Case Study: Contractor By Day, Solo 401k Investor By Night

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A Nabers Group Solo 401k retirement plan is ideal for independent contractors. A Solo 401k works for anyone self-employed without employees. It could be an online retail website or just as easily a blog writer that works as an independent contractor writing blogs for other businesses. Independent contractors are mysterious workers who seem to have all the freedom in the world because they “work for themselves.” They also deserve to have a retirement plan although they don’t have an employer funding it and managing it for them. Part of that freedom is being able to choose your own investments and manage your own Solo 401k!  Check out our case study below to get into detail.

Freelance writers are one example of independent contractors who write articles to sell to publications. Another good example is real estate agents who work under a broker for commissions in exchange for facilitating the sale. The list of independent contractors is almost endless but others include photographers, electricians, plumbers, florists, accountants, auto mechanics, subcontractors of many types, auctioneers, etc.

Retirement Plans for Independent Contractors

According to a Forbes article, 13% of the US workforce consists of independent contractors. This percentage continues to grow, both because employers are reluctant to add permanent headcount and employees are seeking more flexible, self-directed work arrangements.

Are you already or thinking about becoming a part of this growing demographic? If so, there is a great retirement plan for independent contractors. The three most common retirement plans for freelancers and independent contractors are the Solo 401k (aka one-participant 401k), IRA (aka individual retirement arrangement), and the SEP IRA (aka simplified employee pension). However, the Solo 401k has important advantages over the other two. Specifically, in how and how much you can contribute annually to each account type.

The maximum annual contribution is periodically increased to account for inflation with the IRA being the most restrictive. In 2021, the IRA contribution limit is $6,000 ($7,000 if you’re age 50 or older). That’s paltry compared to the Solo 401k that in 2021 allows contributions up to $58,000 ($64,500 if you’re age 50 or older). The Solo 401k also has other highly desirable benefits not available with an IRA such as being able to borrow up to $50,000 from your retirement fund. 

SEP IRA

The SEP IRA does allow higher contributions than a traditional IRA but still doesn’t offer everything that comes with a Solo 401k. For instance, an employer can contribute 25% of each employee’s pay to a SEP IRA. The maximum contribution to a SEP IRA is $58,000 in 2021. There is NO catch-up contribution in a SEP IRA. There is also an important difference in how you can make contributions to a SEP IRA or a Solo 401k.

The Solo 401k allows contributions from both your salary as an employee and contributions from your business as your own employer. This allows tax write-offs for the employer portion and tax deferrals for the employee portion. On the other hand, a SEP IRA is only eligible for employer contributions. That means that although the SEP IRA allows contributions as generous as a Solo 401k, there is less flexibility in how you can fund the contributions and the tax advantages available to you.

Knowing that, let’s look closer at a Solo 401k example for an independent contractor.

Blog Writer Solo 401k Case Study 

When considering this example, keep in mind that the job of blog writer is just an example of a job title. This just as easily applies to other individual contractors like an Uber driver, a DoorDash courier, or someone running a small welding shop out of their garage. A Solo 401k is available to anyone running a business without employees. (Note: there is an easy way to hire help if you need it by hiring other contract workers that are not your employees.)

Jim has been a blog writer for eight years. He started out writing blogs about his favorite hobby of white-water rafting. He was picking up a few bucks by allowing Google Ads on each of his blogs, but it only amounted to a little pocket money. Still, he enjoyed writing about what he loved to do and with a little practice became good at writing his blog in ways that attracted decent ad revenue. 

Jim also wasn’t very happy with his day job as an insurance adjuster dealing with accident claims all day that involved people irritated that they had been in a car accident and had to wade through the paperwork and hassles of filing a claim. His happy days at work were far and few between. After another day of listening to and working with three irritate clients, he decided enough was enough.

Jim Creates a Plan

Jim knew that he couldn’t just quit his day job without having something to fall back on. He also knew that he had started to earn decent money with his blogs now that he had learned the formula for search engine optimization and keywords that advertisers are happy to pay more for. He had also learned that online businesses needed to crank out a few blogs a week with relevant content to attract more customers. Jim thought he might be able to earn a decent salary as a blog writer. He knew that others were. 

