Starting a business is a stressful and exciting venture to embark upon. While creating your business plan, it’s important to consider retirement plans. Thinking about retirement may be nerve-wracking, but it is crucial that you have a plan set up for when that time comes. An individual 401(k) is specifically made for people who are self-employed and/or business owners with no employees.
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What is an Individual 401(k)?
An individual 401(k) is a type of retirement plan that can maximize your savings, specifically if you are self-employed or a business owner. This works similarly to a standard 401(k), however, the main difference is the contribution limit. A business owner can contribute as both an employer and as an employee. For the 2022 tax year, the combined contribution cannot exceed $61,000. If you are 50 or older, the limit is $67,500 for the 2022 tax year.
Traditional vs. Roth Individual 401(k)
Traditional individual 401(k)s are similar to traditional 401(k)s. The contributions that are made are pre-taxed, which reduces taxable income. This also reduces your tax bill at the end of the year. For a Roth individual 401(k), contributions are post-tax. Since contributions are post-tax, when you make a withdrawal from the retirement account, that money is tax-free! Both types of these accounts have their advantages.
Advantages:
One of the primary benefits of having an individual 401(k) is that while you should contribute as much as you can to the plan, you have the option of reducing or even suspending plan contributions if you need to. This plan also allows loans and hardship withdrawals. The individual 401(k) accepts rollovers of funds from other retirement savings as well. With California Pensions, our plan document can be used with any type of investment across multiple asset custodians, including non-standard investments.
Disadvantages:
Although there are many advantages to having an individual 401(k), there are also some downsides. One of the main disadvantages is that individual 401(k)s have greater recordkeeping responsibilities. Additionally, they also tend to have slightly higher fees compared to IRA based retirement options.
Can Spouses Also Have Individual 401(k) Plans?
When it comes to individual 401(k)s, you may include your spouse if they work within the same company. Specifically, if you are the sole business owner while your spouse received a W-2 as an employee. Another way to include your spouse in an individual 401(k) is to file as a partnership and each partner receives a K-1. This way, the partnership won’t pay income taxes him- or herself, rather, passing the profits and losses to each other. Each spouse handles their own income.
