Self-Employed 401(k) Plans for Small Business Owners

How the Solo 401(k) / Self-Employed 401(k) Let You Save $50,000 or More Per Year

Small Business 401(k) Plans
For millions of small business owners, setting up a Solo 401(k) or Self-Employed 401(k) plan is a first step to providing retirement benefits for your family until your company grows large enough to have a traditional 401(k) plan in place.. Jetta Productions, Iconica, Getty Images

If you are ready to start investing and you are one of the many Americans who owns a small business, you may have a huge advantage other investors besides the fact that you are already wired for business-like investing.

Data consistently shows that 50% of American millionaires are business owners or self-employed in some capacity. We already know that 1 in 25 Americans is a millionaire, meaning the implication is that 1 in 50 Americans is a millionaire who made their money by investing in their own company, often starting with nothing more than work ethic and a little bit of savings (if they are lucky).

In a world where a large portion of the population exists on less than $2 a day, that is a staggering success rate, even though the road is fraught with risk and danger (just ask anyone who has ever had a business fail and been forced into bankruptcy).

This is the reason I spent so much time writing guides on limited liability companies and limited partnerships, which are two of the best ways to own your family's business. But another option that isn't discussed is a so-called Solo 401(k) or Self-Employed 401(k). Unlike an ordinarily Roth 401(k), a business owner is both the employer and the employee. As a result, he or she can contribute a staggering $49,000 to their 401(k) plan this year, wiping all of that off their income taxes!

Self-Employed 401(k) and Solo 401(k) Plans Aren't Right for Everybody

Of course, a self-employed 401(k) or solo 401(k) only works if you are running a business by yourself or with your spouse because all employees must be treated equally.

If you were to hire someone else, you would be forced to offer them the same retirement plan, which might not be possible for a small business. Either way, for some types of small business investments, these retirement plans can be very effective ways to set aside huge sums of cash for your golden years, which you can then invest in stocks, bonds, and even real estate, especially for a married couple.

They could sock away a hefty $98,000 per year in retirement savings, keeping that money beyond the reach of income taxes for decades!

Here is how it would work. Say a husband and wife launch their own small business. By the time they are 35 years old, they earn $500,000 per year before taxes from the company (this would make it comparable to owning a mid-tier hotel franchise like a Hampton Inn or a Holiday Inn Express in a city of, say, 50,000 to 100,000 people). This still puts them way off the radar of Wall Street and private equity fund radars but within the so-called capitalist class.

An Example of How a Self-Employed 401(k) Plan or Solo 401(k) Might Be Used

If the couple set up a separate limited liability company to serve as the controlling investor in their small business, so that they were the only employees of the holding company, they could put $98,000 a year into the 401(k) plan at the parent company. That would lower their taxable income to $402,000. Not only that, if they continued to work for 30 to 40 years, all of that money would stay within the protected confines of the 401(k) account, earning dividends, interest, capital gains and profits without having to pay a single penny in taxes until the money was withdrawn.

That means far more money working and compounding for them over a very long period of time.

In fact, if they earned 8% on their money and continued to invest for 35 years until they were 70, their combined 401(k) accounts would have more than $16,887,046 parked waiting to fund their retirement. When they withdrew money, they would pay income tax like normal.

This doesn't require genius and no one outside of their family will likely every know the names of these successful business owners. They would live in an ordinary town and go completely unnoticed. Of course, we know most millionaire business owners never make anywhere near $500,000 per year. Odds are, they make between $50,000 and $100,000. They just live within their means and build the value of their business. Over time, it starts to amount to something. That is the nature of how money works.

You would need to discuss your plans for a Solo 401(k) or Self Employed 401(k) plan with a qualified, respected accountant to make sure you don't violate any rules and you are eligible. For more information, take a moment to read this overview of Self Employed 401(k) plans for beginners.

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