How to Start a 401(k)/403(b) if Self-Employed

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Eligibility and Requirements

Eligibility and requirements for opening a 401(k) or 403(b) plan, especially if you are self-employed, vary based on the type of plan and your own employment status:

For a Solo 401(k):

  1. Self-Employment Income: You need to have some form of self-employment income. This could come from being a sole proprietor, an independent contractor, or owning a small business without any employees other than your spouse.
  2. No Full-Time Employees: You can’t have any full-time employees working for you if you want to establish a Solo 401(k). If you have employees, they generally must be excluded from the plan unless they are your spouse.
  3. Contribution Limits: The contribution limits for Solo 401(k)s are generally higher than traditional 401(k) plans. As a self-employed individual, you can contribute both as the employee and the employer, subject to annual limits.
  4. Filing Requirements: Depending on your plan’s assets and number of participants, you may need to file an annual report (Form 5500) with the IRS once your plan exceeds certain thresholds.
  5. Establishment Deadline: The plan must be established by the end of the business year for which you want to make contributions.

For a 403(b) Plan:

  1. Eligible Employers: Typically, 403(b) plans are only available to employees of tax-exempt organizations under Section 501(c)(3) of the Internal Revenue Code, public school systems, and certain ministers. If you are self-employed, you generally would not be eligible unless you are a minister.
  2. Ministers: Self-employed ministers can participate in a 403(b) plan if they are affiliated with a recognized religious organization and report self-employment income.
  3. Contribution Limits: Similar to 401(k) plans, there are limits on how much you can contribute to a 403(b) plan. These limits can change annually and may be higher if you have 15 or more years of service with certain non-profit or educational institutions.
  4. Catch-up Contributions: Older participants may be eligible for catch-up contributions, allowing them to save additional amounts beyond the standard limit.
  5. Investment Options: While historically limited to annuity contracts, modern 403(b) plans can also include mutual funds.

If you are considering starting a retirement savings plan and are self-employed, determining whether a Solo 401(k) or a 403(b) (if you’re a qualifying minister) is appropriate for you will depend on your specific employment situation and financial goals. It’s important to consult with a financial advisor or tax professional to ensure you meet all eligibility requirements and understand the implications of opening and contributing to one of these plans.

Investment Choices

When it comes to 401(k) and 403(b) plans, especially through a Self-Directed Brokerage Account (SDBA), you have a range of investment choices available to tailor your retirement savings to your financial goals and risk tolerance.

Here are some common investment options:

  1. Mutual Funds: These are perhaps the most common investment choice in these retirement accounts, providing diversified portfolios in stocks, bonds, or other assets managed by professional investment managers.
  2. Exchange-Traded Funds (ETFs): Similar to mutual funds, ETFs hold a variety of assets but trade on an exchange like a stock. They often have lower expense ratios than mutual funds and provide an easy way to diversify your investments.
  3. Individual Stocks and Bonds: With an SDBA, you can select individual stocks and bonds, offering more control over your investment choices compared to traditional mutual fund offerings.
  4. Target-Date Funds: These funds automatically adjust their asset allocation mix as you get closer to a specified retirement date, moving from aggressive investments to more conservative ones over time.
  5. Stable Value Funds: These are available primarily in 401(k) and 403(b) plans and are designed to provide capital preservation and consistent returns.
  6. Real Estate Investment Trusts (REITs): For those looking to include real estate in their retirement portfolio, REITs offer a way to invest in real estate without buying or managing properties directly.
  7. Annuities: Some plans allow for investment in annuities, providing a fixed income stream in retirement, though they can be more complex and have higher fees.

Each investment option comes with its own set of risks, fees, and potential returns. It’s important to research and understand each investment type and consider how it fits into your overall retirement strategy. Consulting with a financial advisor can also help guide investment decisions based on your needs and goals.

Fees and Costs

Understanding fees and costs is crucial when starting and managing a 401(k) or 403(b) plan, especially if you are self-employed.

Here are key points regarding fees and costs associated with these retirement plans:

  1. Plan Administration Fees: These fees cover the management and administrative services of the plan, such as record-keeping, legal, and trustee services. They can vary widely based on the provider and the complexity of the plan.
  2. Investment Fees: This is often the largest component of plan costs, covering the management of the investments within your plan. They are usually represented as a percentage of assets under management (AUM), including management fees, fund expense ratios, and other investment-related expenses.
  3. Individual Service Fees: These fees are charged for optional features offered by the plan, such as loan origination fees, fees for executing individual trades within an SDBA, or fees for receiving personal investment advice.
  4. Sales Charges (Loads): Some investment options, particularly mutual funds, may come with sales charges. Front-end loads are charged when you buy shares, while back-end loads are charged when you sell shares.
  5. Custodial and Maintenance Fees: These fees are for the upkeep and safeguarding of the securities in the plan. Some providers charge annual maintenance fees for your account, which can vary based on the balance and type of investment.

