The dramatic sell-off across equity markets over the last couple of weeks as a result of the downgrade of U.S. debt, sobering economic news from Europe and growing trepidation among individual investors, may make thinking about saving for retirement and investing for the future nerve-racking. As difficult as it may be, it’s often best to stay the course and, if your cash flow allows it, to continue adding to your retirement accounts on a regular, disciplined basis.
These days, the menu of qualified retirement plans is vast, and it may be difficult to understand which plan makes the most sense for your unique set of circumstances. For doctors and other solo practitioners, the solo 401(k), also known as the individual 401(k), may be an appropriate option.
The biggest advantage of the solo 401(k) is the contribution limits, which are generally much higher than other qualified retirement plans, such as a SIMPLE IRA or SEP IRA, due to the way the contribution amount is calculated. Similar to a regular 401(k), you can elect to defer up to $16,500 of your pre-tax income to the plan ($22,000 if you are 50 or older). In addition, as the employer of the company, you can also make a profit-sharing contribution based upon a percentage of your earnings, for a potential total maximum contribution of $49,000 annually (or $54,500 if age 50 or older).
For example, let’s say that, as the sole practitioner of your medical practice, you have net earnings of $25,000 and self-employment income of $23,249. In this case, you would be able defer the maximum of $16,500 to a solo 401(k). You also would be able to make a profit-sharing contribution of up to 20% of your self-employment income, or $4,650. The result would be a total annual contribution of $21,150 for retirement savings.
Compare this to what you’d be able to defer with other retirement plans. Using the same scenario above, you would only be able to contribute $12,177 to a SIMPLE IRA, $4,650 to a SEP and only $2,420 to a Defined Benefit Plan.
While designed to benefit a single business owner or a self-employed individual, the solo 401(k) is actually a misnomer — the spouse of the owner, if also employed by the company, can also contribute to the plan. For a married couple, this is a tremendous advantage, and the potential for retirement savings is significant.
Certainly, for leaner years when you might need the additional cash, you likely will not contribute the maximum allowed. Under this plan, you have the ability to elect the contribution amount each year. In addition, solo 401(k) plans usually permit loans, generally up to a maximum of $50,000 — an attractive feature for any individual or couple who wants to begin saving for retirement but also prefers that some funds are available for emergency use.
Finally, an important benefit is that solo 401(k) plans are fairly easy and cost-effective to set up and administer through a provider, such as Vanguard or Fidelity. For busy professionals like doctors or physicians operating their own medical practices, the time and hassle saved by creating a solo 401(k) rather than another plan (such as a self-directed IRA which may involve creating an LLC or hiring a custodian) alone may prove to be worth it.
Thomas A. Orecchio, CFA, CFP, ChFC, CLU, AIF is principal and wealth manager at Modera Wealth Management in Westwood,NJ. From portfolio management and tax planning alternative investments and estate planning, Tom assists physicians through truly comprehensive wealth management. Mr. Orecchio can be reached at TomO@ModeraWealth.com.
Tom Orecchio examines the principles of wealth management and financial planning-from portfolio and tax management to alternative investments and estate planning-to help physicians achieve financial success.