Self Employed 401k Accounts and Why You May Need One

If you work for yourself, you need a self employed 401k account. Whether you are an independent contractor, sole proprietor, or small business owner, you can get retirement security every bit as good as your peers who are W-2 employees.

Who is this good for?

An independent booth renting hair stylist.

A Real Estate Company with no employees or many employees.

Small businesses like these: lawn care, house cleaning, painting service, electrician, tax preparer.

Anyone who doesn't get a W-2 from another company can still have a 401k savings plan.

Why An IRA is Not Good Enough

The amount you're allowed to save in an IRA is not likely to be enough to fund a comfortable retirement, especially if you're starting late.

You need to save more than an IRA allows.

A regular savings account is no good for retirement savings, either.

To get the greatest benefit you need to be able to exclude the amount you save from your current taxes, too. You don't get that benefit with a "standard" savings account.

Another problem with after tax savings in a regular savings account is this: you have access to it any time you want it.

There are no penalties to discourage you from spending it on a fabulous vacation or a fancy new car when spring fever hits you.

That's where an individual 401k account comes in.

Think of it as a personal 401k pension plan that picks up where your IRA left off.

In 2014, you can send $17,500 to a 401k account, tax deferred. For your IRA, you can only contribute $5,500 in 2014 in before tax dollars.

Decision chart for savings accounts

Once you have a 401k funded, you can raid your personal savings account all you want and you won't be sabotaging your future.

You'll think twice about raiding your personal 401k account because, on top of the taxes you'll have to pay immediately, there are stiff penalties for early withdrawals.

Combined you'll lose 20% of your hard earned savings for such a withdrawal. Those are strong deterrents that are meant to keep you focused on building your nest egg for retirement.

You should just make up your mind never to touch the savings in those 401k or IRA accounts. NEVER! Until you're officially retired.

Here's what the IRS tells us about self employed 401k plans.

A Self Employed 401k
Helps You Pay Less in Taxes

Remember, the dollars you send to your retirement savings accounts are tax free (up to certain income levels). That means you pay less taxes now because the tax is deferred until you withdraw the money in retirement.

Your total tax liability at the end of the year is lowered by the amount you send to your self employed 401k savings account.

Once you retire, those tax savings will continue because you will be in a lower tax bracket when you withdraw the money.


The Option to Retire Early

Another wonderful benefit of 401k retirement savings, and my favorite, is the option to retire at age 55. If your only retirement savings comes from an IRA, you are very limited in your options before age 59 1/2.

But, if you decide to quit working before that age, you can tap your 401k account as early as age 55 so long as you quit work in the same year.

Note: this only applies to the 401k associated with the job you are quitting, so this means it's a good idea to roll over old 401k funds to new ones when you change jobs.

What About the Match?

Surprisingly, your business can also provide a company match to your 401k contributions.

One financial services company that can help you with setting up your 401k is Fidelity Investments.

They can help setup a self employed 401k plan or a small business 401k plan, whichever fits your business.