Now that I’m not working for an employer other than myself, I no longer have the benefit of investing part of my salary in a company-managed 401(k), and I also no longer have the benefit of the employer-matched contribution. I’ll miss the 100% return on the first 4% of my pay. Before leaving my day job, I researched my options for replacing my employer’s 401(k), and after carefully considering my choices, I decided to open an Individual 401(k) to accompany my already-existing SEP IRA.
Deal of the Day: Earn 1.05% APY on an FDIC-insured savings account at Synchrony Bank.
Benefits of an Individual 401(k)
There are two types of contributions that an Individual 401(k) — also called a Solo 401(k) — can take: employer’s contributions and employee’s contributions. There are slightly different rules for sole proprietors than there are for corporations. Since my business is a corporation, the maximum employee contribution is $16,500 or up to 100% of compensation, whichever amount is lower, just like a regular 401(k). This contribution, combined with the employer contribution, have a maximum of $49,000.
For tax purposes, the employee contributions are taken before they income is taxed and reduce the income of the employee, while the employer contributions are deducted from business income.
For me, choosing Vanguard for the Individual 401(k) made sense. Their low-cost Admiral shares will, if one believes the principle of investing in index funds and a buy-and-hold strategy, provide the best returns by the time I “retire.” There is an annual maintenance fee of $20 for the account per participant, but that fee is waived if you qualify for Vanguard’s Voyager Services. Once you have $50,000 at Vanguard across almost any type of account, you qualify for the eliminated fees with Voyager Services. In fact, if you have more than one employee, it only takes one employee to qualify for Voyager Services to fees to be eliminated for all participants.
Update: I signed up for Admiral shares in my Individual 401(k), but it turns out they are not available. Apparently, Vanguard does not want to offer Admiral shares in Individual 401(k) accounts because it would amount to unfairness between highly-paid employees and those who are not. Vanguard offers Admiral shares to encourage customers to move more money, but in situations where Vanguard is a an employer’s choice, rather than an individual’s choice, they want all employees to have a level playing field. (I would argue that they should offer the lower cost option to all employees if they want equity among various income levels.)
Although I chose Vanguard, many popular brokers offer Individual 401(k)s. Fidelity and T. Rowe Price are two low-cost options as well. My brick and mortar bank offered me the option when I visited the other day to talk about my business checking account, but I was not happy with their investment options and fees.
The opening process
Establishing a new Individual 401(k) is not as simple as applying for a savings account online, however. Visit the Small Business section of Vanguard’s website and locate the information on the Individual 401(k). There is a link to download the Individual 401(k) Kit for Employers. This is a PDF document that contains all the forms you need to establish a new Individual 401(k) for your business as well as accounts for any participants. The forms cannot be submitted online.
Here is what the kit includes:
- Individual 401(k) Plan Adoption Agreement. This establishes the Individual 401(k) plan from the employer’s side.
- Individual 401(k) Plan Authorization Form. This form informs Vanguard who will have access to make decisions about the 401(k) on the company’s behalf. Although Vanguard includes an attachment with this form as required by law, do not complete the Attachment A. If you complete the attachment and include it with your paperwork, Vanguard will not be able to establish or amend your plan as necessary.
- Individual 401(k) New Account Form. I am my only employee, so I completed this form to establish the employee side of the Individual 401(k). If there were other employees, I could copy this form, have all employees provide their own information, and include the completed forms in the package.
When all forms are complete, just send the package back to Vanguard, to the address provided multiple times within the collection of forms. Not long after Vanguard receives the information, the brokerage will provide more information about how to contribute to your Individual 401(k). It took me longer than I wanted to get around to completing the forms, but it was much simpler than I imagined. You will be able to establish recurring contributions for the employer as well as the employees.
Accessing your Individual 401(k)
Vanguard has a separate website for small business customers. While I can view my Individual 401(k) using the normal user name and password I’ve had established for years, the Individual 401(k) requires me to establish a new user name and password for the small business side. All contributions, both employer and employee, will need to be established using this alternate user name. I don’t particularly like having two separate user names for the same brokerage.
After Vanguard processed my paperwork and established my account, I received an email to link my new participant account. Logging in was a frustrating process at first because I did not know that a new user name was necessary. The small business website rejected my user name, and I called customer service for help. The representative was able to explain the above to me, and I established my account. Furthermore, you cannot be logged into the individual investor side of Vanguard.com and later log into the small business side. You must clear your browser’s cookies in order for the login to work properly.
Contributing to the Individual 401(k)
Like many businesses, it will be difficult for me to predict what my business income will be for 2011, and will therefore prevent me from knowing exactly what my personal income will be. While it’s usually better to invest as much as possible at the beginning of the year, this unpredictability leads many businesses to contribute to these plans at the end of the year. I’ll be investing throughout the year, month by month, once I determine each month’s income.
Updated October 21, 2015 and originally published February 4, 2011. If you enjoyed this article, subscribe to the RSS feed or receive daily emails. Follow @ConsumerismComm on Twitter and visit our Facebook page for more updates.