After becoming self-employed, one of the most difficult adaptations we needed to make was learning how to save for retirement. Most regular jobs offer retirement programs as a benefit to employment. We simply signed a form, had money deducted from our paychecks, and our retirement savings was basically taken care of. Being the retirement savvy individuals we are, we also tried to maximize our retirement savings through individual accounts like a Roth IRAs and other investments.

But, once we make the leap to self-employment, those company benefits were gone. There was no company sponsored retirement plan set up, waiting for us to join. There’s no more company match to help us save even more. Our retirement savings became our problem, and ours alone. It was all on us now.

Luckily, when you’re self-employed, there are a wealth of wonderful retirement savings options available. In addition to Traditional and Roth IRAs, you can take advantage of SEP IRAs, SIMPLE IRAs, and even Solo 401(k) plans. All of these allow you to save money for retirement while reducing the amount of money you owe in taxes. And, as long as you have some self-employment income to report, anybody with a side gig can take advantage of these plans.

So, what option did we choose? Let’s explore!

Retirement, Self-Employment Taxes, and More

When we first started making substantial blog and freelance income, we decided to open our own LLC. This helped us protect our personal assets from our business assets, plus it helps us kept business and personal funds separate. At the time, we elected for the LLC to be taxed as a partnership because a) It was less paperwork and headache, and b) We didn’t know any better.

After Holly quit her job, we needed to find a way for her to save for retirement. After looking at some different options, we initially settled on the SEP IRA. Without getting too much into the logistics, a SEP IRA allows you to contribute up to 25% of your W-2 income – which equals 20% net of self-employed income – in your retirement plan. Savings are tax-deferred, and the 2016 contribution limit for a SEP IRA is $53,000. It’s a really simple plan to open and operate, and it worked well for us.

Fast forward a couple of years, and we started making considerably more money from our business. That meant paying a butt-load  more in self-employment taxes. (That’s legit IRS jargon, BTW.) You see, when you work for yourself, it’s not just retirement you have to take care of. You also have to pay all of your own taxes.

Limiting our Tax Liability

Most people don’t realize that they only pay for half of their FICA taxes from their own paycheck. Their employer pays the other half of the Social Security and Medicare taxes. When you’re self-employed, that means paying an additional 7.65% in taxes to cover the total self-employment tax of 15.3%. That’s in addition to the income tax you pay.

As our self-employment taxes grew, we started looking for ways to reduce our tax liability. The first we did was reconfigure our business to operate as a LLC taxed as an S-Corporation. The short story is that we were now required to pay ourselves a monthly salary. While we’d effectively pay self-employment tax on our salaries, the rest of our company profits are available to be taken as distributions. That money is still subject to income tax rules, but not self-employment tax.

Electing S-Corp taxation status was great, but we knew there were more ways to save. We talked to a few of our friends and discovered that we could save even more in taxes by changing how we saved for retirement. By switching from a SEP IRA to a Solo 401(k), we had the ability to save gobs of money for retirement while reducing our tax burden even further. That sounded great to us, and we jumped on the opportunity.

Solo 401(k) Features

So, what makes a Solo 401(k) such a great retirement savings option for self-employed individuals? With a Solo 401(k), also known as an Individual 401(k), you can sock away considerably more money in tax-deferred retirement savings. Here are some of the plan’s key features:

  • Employee and Employer Contributions – You can choose to make either employee or employer contributions (or both) to the plan.
  • Tax-deferred Savings – Employee contributions are tax-deferred. So, as an employee of my own company, I withhold pretax money from my paycheck. The money I put into our Solo 401(k) decreases my income tax liability now and will be taxed once I start withdrawing the money during retirement, ideally at a lower income tax rate.
  • Save Up to 100% of Income – Employees are allowed to contribute up to 100% of their W-2 income to the plan, capped at $18,000  in 2016 (or $24,000 if you’re above age 50).
  • Profit Sharing of 25% – Here’s where some of the biggest savings come in. Your business is allowed to contribute up to 25% of the employee’s (your) W-2 wages as profit sharing, but the total contribution per year is capped ($53,000 in 2016).
  • Withdrawals – As with most tax advantaged retirement plans, you can begin taking withdrawals without penalties after age 59 1/2. You’re also allowed to take a loan from your Solo 401(k), although I never plan to do that.
  • No Employees – Solo 401(k) plans are only available to self-employed persons and their spouses. The business can not have any employees.

