Solo IRA's & Solo 401(K)'s - What They Are Used For & Their Differences

If you are self-employed (S.E.) or a business owner you may have heard of a Solo IRA or Solo 401(K). But do you know the differences? Solo 401(K)'s are sometimes referred to as a Solo K or S.E. 401(K). When you get your federal income tax return, Solo IRAs are listed as SEP-IRA (simplified employee pension) or a broker may call it a SEP. I will explain the differences between the two, along with the pros and cons of each.
 
Only people who are self-employed and/or business owners and their spouses, are allowed to open a Solo IRA, whether they have employees or not. You and your spouses can also open a Solo 401(K), but only if you have no employees who get a W-2. So for example, if you own a restaurant and have employees, you would not be eligible to open a Solo 401(K). Although you can hire out (outsource) help as contractors, etc., because these people are in business for themselves and do not get a W-2 from you along with their pay. Solo IRA's & Solo 401(K)'s can also be 'self-directed' as well.
 
As with any form of investing for retirement, there are rules or guidelines governing Solo IRAs and Solo 401(K)'s. For instance, Solo IRAs can only be a Traditional account (Traditional Solo IRA), and not a Roth. Anyone can have a Roth IRA, whether they are self-employed and/or business owners or not. Many self-employed people and business owners have both, a Roth IRA, and either a Solo IRA or Solo 401(K).
 
Solo IRA and Solo 401(K) contributions are tax-deductible, which means taxes on contributions are not paid until funds are withdrawn at retirement. But there are differences between the two. Solo 401(K)'s have a higher yearly limit on contributions and they require much more paperwork involvement. So it may be difficult to find a company or broker that offers this service. The yearly allotted contributions for both a Solo IRA and Solo 401(K) changes yearly. So Do Your Homework! With Solo IRAs and Solo 401(K)'s, the maximum allotted yearly annual contribution per couple in 2008 was over $100,000. Solo IRAs and Solo 401(K)'s carried the highest maximum contribution dollar amount of any contribution investments, but it is based on a percentage of income or company profits.
 
For example, a Roth IRA only allows for a maximum annual yearly contribution of $10,000 per couple, or $5,000 per individual and will continue to increase $500 a year starting in 2009 due to inflation. You can read up more on Roth IRAs, self-directed IRA's, and self-directed 401(K)'s at ezine articles online under author Colleen K. Rich starting with 'IRAs: The Differences You Should Know' and 'Different IRAs and Their Investment Options'. Now if you have both, a Roth IRA, and either a Solo IRA or Solo 401(K), there is also a combined maximum allotted yearly contribution dollar amount. You can consult your accountant or broker for more information.
 
So as you can see, if you are a self-employed and/or a business owner and your yearly income is higher, you benefit by having a higher annual yearly contribution dollar amount. The downside to Solo IRAs and Solo 401(K)'s, is that they are not tax-deferred, and therefore you pay taxes on distributions at retirement (higher dollar amount), versus paying taxes on contributions now (lower dollar amount), and do not benefit from having contributions at retirement distributed tax-free.
 
I know that sometimes retirement planning can seem confusing or complicated. But keep in mind that there are groups/teams out there available to help you, when you decide to go forward with your retirement planning, if self-employed or an entrepreneur.