Three Reasons You Need to Open a Solo 401(K) Now

Nobody likes paying more taxes than they need too.  Small business owners are lucky to have many opportunities to keep more of their hard-earned money through expert tax planning.  One of the biggest ways to slash your tax bill if you own an S-Corp is to open a Solo 401(k). For those who maximize contributions, the tax savings can be in the tens of thousands of dollars per year.

As I write this in late October, many of you business owners just finished your 2018 taxes. My phone has been ringing off the hook will business owner referrals from CPAs and Tax attorneys. These business owners are dismayed at how much they ended up owing in taxes for 2018. They realized they needed to be proactive for 2019, and are looking for guidance on how to pay less in taxes this year

Tax planning for small business owners has changed under the Trump Tax plan. What you may have worked a few years ago, may not be optimal today.

Similarly,  your business revenue, and hopefully profit, has grown of the past few years as well. Bigger profits further necessitate more active tax planning for your business.  Bottom, the more you make, the more taxes your business will face.

The Solo 401(k) is a great starting point to reduce your current tax liabilities. If you are already maxing out your Solo 401(k), you can look at adding a Cash Balance Pension Plan to the mix, which may allow you to triple or even quadruple your tax savings. More on that at a later time.

1)     Huge Tax Deduction

One of the motivating factors for small business owners to open a Solo 401(k) plan is the possibility of a huge tax break. With a solo 401(k) plan, you can potentially sock away $56,000 pre-tax this year. That means you won’t owe federal taxes or state taxes on that income at this time. Think of how much money that could save you. Would you prefer to write a check to the IRS or your own future?

Related: How to Choose the Best Retirement Plan for your Small Business.

2)     Deadline to Open a 401(k) in Looming

If you wish to use a Solo 401(k) plan to lower your 2019 taxes, there are deadlines you need to meet. These plans need to be set up by December 31st, 2019.  Don’t be that person who tries to find a financial advisor to open an account on New Year’s Eve. I won’t be taking your call, and I’d expect any good financial advisor would already be out of the office by 5 pm to celebrate New Years’.

The good news here is that the plan doesn’t have to fully funded until you file your taxes. But, the plan does need to be set up. Employee contributions should be made during the calendar year, whereas you have nearly an extra year to get the employer contribution in, assuming your file your taxes on an extension.

3)     Great Way to Save for Your Future

When you own your own small business, setting up a retirement plan falls squarely on your shoulders. Opening and aggressively funding a solo 401(k) plan is a great way to stay on track for financial freedom. Your work hard for your money; it is time to let your money work hard for you as well. Talk with a fee-only fiduciary financial planner to see how much you need to be saving to achieve your retirement goals. Then get saving and fund your retirement accounts.

Here are the Contribution Limits for a Solo 401(k) in 2019

2019 Solo 401(K) Contribution Limits as an Employee:

For a Solo 401(k) plan, you can contribute $19,000 in 2019 as an employee of your business. You can also make a $6000 catch up contribution if you have reached the fabulous age of 50. The big caveat is that your contributions can’t exceed your salary or earned income. Earned income equals your net earning minus half of your self-employment taxes and 401(K) contributions. Don’t worry; it’s not as complicated as it sounds.

2019 Solo 401(K) Contribution Limits for the Employer:

You can make a profit-sharing contribution up to 25% of compensation or 20% of earned income. This is above and beyond the employee contribution above. The total contribution limits for Solo 401(K) plans in 2019 is $56,000. That jumps to $62,000 for those over 50. 

I am just providing a high-level overview of the Solo 401(k). The IRS regulations for this plan need to be followed. Talk with your trust tax advisor and financial planner to ensure you plan in set up properly, invested well. Of course, make sure it fits with your overall financial plan.

Already maxing out your 401(k) plan? Then check out the 401(k) Defined Benefit Plan combination to lower you income taxes even further.

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