Solo 401(k)s Pack a Retirement Punch

Let's look at how the various options break down for an unincorporated, self-employed individual with $70,000 in income:

Retirement Options Benefits of going solo Plan Salary deferral allowed Profit sharing allowed Total Solo 401(k) $16,500 $14,000 $30,500 SEP IRA $0 $14,000 $14,000 SIMPLE IRA $11,500 $2,100 $13,600 SOURCE:

Let's assume this person is single, and that after non-retirement deductions, she has an adjusted gross income of $60,000. Making the maximum $30,500 contribution to a solo 401(k) would significantly reduce her taxes. Without a retirement account, this taxpayer would owe $11,605. But by contributing the maximum, her tax bill drops to just $4,425, in part because it lowers her tax bracket. An extreme and simplified example, yes, but the premise works at other income levels too.

Sadly, no retirement plan will lower your self-employment tax. The IRS collects 15.3% of your business profits, prior to deductions, to cover Social Security and Medicare.

When a solo 401(k) is not for you: If you've got employees beyond you and your spouse, you can't open a solo 401(k). If you plan to hire people soon, you may want a SIMPLE IRA, because you could keep the same plan as the business grows, though you'll have to provide contributions for employees. The SEP IRA may be better for high-income individuals -- those who make enough to contribute the maximum $49,000 as profit-sharing. In 2009, that would be $245,000 in an unincorporated business, or $196,000 in a corporation.

Who provides solo 401(k) plans? Portland, Oregon-based 401khelpcenter.com features a list of providers. The list, last updated in 2008, includes more than 100 firms, ranging from local mom-and-pops to well-known public companies such as Fidelity, Fifth Third Bank(FITB Quote), The Hartford(HIG Quote), Legg Mason(LM Quote) and Charles Schwab(SCHW Quote). When opening a solo 401(k) plan, consider each provider's fees and investment choices.