DYK: Solo 401K

Solo 401K - 401K - Wealth Management - Financial Planning - Norfolk Wealth Management

Are you or someone you know self-employed? If so, at some point you’ve had to think about setting up a retirement plan for your business. Someone may have approached you with the idea of a SEP IRA or a similar arrangement, but did you know that you also have the option to set up your own 401k? Depending upon your situation, this might be a significant opportunity!

To understand why let’s dive a little deeper and compare.  We’ll start with the most common alternative: the SEP IRA. With a SEP IRA, the self-employed individual can make ‘employer’ contributions of up to 25% of their eligible compensation.  There’s a limit to this, though, and it’s capped out at $56,000 (as of 2019). This tends to work well for the business owner who has no employees and earns a high income with little variation from year to year. But what if someone doesn’t make as much money from the business, yet still wants to contribute a high percentage of their income?

A Solo 401k could allow that person to make contributions on two fronts:  as both the ‘employer’ and the ‘employee’. If you’re a savvy reader or particularly well-versed in this from having done this research for your own business, you might be thinking, “But, there’s still the same overall cap of $56,000, so what’s the difference?”

Let’s take a closer look with a couple of hypothetical scenarios:

Scenario 1: Jack, a 50-year old sole proprietor, is making $200,000 per year (net profit). In determining what he could contribute to his SEP IRA, he first has to reduce that figure by a certain percentage (based on IRS guidelines & formulas). For this situation, the end result is an allowable SEP IRA contribution of somewhere around $37,000 for the given year.

Scenario 2: Diane, a sole proprietor who also happens to be making $200,000 in 2019, sets up a Solo 401k. She wants to ensure that the account is funded before December 31st, so she contributes the maximum amount that she can as an employee right away – $19,000. But remember, she gets to contribute as the employer, too.  Once she has a better idea of her tax situation, she funds the account with as much as she can on the employer side.  Now, this puts the total amount just shy of the standard $56,000 limit – already a big difference! However, like Jack, she happens to be 50 years old. As is the case with other/larger 401k plans, a Solo 401(k) has an additional “catch-up” provision that allows people over 50 to contribute more.  This catch-up amount is $6,000, which effectively raises her overall funding limits, as well.

The End Result: A net Solo 401k contribution of nearly $62,000 – roughly 67% more than Jack!

Said differently, Jack funded a SEP IRA with around 19% of his income, while Diane could contribute close to 31% through her Solo 401(k).

Choosing the right retirement plan for your business can be difficult and can involve unforeseen or unintended effects. If working out these scenarios seems tricky, or if you just don’t have the time to work through all of that, it often makes sense to consult with an advisor who has experience navigating this complex landscape.  Doing so will make it easier for you to evaluate options, coordinate with your tax professional, and feel confident that you’re making the right choice for you and your business.

 

Rhett Garner, CLU®, ChFC®, CFP®
Vice President – Financial Advisor
Heritage Wealth Management Group

 

This content is being provided for informational purposes only and should not be construed as financial, investment, tax, or legal advice. The views and opinions expressed do not necessarily reflect those of the company. Always consult a licensed investment professional before making investment decisions. All investments and financial strategies involve various risks, including the possibility of loss of principal. Investment values and returns will fluctuate. There are no implied guarantees or assurances that any target objectives will be met. Future performance may differ significantly from past performance due to many different factors. The Heritage Wealth Management Group, its employees, affiliates, and associated persons shall not be held liable for losses resulting from financial decisions based on information or viewpoints presented herein.

 

DYK: Dollar Cost Averaging

Heritage Wealth - Dollar Cost Averaging - Investment Strategies - Wealth Management ProviderDollar Cost Averaging – is an investment strategy in which an investor makes purchases of an investment or group of investments with a fixed dollar amount at regular pre-determined intervals. This may sound familiar. A lot of us have used this strategy without being aware of it. Many of us have, for example, made a set dollar contribution to a 401k, IRA, or Educational Account. So, we know from experience that Dollar Cost Averaging (‘DCA’ for short) can be used to build wealth over time. But are there other reasons that someone might want to consider this strategy?

Dollar Cost Averaging can also be used to offset some of the risk associated with volatility in a particular investment, or in an overall portfolio. If this approach is implemented during a period where the investment experiences volatility, it can result in a higher average price per share than the average cost per share. Of course, that description doesn’t help us all that much, so let’s translate this into ‘human’ language through a hypothetical scenario:

To illustrate, let’s say that you bought $60,000 worth of stock in Company X on January 1st at $20 per share. When you check back in at the end of six months, the price of the stock is $14 per share. If you were to sell at that point, you would realize a loss of around 30% – or in other words, around $18,000.

Now, let’s say that instead, you made an initial investment of $10,000 and followed that up with additional purchases in $10,000 increments until you reached your full investment amount of $60,000. When we first glance at the end-of-month stock prices, the situation actually looks even worse. Those prices were: $20 (starting price), $16, $5, $12, $9, $13, and finally our end price of $14. That’s a lot of volatility! But… If we take a look at the number of shares we bought with each $10,000 investment, the situation starts to come into focus. The number of shares purchased each month were: 500, 625, 2000, 833, 1,111, and 769, respectively. That gives us a total of 5,838 shares. When we multiply that by our final stock price of $14, we are left with a market value of $81,732. That represents a roughly 36% increase over the total amount invested! You knew you were a genius for buying into Company X, and for the record, I believed in you the whole time….

Bottom Line:

Clients generally experience the most success Dollar Cost Averaging in the following two circumstances:

1.) When they don’t have a lump-sum dollar amount to invest – In this case, DCA is a great way to build in the discipline of regular contributions. It also helps some clients feel they can take on slightly more risk in their choice of investments early on.

2.) When they know their money should be invested according to their personal risk tolerance, but they also have significant concerns around the potential of a sharp, near-term decline in the market.  Put another way, when they know they need to get from point ‘A’ (not invested) to point ‘B’ (invested), but they are struggling with how to get started, given their feelings about the market. In this situation, Dollar Cost Averaging into a diversified portfolio can be a particularly effective strategy.

If you would like to have a conversation around this or any other investing-related concepts, please feel free to reach out to us at the Heritage Wealth Management Group. As always, we’ll do whatever we can to advocate and to be of service.

 

Rhett Garner, CLU®, ChFC®, CFP®
Vice President – Financial Advisor
Heritage Wealth Management Group

 

This content is being provided for informational purposes only and should not be construed as financial, investment, tax, or legal advice. The views and opinions expressed do not necessarily reflect those of the company. Always consult a licensed investment professional before making investment decisions. All investments and financial strategies involve various risks, including the possibility of loss of principal. Investment values and returns will fluctuate. There are no implied guarantees or assurances that any target objectives will be met. Future performance may differ significantly from past performance due to many different factors. The Heritage Wealth Management Group, its employees, affiliates, and associated persons shall not be held liable for losses resulting from financial decisions based on information or viewpoints presented herein.