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Solo IRAs, 401Ks and Other Options for the Self-Employed
By Adam D. King Platinum Quality Author
 

Solo IRAs and 401Ks are good choices for the self-employed, but opening a Roth IRA might also be a good idea. There are advantages and disadvantages to each type of account, as well as differences in the applicable tax laws. Here's a brief overview.

First, to avoid confusion later, let's look at what these accounts are sometimes called. The Solo 401K is sometimes referred to as the Solo K or the self-employed 401K.

On your federal income tax return, Solo IRAs are listed as SEP-IRA, an abbreviation for simplified employee pension. Brokers that offer the account may simply call it an SEP.

Solo IRAs can only be the traditional type (not a Roth), but you can have a separate Roth, whether or not you are self-employed. All the names can be confusing, so for the sake of clarity in this article, you will only see the terms solo IRAs, solo 401Ks and Roth.

Solo IRAs allow tax deductible contributions. Regular income taxes are paid on disbursements after you reach retirement age. The paperwork is very simple and most brokers can handle the account.

Tax rules regarding solo 401ks are similar to solo IRAs, but the limit for yearly contributions is higher. There is more paperwork, so only a few brokerages offer the solo 401K.

The tax advantages to a Roth are different. Contributions are not tax deductible. You pay income tax during the tax year that you made the contribution. But, (and this can be important) distributions are not taxed. So, when you retire, the money that you take out of your Roth is not taxed. In addition, gains or profits within the account are tax free.

Anyone can open a Roth. Only self-employed people and business owners (with or without employees) can open solo IRAs. The solo 401K is only an option if you are self-employed and have no employees, other than yourself and your spouse. You can hire contractors, but if you have an employee that gets a W-2, you cannot open a solo 401K.

Maximum allowable contributions change with each tax year, but solo IRAs and 401ks have the highest maximum, currently over $100,000 per year for a couple, based on a percentage of your income or company profits. With a Roth, the maximum yearly contribution in 2008 is $10,000 per couple.

So, if your income is high or you want tax deferred income, then solo IRAs or 401ks are the way to go. If your income is lower or you would rather pay your taxes now and pay no taxes later, then a Roth is the way to go. Or, you can do a little of both.

If you have both, there are maximum yearly contributions that you can make all of your accounts combined. Your accountant or tax preparer can give you the details on that.

One expert suggestion is to convert solo IRAs into Roth accounts. That way, you get the immediate tax break and tax free disbursements.

While opinions vary, many experts feel that the flexibility and tax free disbursements of the Roth will lead to more money at retirement. Another advantage is that principal deposits can be withdrawn before retirement age, without paying penalties or income taxes.

In order to have the most flexibility, you want to look for a brokerage that offers self-directed accounts of all three types. You also want a broker that allows their clients to invest their retirement funds in things other than stocks and bonds.

Real estate, for example, is becoming more popular as a tool to grow retirement accounts quickly. In today's economic environment, you need to be able to diversify, if you want a comfortable future.

Self-directed solo IRAs may be a little more difficult to find, but down the road, you will be glad that you went to the effort. One brokerage that offers all types of accounts and options to their clients is Equity Trust.

There are also advisors that can help you find real estate deals. With the right deal, it is possible to double or triple your initial contribution in a relatively short period of time. And, remember that profits made within solo IRAs are not subject to capital gains taxes.

As a self employed person, you worry about taxes and profits, but you need to plan for your retirement, either with solo IRAs, 401ks, a Roth or another plan. So get some help and choose the one that's right for you.

 
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