My Personal Finance Journey

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Self Employment 401(k) Brokerage Choices

Contributed by mm | November 26, 2005 3:05 PM PST

In my recent tax planning series for self-employment income, I highly advocated using self-employment 401(k), also called individual 401(k), as an effective tool to defer a big chunk of income from immediate taxation. I recommend the tool because the sheer size of tax deferral it can provide (up to $42,000, and $46,000 for the elderly), and the flexibility of the tool (no required contribution every year). (Still, the key limitation is it will not be advantageous to set up such plans when there are non-owner employees in the business.)

So technically, how can you set up a self-employment 401(k) plan and start your grand saving plan?

Not many brokerage firms offer such options right now, and for those who offer, my vote goes to Fidelity. Fidelity provides a streamline self-employment 401(k) solution that requires no application fee, no annual maintenance fee, rich resources in terms of access to mutual funds and research, and top-notch customer service. What it takes is you download a few pre-formatted forms, add your information and sign it off, and send it back to Fidelity. In my experience, new accounts were set up within a week. (Tip: it might be a good idea to give Fidelity a call to make sure you understand how to fill up some fields in the forms.)

I chose Fidelity also because both my wife and I have 401(k) accounts, Roth IRA accounts and brokerage accounts with them, and it makes sense for us to consolidate "vendors." (We are also satisfied Fidelity customers without a doubt.) As a matter of fact, we set up four self-employment 401(k) accounts: two for each of us on individual/family basis, another two as owner-employees for our newly-founded C corporation. Hey, everything is free!

One drawback of Fidelity's pre-formatted self-employment 401(k) plan is it does not provide loans. By law, self-employment 401(k) administrators can choose to offer loan features in such plans. This is not a material problem for us -- we have more than enough cash to deploy and we don't foresee we need to borrow from 401(k) contributions. If 401(k) loan is important to you, you may be able to use 401Brokers.com, which provides turn-key solutions of setting up self-employment 401(k) accounts at either Ameritrade or Vanguard. (However, an annual charge of 0.25% may hurt your tax-deferred growth somehow.)

This Post Has Received 4 Comments. Share Your Opinions Too.


Carol Commented on November 26, 2005

I've heard Fidelity will NOT be offering the Roth option on their self-employed 401(k) that the tax law makes available starting January 1. Does anyone know for sure?


Sue Andrews Commented on February 16, 2006

Hi there, I have been collecting articles to help people manage their finance so that they dont get into trouble at old age, however I found that most of them are pretty careless in beginning years where they could have made significant savings in 401K. And as years passes by, they start worrying about their options etc. which is not a good strategy.


Making Our Way Commented on March 22, 2006

Dear PFBlog,

hmmm...I'm a bit confused. Are you making two contributions each to your various individual 401ks; i.e. for 2005 did you put away $14,000 x2 x2 for a total of $56,000?

if so, please explain the approach, I'd like to see if I can do it as well.

I have several individual 401ks (Schwab and TD Waterhouse).

Thanks,

Making Our Way
http://makingourway.blogspot.com

PS My favourite feature of the individual 401k is that it allows you to contribute the first $14k in earnings each year ($15k in 2006) to your account before it starts factoring in the 25% of income rule.


MM Commented on March 22, 2006

I haven't really practiced it but theortically you and your wife can put more than $56k in total every year.

http://www.pfblog.com/archives/3600_tax_strategy_for_selfemployment_income_part_4_individual_401k_introduction.shtml


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