, you will be taxed when you make withdrawals.   In the Roth version tax benefits are realized upon retirement but not during contribution.   Choosing to contribute to both versions of the Solo 401k for self employed individuals is at your discretion.

The Solo 401K allows the plan holder to save more compared to other retirement plans.   It allows you to contribute both the employee's and employer's shares.  The employer's share consists of 25% of the employee's share.  The contributions are not pegged at a certain rate so that you can save more when there is more income and less when there is less.

Just like the IRAs, the Solo 401K plan stipulates that the money has to be invested up to the time you are 59 1/2.   Withdrawals made prior to the retirement age would mean the imposition of a 10% taxes aside from the income tax when you make the withdrawal.   However, there are exceptions where one can withdraw from the funds before the prescribed age without being penalized.   These situations include the purchase of the plan holders' first principal residence and expenses for higher education. A hardship withdrawal is also permitted without being penalized as in the case of expenses for large medical bills or the permanent disability of the plan holder. 

 If your reason for your withdrawal does not fall under the abovementioned reasons, the option is to take out a loan on the account.   In this way, you avoid the tax penalty.   You can borrow up to 50% of the total value of the account but not to exceed $50,000 if you use your retirement account as collateral.

The Solo 401K for the self-employed indicates that you invest the money into financial instruments such as stocks and bonds for it to increase in value in time for your retirement.   If you are not experienced in this area, it would be a good idea to get 401K advice from experts.  These financial experts can provide inputs not only on the investment aspect of the fund but can also provide invaluable advice on the type of Solo 401K you would contribute to because of tax issues.   The higher your income is the higher your tax bracket is going to be.   Similarly, the basis for taxation of a higher bracket is also higher.   And so experts can also advise you on the choice between the traditional or Roth Solo 401K or on the right combination of both.