By Dan Miller, WCI Contributor
If you own your own business or work as an independent contractor, you have access to a few different retirement savings strategies. If you're an independent contractor, you don't have a separate employer who is funding your 401(k), so if you want to save for retirement, you'll have to manage it yourself. A SEP (Simplified Employee Pension) IRA is one option, but a solo 401(k) is usually an even better way to save for retirement.
What Is a Solo 401(k)?
Solo 401(k) plans were first introduced in 2002 as an alternative way for independent contractors and the self-employed to save for retirement. With a solo 401(k), you are not limited by the annual employee contribution limits ($20,500 in 2022 and $22,5000 in 2023). Instead, you have the ability to put in the employer contribution AND the employee contribution (a total amount of $61,000 in 2022 which increases to $66,000 in 2023 or $73,500 if you're over the age of 50). If you're a sole proprietor or an independent contractor, this is probably all the same money anyways, so it's nice to be able to maximize your overall contributions.
There are rare situations where you might want to use a SEP IRA instead, so it's important to understand the differences to make the right financial decision for your specific situation.
More information here:
What to Look for in a Solo 401(k) Provider
When you're looking for a solo 401(k) provider, there are a few things that you'll want to look for to find the best fit for you:
- What types of contributions does it allow: Traditional, Roth, after-tax (aka Mega Backdoor Roth), or all of the above?
- Costs: Look at the costs to set up the plan and to maintain it and see what kind of transaction costs are there for the types of transactions you're looking to do.
- Investment options: Are you limited to basic stocks and mutual funds? Or can you invest in alternative assets like real estate, art, startups, or cryptocurrency?
- Rollovers: If you're planning a rollover, you'll want to make sure your provider supports it.
E-Trade Solo 401(k)
E-Trade is one of the original online brokerages, and it has a comprehensive solo 401(k) program. You can make traditional or Roth 401(k) contributions, and you can accept any kind of rollovers into your account. You also have the ability to take out loans from your E-Trade solo 401(k) account.
There are no fees to set up your account, and like any solo 401(k), IRS Form 5500 is generally not required until you have at least $250,000 in your account. You are subject to the regular E-Trade commissions for trades. But currently, there are no commissions for stock or ETF trades, and E-Trade also offers more than 4,500 no-load, no-transaction-fee mutual funds. Don't expect to be able to invest in alternative investments like a true self-directed solo 401(k) at E-trade.
In the past, The White Coat Investor has recommended E-Trade (among others) as a solo 401(k) provider and an IRA/Roth IRA provider.
Vanguard Solo 401(k)
Vanguard is another popular option for solo 401(k) accounts. With a Vanguard solo 401(k), you can also set up either traditional or after-tax Roth contributions. There's no fee to set up an account, but Vanguard does charge a $20 fee per year for each fund held. This fee is waived if at least one participant has at least $50,000 in qualifying Vanguard assets. Again, you won't have to fill out Form 5500 unless you have at least $250,000 in your account.
One area where Vanguard falls short of some other solo 401(k) providers is the investment options. Vanguard only allows you to choose Vanguard mutual funds as an investment option. And while there are more than 100 different Vanguard funds to choose from (including the lower-cost Admiral funds), you're out of luck if you want to invest in any individual stocks, bonds, or alternative investments. You also can't take out a loan against the proceeds of your Vanguard solo 401(k). Vanguard used to not allow IRA (including SEP-IRA) rollovers into its solo 401(k)s, but that rule was relaxed a few years ago.
Still, as noted by WCI, Vanguard is one of the best solo 401(k) providers around.
More information here:
E-Trade vs. Vanguard Solo 401(k)
If you're comparing an E-Trade and a Vanguard solo 401(k), they share a variety of similarities but also have some key differences. For most people, E-Trade will probably end up being better, since it has lower fees and more investment options. Still, if you are wanting to invest in Vanguard funds and you already have other Vanguard accounts, you might want to consider a Vanguard solo 401(k) for the sake of simplicity. Plus, Vanguard's low-cost index funds, like VTSAX and VFIAX, are considered some of the best in the business.
In recent years, Vanguard has slipped a little regarding customer service, and other low-cost brokerages like Fidelity and Schwab have seemingly caught up to Vanguard. But physicians and other high-income earners still tend to work with Vanguard, because it has a long history of providing great value for investors. We also hear complaints from white coat investors about hassles with their solo 401(k) at E-trade. You can read some of the complaints in the comments on this post about the Best Solo 401(k) Providers.
Note that none of the “off the shelf” solo 401(k) plans from E-Trade, Vanguard, Fidelity, or Schwab permit true self-direction of the investments. You can't invest in real estate properties, precious metals, small businesses, or crypto with any of them. However, there are solo 401(k)s that can do this. The WCI-recommended Retirement Account Professionals can help you design one (or help you do a study of your practice or small business to determine which retirement account is right for you). Just be aware that fees are significantly higher to get that feature. You also generally need a more custom-designed solo 401(k) to get Mega Backdoor Roth IRA contributions.
The Bottom Line
A solo 401(k) is another option for saving for retirement for independent contributors and sole proprietors. With a solo 401(k), you can make contributions as both the employee and employer up to a maximum of $61,000 in 2022 and $66,000 in 2022. You have a variety of different providers that you can choose from when looking for a solo 401(k) provider, including E-Trade and Vanguard. Make sure to compare the two options to decide which option works best for you.
If you need extra help with planning for retirement or have
questions about the best way to save your money in tax-protected accounts, hire a WCI-vetted professional to help you figure it out.
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