When he looked further into it, he found the website UpWork where he could connect with businesses looking to hire professional blog writers. He didn’t quit his day job immediately, but he did start writing professional blogs in the evenings and on weekends. Faster than he thought it would happen, he had half a dozen repeat clients that he was writing blogs for. He realized that he could quickly take on more clients if he became a full-time blog writer… so he did. He quit his miserable job as an insurance claims adjuster.

It turned out that three of his blog gigs were writing about real estate. Jim quickly learned a lot about the real estate investing world from his blog research. He also learned about using a Solo 401k to invest in real estate for a retirement plan (which he was no longer funding after quitting his day job). All the pieces to his gig work were falling in place.

Jim Opens a Solo 401k

Jim set up his Solo 401k plan with Nabers Group. The online setup took about 10 minutes. Nabers Group provided a new tax ID number for Jim’s 401k plan and provided the documents that he spent about two hours to complete for his new retirement plan. With that, he was ready to fund the plan and begin investing in real estate. 

Rolling Over Funds – Jim used our unique software to type in his retirement plan details and received a customized rollover packet. Jim rolled over his entire 401k from his old job into his new Solo 401k fund. (Note: you can roll over other existing retirement funds such as an IRA, a 403b, TSP (Thrift Savings Plan), Defined Benefit Plan, 457b, and more). 

Jim’s wife is still employed at her current firm, therefore she can’t roll over the current employer 401k. However, she’s considering rolling over a past employer 401k plan. She’ll probably do this if she starts working in Jim’s blog writing business because a spouse can be the only other employee in a Solo 401k plan. 

Jim’s immediate contribution to the Solo 401k amounted to $180,000. The transfer included opening a bank account in the name of his Solo 401k trust. He deposited the rollover into the 401k trust bank account and now had complete checkbook control.

Finding the Real Estate Deal

Jim had already learned about real estate investing from his blog writing but now was the time to find an investment property. His plan was for about a $200,000 property and he’d use a non-recourse loan for a mortgage. There is no personal guarantee with a non-recourse loan. The only recourse in the case of a default is to take the property in question. No other assets from the Solo 401k or personal funds are affected as a part of the investment.

Jim decided on a turnkey investment property company that had great reviews. The company specializes in working with self-directed retirement accounts and already had non-recourse lending built right into the deal. Jim and his wife looked at photos of several properties and reviewed the numbers. The due diligence process helped them identify a deal right for their portfolio and risk tolerance.

Completing the Investment

Because the non-recourse lending was already built into the deal, Jim saved a step in finding a hard money lender, bank, or private lender for a loan. Jim and his wife chose the property they wanted and signed the paperwork. The property costs $200,000 and Jim put down 40% to qualify for the non-recourse loan. He invested $80,000 of his own money and the remaining $120,000 will be a mortgage in the name of the Solo 401k trust. Jim still has about $100,000 in his Solo 401k to look for another investment.

The property is titled in the name of his 401k trust. Just like the bank account, the closing paperwork uses the tax ID number for the Solo 401k trust. Jim sent a wire from his 401k trust bank account to the closing table. After the closing paperwork was signed, the deal was done!

Rent Checks on Repeat

A property manager handles the day-to-day operations for the investment. The property manager finds and screens tenants as well as collects the rent. Jim also arranged for the property manager to pay the mortgage payment to the non-recourse lender. The rent check arrives in his Solo 401k trust bank account every month. Any expenses or repairs on the property are paid with 401k trust funds. This way, the retirement funds remain separate from his personal funds.

All expenses and repairs on the property are done by a third party, usually hired by the property manager. Furthermore, this avoids any prohibited transaction from the account holder doing “work” on the property owned by the trust.

Above all, the investment property provides growth for Jim’s Solo 401k retirement plan. He continues receiving cash flow income from the property and the investment is appreciating in value. Remember, Jim funded his Solo 401k from an initial rollover totaling $180,000. He spent $80,000 to buy their first property and still has $100,000 to invest in more property or other investments. Along with the rental income adding to his retirement account every month, he expects the property to appreciate significantly in value as long as he owns it. 

Jim thinks it’s reasonable for his Solo 401k to double or triple in value over the next five to seven years (all tax-deferred). He will also continue to contribute new money to the Solo 401k from his earnings as a blog writer. Once the cash flow stream is big enough, Jim plans to continue making several more investments! 

With a super-charged retirement plan and 20 years remaining before he plans to retire, Jim and his wife are now planning to retire wealthy!

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