401k Options for Small Businesses

I work a 9-5 job that offers a typical 401k program. Over the last couple years I've realized that I don't want to work until I'm 67 or whatever the retirement age will be when I decide to hang em up. Therefore, I've become really aggressive with my 401k account and am on pace to make the maximum contribution this year. If you're in a similar situation as me, I highly recommend maxing out your account also. It's tax deductible and with a low cost portfolio that's based on index funds you'll be well on your way to a solid return rate.

By the way, I'm a huge fan of index fund investing. If you're new to investing, I highly recommend reading a A Random Walk down Wall Street: The Time-tested Strategy for Successful Investing. Its breaks things down easily and promotes a low-cost passive index fund investing strategy.

My wife does not work a 9-5 gig. She's the owner of a San Diego based marketing agency and primarily operates solo. What can she do to make sure that she's set up nicely in the future? A traditional IRA and Roth are good options, but they are limited to income and only allow contributions of $5,500 per year. We were looking for more more than that. Fortunately there are lots of tax optimized options!

Here are the options we looked. These work for Sole Proprietors, or S-corps with no full time employees other than a spouse. We have Vanguard accounts and are really happy with the service and low cost options, so I exclusively looked at what they offered.


Who is it for: Sole proprietors, partnerships, C corporations, S corporations

Details: Works very similar to a traditional IRA in that you'll be allowed a tax deduction for any contributions and distributions will be taxed when they are taken.

Contribution Limits: Up to 25% of net earnings minus 1/2 of self employment tax deduction, up to a maximum of $54,000

Investment Options: Can be invested just like a normal IRA. Vanguard mutual funds, plus ETFs and individual securities through Vanguard Brokerage Services

Simple IRA

Who is it for: Sole proprietors, partnerships, C corporations, S corporations. Must have less than 100 employees

Details: Again this will work just like a traditional IRA, just with different contribution limits.

Contribution Limits: Employee can contribute 100% of salary up to $12,500 ($15,500 if over 50) and employer may contribute up to 3% of net profit minus self employment deduction.

Investment Options: Vanguard mutual funds

Individual 401k

Who is it for: Sole proprietors, partnerships, C corporations, S corporations. Must have no employees other than a spouse.

Details: Works very similar to a 401k through an employer EXCEPT you can contribute as BOTH an employee and employer.

Contribution Limits: Employee can contribute up to $18,000 ($24,000 if 50 or older) and employer can contribute 25% of the business profit minus 1/2 of your self employment tax deduction.

Vanguard also lets you set this up as a ROTH option (tax upfront).

Which one is best?

For example: Let's say you run a business by yourself with no employees other than your spouse. AND you're under 50 years old.

Net Profit after subtracting self employment deduction: $100,000

Maximum Contributions:

SEP IRA: ($100k x 0.25)= $25,000

Simple IRA: $12,500 + $3,000 = $15,500

Individual 401k: $18,000 + $25,000 = $43,000

With Vanguard all of these have relatively low annual fees, coming in around $20 per year. With that being said, in this case we went with the Individual 401k option.

Opening an account was fairly straight forward, although they did require you to call in to open an a small business account. The Vanguard representative was very friendly and knowledgeable and the phone call lasted under 20 minutes. I continue to be impressed with Vanguard and feel comfortable knowing that our future is with them.

As always, make sure to consult with your CPA and/or Financial Planner before investing.

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