Reviewing and understanding all the fees associated with your 401(k) or 403(b) plan is important, as they can significantly impact your investment returns over time. Lowering your fees, even by a small percentage, can substantially increase your account balance by the time you retire. Always ask for a full disclosure of all fees and compare different plans and investment options to find the most cost-effective solution for your retirement savings.

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Rollovers and Transfers

Understanding rollovers and transfers is essential when managing your 401(k) or 403(b) plan, especially if you’re considering changing jobs, retiring, or consolidating your retirement accounts. Here’s what you need to know:

  1. Rollover Options: When you leave a job or retire, you have several options for your existing 401(k) or 403(b) funds. You can leave the funds in your former employer’s plan, roll them over into a new employer’s plan, roll them over into an Individual Retirement Account (IRA), or take a cash distribution (which may result in taxes and penalties).
  2. Direct vs. Indirect Rollovers: A direct rollover involves transferring your retirement funds directly from one account to another without you taking possession of the funds. This method is preferable as it avoids taxes and penalties. An indirect rollover means the funds are paid to you first and then you deposit them into another retirement account. You must complete the transfer within 60 days for indirect rollovers to avoid taxes and penalties.
  3. Transfer Rules: Transfers between like plans, such as 403(b) to 403(b) or 401(k) to 401(k), are typically straightforward and not subject to tax. However, transferring funds from 401(k) to 403(b), or vice versa, may have certain restrictions or tax implications depending on the plan rules and IRS regulations.
  4. Consolidating Accounts: If you have multiple retirement accounts, consolidating them into a single account can simplify your financial management and potentially reduce fees. However, it’s essential to consider each plan’s investment options, fees, and features before consolidating to ensure it’s in your best interest.
  5. Professional Advice: Consult with a financial advisor or tax professional before making rollovers or transfers. They can help you understand the tax implications, decide the best option for your situation, and ensure the process is completed correctly to avoid unintended penalties or taxes.

Comparisons with Other Retirement Accounts

When comparing a 401(k) or 403(b) with other retirement accounts, it’s important to consider several factors to determine which is best suited to your financial situation and retirement goals.

Here’s how these plans stack up against other popular retirement savings options:

1. 401(k)/403(b) vs. IRA (Individual Retirement Account):

  • Contribution Limits: 401(k) and 403(b) plans typically allow for higher annual contribution limits than IRAs.
  • Employer Match: Many 401(k) and 403(b) plans offer employer matching contributions, which IRAs do not.
  • Investment Options: 401(k) and 403(b) plans usually have a more limited selection of investment options than IRAs.
  • Tax Treatment: Both types of accounts offer traditional (pre-tax) and Roth (after-tax) options, but the specifics of tax treatment can vary.
  • Early Withdrawal Penalties: Both accounts typically impose penalties for early withdrawals before age 59½, with certain exceptions.

2. 401(k)/403(b) vs. SEP IRA (Simplified Employee Pension):

  • Intended For: SEP IRAs are intended for self-employed individuals or small business owners, whereas 401(k) and 403(b) plans are generally for employees of larger organizations.
  • Contribution Limits: SEP IRAs allow for higher contributions than traditional IRAs but are usually less than 401(k)/403(b) maximums.
  • Employer Contributions: SEP IRAs are funded solely by employer contributions, while 401(k) and 403(b) plans can be funded by both employee and employer contributions.

3. 401(k)/403(b) vs. SIMPLE IRA (Savings Incentive Match Plan for Employees):

  • Employer Size: SIMPLE IRAs are designed for small businesses with fewer than 100 employees, while 401(k) and 403(b) plans can be used by companies of any size.
  • Contribution Limits: SIMPLE IRAs have lower contribution limits than 401(k) and 403(b) plans.
  • Matching Contributions: Both SIMPLE IRAs and 401(k)/403(b) plans may offer employer matching, but the specifics can vary.

4. 401(k)/403(b) vs. Solo 401(k):

  • Intended For: Solo 401(k)s are designed for self-employed individuals with no employees other than a spouse, while 401(k) and 403(b) plans are for employees of organizations.
  • Contribution Limits: Solo 401(k)s allow for high contribution limits, similar to standard 401(k) plans, including both employer and employee contributions.
  • Flexibility: Solo 401(k)s offer a high degree of flexibility in contributions and can include a Roth option, similar to a standard 401(k).

5. Roth IRA vs. Roth 401(k)/403(b):

  • Income Limits: Roth IRAs have income limits for contributions, while Roth 401(k) and 403(b) plans do not.
  • Contribution Limits: Roth 401(k) and 403(b) plans have higher contribution limits than Roth IRAs.
  • Withdrawals: Roth IRAs offer more flexible withdrawal options than Roth 401(k) and 403(b) plans.

When deciding which account is best for your needs, consider factors such as your employment status, income level, retirement goals, and whether you have access to employer-sponsored plans. Each account type has unique features, tax benefits, and limitations, so aligning your choice with your personal and financial situation is important.

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