Why a Solo 401(k) plan can be a wise retirement plan for farm and ranch owners
A Solo 401(k) also known as an individual 401(k) can be an excellent retirement plan for a farm or ranch owner who doesn’t have employees or who has employees that can be excluded from coverage. The advantages of a Solo 401(k) plan include:
» Low administration fees.
» High annual contribution limits.
» The choice of pre-tax (Traditional) or after-tax (Roth) contributions.
» The ability to make loans from the account.
Certain employees can be excluded from participation in a Solo 401(k). These include:
» Employees under age 21.
» Employees who work less than 1,000 hours per year.
» Union members.
» Employees who are non-resident aliens.
Although a Solo 401(k) plan is designed for an individual business owner, it is available to the spouse of the business owner and any shareholder or partner in the business, as well. This retirement plan must be established by the end of the business tax year in order to make a contribution for that year (unlike a SEP IRA which can be setup until your tax filing).
Setting up a Solo 401(k) is easy to do and is available to owners of an S Corporations, C Corporations or partnerships. Unlike traditional 401(k)s, there are no complicated discrimination testing requirements or Form 5500 filings.
Contributions to a Solo 401(k) plan are comprised of two parts, employee deferrals and employer profit sharing contributions. The yearly maximum employee salary deferral contribution is $18,000. Participants age 50 or older can contribute up to $24,000 annually. In addition to employee deferral contributions, a business can also make profit sharing contributions up to 25 percent of your W-2 income, increasing the total possible annual contribution to $53,000 for people under the age of 50 and $59,000 for those 50 and older.
A SEP IRA is another attractive retirement plan for the small business owners. A Solo 401(k), however, may allow you to contribute more money. Let’s look at a comparison of both plans for a self-employed 50-year-old ranch owner who has $100,000 in compensation.
The SEP IRA and Solo 401(k) both allow $21,175 in employer contributions. This is derived by multiplying 25 percent X $84,700, which is their net earnings after subtracting self-employment. With the Solo 401(k), the business owner can also make a $24,000 employee contribution on top of the employer contribution. That option is not available for a SEP IRA. In 2017, the SEP IRA contribution limit is 25 percent of compensation, so for our 50-year-old rancher, that amounts to $25,000. In total, the ranch owner can contribute $45,175 to a Solo 401(k) vs. $21,175 to a SEP. That’s a difference of $20,175.
When setting up an individual 401(k) plan, there are some important decisions that you have to make. The most important decision is how to invest the contributions. Another is how much of the employee deferral to make pre-tax and how much to contribute post-tax (Roth). Obtaining the services of an experienced financial advisor is one of the best ways to make these decisions wisely. For objective investment advice, it is best to work with a Registered Investment Advisor because they have a fiduciary duty to act in your best interest.