With no discrimination testing necessary, I reap the rewards without toting the baggage

June 1, 2015 — 5:13 AM UTC by Guest Columnist James Osborne

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Being self-employed comes with a lot of perks.

Like the fact that I put the little one down for nap today to help out my wife and plan to sneak out for a ride this afternoon. And that I only answer to my clients (and the regulators, I suppose). No staff meetings, no memos being handed down, no one to supervise. I like it this way. Really. See: My 10-year journey from a BoA call center to establishing a solo $73-million AUM RIA.

But one of the greatest parts, financially at least, is the ability to fund an individual 401(k). For the sole proprietor, a solo 401(k) is a gift.

Like any other 401(k), I can fund $18,000 of employee contributions every calendar year. If I was over 50, the catch up would kick in for an additional $6,000 in 2015. On top the payroll contribution, I get to make company-level profit sharing contributions of an additional $35,000 to hit the annual limit of $53,000, up to 20% of total compensation.

Simple solution

Most small company 401(k) plans easily rack up a few thousand dollars a year in administrative costs between recordkeepers and third party administrators. Plan testing, reporting and filing the form 5500 has to be done every year. But this doesn’t apply to individual 401(k) plans. Since there is only one participant, there’s no discrimination testing necessary. Plans with less than $250,000 in assets are not required to file a 5500 (over $250,000, filers use form 5500-EZ to comply with requirements). My individual 401(k) account at Schwab has no monthly or annual maintenance fees. I can invest in a portfolio of low-cost ETFs for just Schwab’s ticket charges. See: How exactly I started a specialized RIA for under $10,000.

If you are self-employed, with no employees and a high ability to save, the individual 401k is your best friend.
If you are self-employed, with no
employees and a high ability to
save, the individual 401k is your
best friend.

The contribution math makes an individual 401(k) much more attractive than a SEP or SIMPLE-IRA. SIMPLE contributions are $12,500 for 2015, plus a 3% matching contribution. SEP contributions for the self employed are simply 20% of compensation net of half of self-employment taxes. So what does this mean?

Let’s assume a self-employed individual under age 50 with $120,000 in annual income. How does each plan stack up?

The SIMPLE-IRA gets you the $12,500 plus another $3,248.22 for total contributions of $15,748.22.

The SEP contribution is maxed out at $22,304.45 — 20% of earnings less the self-employment tax.

The Individual 401(k) blows away the competition. First you get the $18,000 contribution, and then the profit-sharing contribution on top of that. Essentially, it is the SEP contribution plus $18,000, for a total of $40,304.45.

SE retirement account limits 2015

The math holds out across all income levels until the SEP and Solo 401(k) reach parity just north of $250,000. There is no scenario where a SEP-IRA will allow more deferrals than a Solo 401(k). If you are self-employed, with no employees and a high ability to save, the individual 401(k) is your best friend. A growing list of individual 401(k) providers will now allow Roth contributions for the employee deferral portion, which may be attractive for younger savers or those already in a lower tax bracket. See: One killer Roth conversion strategy in seeking a single-digit tax return.

I’d love a world where there is parity of contribution limits across all retirement account types. There’s not much sense in having a dozen different retirement plans with separate deferral and contribution rules for each one. I’d love it If things were simple and everyone had access to a traditional or Roth IRA with the same contribution limits as us lucky self-employed get. But for those of us in the sweet spot, ignoring the slam-dunk of an Individual 401(k) is regrettable.

This article was originally published May 13 in the Bason Asset Management blog.

James Osborne is a financial advisor, CFP and has an MBA in Investment Management from the University of Colorado. James has previously instructed CPE courses for the Colorado Society of CPAs. His disillusionment with the standard practice of investment management firms led to the creation of Bason Asset Management in late 2012. He has written multiple columns for RIABiz including: My 10-year journey from a BoA call center to establishing a solo $73-million AUM RIA.



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