Where to Open a Solo 401(k)

For us, a Solo 401(k) seemed like a no-brainer. So, we looked at several different online investment brokers to see what our options were. In the end, we came back to where we started. We decide to open our Solo 401(k) with Vanguard. And in case you were wondering, we’re not paid by Vanguard in any way to say that. #notaffiliatelinks

We already had several different investments with Vanguard and had been very happy with them. We love their low fees and have never had any issues with any of our investments. Plus, we are pretty boring when it comes to our investments. We prefer to stick our money mostly in index funds and let the market work its beautiful compounding magic!

The onboarding process at Vanguard is pretty easy. You’ll receive about 115 pages of documents, but the only thing you really need are the forms. Personally, I chose to have them mailed to me, but you can also download them online.

Why we use Vanguard for our Solo 401(k)

Here’s what the Solo 401(k) packets look like.

You’ll be required to open your new Individual 401(k) using the Authorization Form and the Individual 401(k) Plan Adoption Agreement. After that you’ll the Individual 401(k) New Account Form to open accounts for you and your spouse. You may also wish to complete the Salary Reduction Agreement for each employee to keep your files legit. Simply complete the forms and mail them to Vanguard (minus the Salary Reduction forms).

The whole process takes about 30-45 minutes, and your new Solo 401(k) will be up and running in a matter of days. If you need help, you can call 800-376-9162.

5 Benefits of a Vanguard Individual 401(k)

There are a number of different companies offering Solo 401(k) plans, but we decided to stick with Vanguard. Here are a few reasons why.

  1. Low Expenses – According to Vanguard, their average expense ratio is 82% less than the average. Personally, our annual operating expenses are 0.16%, which I’m thrilled with.
  2. No Setup Fees – There are no fees to set up the Solo 401(k) through Vanguard.
  3. Multiple Investment Choices – With Vanguard’s Individual 401(k) plan, you have access to more than 100 different investment choices. We tend to keep things simple and use mostly target date funds, but you can choose whatever you like.
  4. Easy to Open and Manage – As I mentioned, we’ve used Vanguard for several other investments and we like how easy the entire process is. Now that the account is open, we just log in once a month to make an electronic transfer. The money is then transferred to the Solo 401(k), and we’re done!
  5. More Tax Savings – Although the advantages of using a Solo 401(k) aren’t limited to Vanguard, we are stoked about how much money we’re allowed to save for retirement each year. The $18,000 per person plus the 25% profit sharing – considered at business expense – helps us save for retirement while reducing our tax burden. It’s huge!
Why we use Vanguard for our solo 401k

Adding funds is easy! Here’s what you’ll see when you’re ready to make a contribution to your new plan.

Disadvantages of Vanguard Individual 401(k)

A Vanguard Individual 401(k) may not be right for everybody who is self-employed. If you don’t have much investing experience, or if you prefer a lot investment Being self-employed means paying for your own retirement. With several good options to choose from, we went with a Solo 401(k). Here's why.advice, Vanguard probably isn’t the right place for you. Investing with Vanguard is DIY. It requires you to do your own research and make all of your own decisions. So, if you need more advice, you might want to speak to an investment professional or go with another plan through a company like Wealthfront.

If you’re trying to decide what type of retirement account to open, keep in mind that you can’t use a Solo 401(k) if you have employees. If you employ others or are planning to hire employees in the near future, you may want to look into other types of retirement accounts.

Furthermore, if you aren’t making a lot of self-employment income, a Solo 401(k) may be more trouble than its worth. You could find other retirement savings plans that are simpler and structured in a way that might actually save you more money. Personally, I’d start really considering the switch once you hit about $100,000 a year in self-employment income, but everybody’s situation is different. We spoke to several friends and an accountant before we made the leap, and highly suggest you do the same.

Loving our Solo 401(k)

Switching to a Solo 401(k) was a great financial move for us. It’s allowed save thousands of dollars more toward retirement while reducing our tax liability at the same time. Frankly, it is one of the best financial decisions we’ve made.

Are you self-employed? What type of retirement savings vehicles do you prefer? Let us know in the comments below!