Allen Ostrofe
Special to The Union

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March 19, 2013
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Solo 401K: Retirement plan on steroids


Last week, clients Vicky and Charles called in from San Francisco. They have pretty much finished up their 2012 federal and state taxes.

Vicky is an author of children’s novels that have won several national awards. She was very pleased with her income versus expenses, which has been growing quickly over the past few years. Charles works for Bay Area Rapid Transit and is a government employee, so he covers their health insurance needs, even through retirement. But she wondered whether she could keep more after taxes with a different plan for next year.

Since Vicky is self-employed, she must pay both employer and employee portions of Social Security and Medicare payroll taxes. In addition, her Social Security taxes have increased from 10.4 to 12.4 percent in 2013! But she also gets to take advantage of this dual role (employer/employee) in saving for retirement.

We suggested that Vicky open a Solo 401K before the end of this year, allowing her to contribute up to $23,000 because she is over 50. This terrific opportunity is available for all self-employed and small-business owners. Additionally, before she files her 2013 tax returns, she will also be able to contribute up to 20 percent of her net self-employment income (on federal Form 1040, called “Schedule C,” or “business income”), which is her net income minus half of her FICA taxes. The maximum contribution for a Solo 401K for 2013 is $56,500 (over age 50). That beats the maximum allowed under a simplified-employee-pension individual retirement account, which doesn’t include a “catch-up” provision for those 50 and older.

Because of the dual-contribution formula, Vicky can contribute more to a Solo 401K, than she could to an SEP IRA at the same income level. The rules of the Solo 401K were originally outlined by the IRS in 1981, along with the other 401K plans. The Solo 401K plan was further clarified in 2001 with the passage of the Economic Growth and Tax Relief Reconciliation Act, which stipulated how the self-employed or small-business owner could use the 401K.

Vicky was getting excited. Then, I told her there was more! Since the royalties from her books were coming in with such consistency, she and Charlie could, in addition to the Solo 401K, each contribute $6,500 to “non-deductible IRAs” for 2013. Vicky is not just a great writer but equally adept at math and quickly concluded our recommendation of these three investments would lower their taxable income by $56,500 and allow $13,000 further to grow tax-deferred.

We further suggested that the ever-healthy Vicky and Charlie invest in two long-term care policies, paying the premiums through her business, which may also be deductible, up to the Internal Revenue Service maximum for their ages. That is something Vicky was never able to deduct on her federal return because, luckily, her medical expenses never exceeded 7.5 percent of her adjusted gross income.

High contribution limits are just one of the many features that draw business owners to the Solo 401K. Now, might be the perfect time for you to see if a Solo 401K is right for you. With talk of increasing tax rates and fiscal cliffs, the ability to defer more taxes and maximize deductions is especially attractive. The new higher limits for the Solo 401K couldn’t have come at a better time.

The information in this article does not constitute advice of any kind, including tax advice. Please consult your tax adviser for specific information about your tax situation.

Allen Ostrofe, MBA CFP, is president of Ostrofe Financial Consultants Inc., an SEC fee-based registered investment advisor. For questions, visit http://ostrofefinancial.com. Branch address: 565 Brunswick Road, Suite 15, Grass Valley.


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The Union Updated Mar 19, 2013 10:55PM Published Apr 17, 2013 12:21AM Copyright 2013 The Union. All rights reserved. This material may not be published, broadcast, rewritten or redistributed.