Financial independence encourages thinking about one’s financial future in a different way. You were told to “build a career and retire at age 65.” Financial independence says you should write your own financial script. The system, your parents, and a large employer should not be the authors of your financial future.
Guess what goes perfectly well with a financial independence mentality? The Solo 401(k)! The Solo 401(k) helps you control today’s tax burden and helps you plan for your retirement your way.
Here are three ways the Solo 401(k) can support the financial independence journey.
Choice and Low Fees
One advantage of working for yourself is you gain control over your workplace retirement account. Solopreneurs themselves determine where their Solo 401(k) is established and the investment options available to them. They determine contribution levels and whether or not to contribute to a Roth account.
Solopreneurs are no longer at the mercy of a large employer’s 401(k) plan, which may not have the investments they want, a Roth option, and/or low fees.
Further, many Solo 401(k) providers offer low or no fees to establish a Solo 401(k) with their institution. For example, today neither Schwab nor Fidelity charges Solo 401(k) fees, other than the fees of the underlying investments (such as mutual fund expenses). Vanguard charges $20 per mutual fund inside a Solo 401(k) (other than the underlying fund fees), though the $20 fee can be waived if the solopreneur has enough qualifying assets invested with Vanguard.
Tax Rate Arbitrage
The Solo 401(k) supports very significant tax deductions. For those at their peak earning years, contributions to Solo 401(k)s can benefit from high marginal tax rates. Further, in certain circumstances, traditional deductible Solo 401(k) contributions can help solopreneurs qualify for the qualified business income deduction, increasing the marginal tax rate benefit of traditional, deductible Solo 401(k) contributions.
During early retirement, retired solopreneurs can convert traditional retirement accounts to Roth accounts. Those Roth conversions can be sheltered by the standard deduction, and then taxed at the 10 percent and 12 percent marginal federal income tax rate. This arbitrage opportunity (deduct contributions at high marginal rates, later convert the contributions and earnings to Roth accounts at lower tax rates) can supercharge the journey to financial independence.
Reducing MAGI for PTC Qualification
Many solopreneurs have their medical insurance through an Affordable Care Act plan. These plans often have hefty annual premiums. However, there is a Premium Tax Credit (“PTC”) that can significantly reduce the cost of those premiums.
PTCs decline as modified adjusted gross income (“MAGI”) increases. Very generally speaking, from a planning perspective, as MAGI increases, PTCs decline by approximately 10 to 15 percent. Solopreneurs can reduce MAGI by contributing to a traditional deductible Solo 401(k). That decrease in MAGI can significantly increase the PTC, defraying their ACA medical insurance premiums.
Conclusion
The Solo 401(k) can help solopreneurs achieve financial independence. Chapter 13 of my new book, Solo 401(k): The Solopreneur’s Retirement Account, goes into further detail about marrying the Solo 401(k) with one’s own FI journey. The book is available from Amazon, Barnes & Noble, and other outlets.
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This post is for entertainment and educational purposes only. It does not constitute accounting, financial, legal, or tax advice. Please consult with your advisor(s) regarding your personal accounting, financial, legal, and tax matters. Please also refer to the Disclaimer & Warning section found here.