Creation of the individual 401(k) with the Bush-era tax cuts went practically unnoticed, and the financial services industry was slow to set up these retirement plans and still has not done much marketing.
But the solo 401(k) can be a boon to a sole proprietor like a freelancer or small business owner with no full-time employees, allowing the same tax deduction for contributions available to employees of corporations.
In fact, the solo 401(k) can be even better, because the single participant is in charge of choosing the investment options and can even get a tax deduction for additional contributions in his or her role as the employer.
This year, a plan participant can put in $18,000 as employee ($24,000 if 50 or older), plus an employer’s contribution of up to 25 percent of his compensation, with total contributions limited to $54,000 ($60,000 if 50 or older).
[See: 12 Steps to a Stronger 401(k).]
As with all 401(k)s, investment gains are tax-deferred, and withdrawals are taxed as ordinary income. You can set up a solo 401(k) as a tax-free Roth account, or convert to a Roth later.
But along with latitude and high investing limits come some tough choices: which fund company, bank or brokerage should you choose as the plan’s provider? While the law allows participants to invest in just about anything they want, some providers limit the options. What should you look for in choosing a provider, or in switching if you’re not happy?
What investments are allowed? As mentioned, some custodians allow just about any mutual fund, exchange-traded fund or individual stock or bond, while others keep it to in-house products. Obviously, you should know the policy before setting up the account.
“If you go with a single firm you may run onto restrictions, but if you use a brokerage account platform then there should not be any investment restrictions,” says Scott W. Cody, partner in Denver-based Latitude Financial Group.
If you want the greatest possible freedom to invest, make sure the provider, whether a mutual fund company, bank or brokerage, can set up the account as a brokerage account.
Fees. Keep an eye out for administrative fees that could gnaw at your investment returns. Some providers do not charge account maintenance fees but may charge trading commissions (though probably not for reinvesting dividends). You would, of course, pay ordinary expense ratios on any funds in your plan.
“Typically, year one of the plan will be slightly more expensive because there may be a one-time setup fee,” Cody says. “After year one, there may be an ongoing administration fee.”
How fast are they? If you’re not happy with the provider you started with, you can shift to another in the same way you’d move assets from one individual retirement account to another. But it’s important to know just how this will be done.
Often, it can be an “in-kind” transfer of fund shares to the new account, leaving you with the same holdings you started with. In other cases holdings must be sold and…