Your retirement years are called the golden years for a good reason. You spend most of your life working (and hopefully saving) while dreaming of what life would be like if you had all the time and money to do precisely what you want. Here we look at how you can fund big retirement dreams with small incremental savings by including a Solo 401k in your planning.
If you could choose your own adventure, what would it be? Taking a foodie tour through Europe, retiring on a beach, and becoming a late-in-life surfer? It’s sure fun to think about. To turn your dreams into reality, you must start today with a financial vision and plan for your real-life retirement tomorrow.
Does Your Retirement Plan Include a Solo 401k?
One of the best things about retirement is that it can be an opportunity to rethink just about everything in your life — from the way you spend your time to where you choose to live.
If you don’t have a detailed retirement plan that includes a realistic estimate of your retirement income (from your 401k investments, pensions, and Social Security), now is the time to do those calculations.
The truth is that most people working today will not receive a corporate pension as part of their retirement funding. Millennials and others in the workforce are much more dependent on 401ks for their golden years. Since that is the way it is, you need to know the rules governing 401ks. Importantly, you need to know that you can contribute to more than one 401k in the same tax year. In fact, contributing to both a Solo 401k and a day job 401k will dramatically impact both your savings and taxes in a positive way.
You can have a Solo 401k and a regular 401k. If you have a day job and you also run a small business on the side, you can have a retirement account at both jobs. The IRS allows workers to contribute to multiple retirement accounts if they have more than one job. You can have a traditional 401k at your day job and a Solo 401k for your small business. In this case, you can increase your retirement savings while at the same time reducing your tax bill for the year.
Per the IRS, there are two 401K contribution limits:
- More commonly known is the $20,500 employee tax-deferred contribution limit for 2022
- Lesser known and often misunderstood is the $61,000 overall contributions limit for 2022; this is the combined employee and employer’s contributions.
If you are only familiar with a corporate 401k through your employer, you probably have no idea that the allowable tax-deferred contribution limit is anywhere near that high. The little-known secret is that being your own boss (with a Solo 401k) can make a wallop of a big difference in your retirement planning. And the story gets much bigger and much better…
You can max out your day job Solo 401k to make sure you take all the matching contributions that your employer offers and still make another matching contribution to your Solo 401k by being your own boss. It pays to be your own boss!
As the boss, you can make the company contribution to your Solo 401k without making the employee contribution. You can add up to another $40,500 contribution on top of whatever your day job employer is matching. That means a potential total contribution of $100,500. However, few people will reach the maximum because day job employers don’t maximize their matching contribution – but you can from your small business.
Here is how the IRS rules work:
Rule #1 – One Universal Employee Contribution Limit. While you can contribute to multiple 401Ks, the employee portion of the contribution limit applies across all 401Ks. In other words, your employee 401K contribution limit is the sum of all your employee contributions across multiple 401Ks. That is the $20,500 employee tax-deferred contribution limit for 2022.
All your employee contributions get reported to the IRS through W2s, 1099 forms, and your personal income tax return. That means you must track and fully abide by that limit. The IRS expects you to know how much you contribute each year as an individual.
What the IRS doesn’t expect is for each employer (day job and your small business) to track the profit sharing (matching) contributions made by different employers.
Rule #2 –$61,000 Per Unrelated Employer (includes your LLC) Contribution Limit. Remember the $61,000 total contribution limit mentioned earlier? In the day job world, the overall limit is a mix of employee and employer contributions. But what if you own a business, like a contracting LLC, and set up a solo 401K plan for yourself? The IRS allows each unrelated employer to have their own $61,000 limit! Did you know that? Each employer, such as your own business, can contribute, even if the employee (you) doesn’t contribute a dime.
That’s a crazy and legal way to turn an additional small tax-deferred contribution into your big retirement dream! For example, if your business makes $290,000 in net profit, then you can apply 20% of the net profit towards employer contribution in a solo 401K. That’s $58,000 into tax-advantaged investing. Better yet, with a Solo 401k, you’re not limited in what you can invest in the way you are with the day job 401k. Instead of limiting your investments to the greed of Wall Street, you can make alternative investments in almost anything you think will earn you a better return.
A small contribution through your Solo 401k can make an enormous difference in what you have when retirement comes. Many investors have turned this into legacy planning that includes their own dream retirement and being able to leave a substantial amount to heirs. And it gets even better…
Rule #3 – 50 years old and over? Don’t forget about catch-up contributions (add $6,500 in 2022 to your employee contribution limit). This one is pretty simple. If you’re 50 or over, then your employee contribution limit goes up to $27,000, and your new combined employee and employer contribution limit is $67,500.
Now that you know where to find some extra investment money let’s look at how you can seriously make it grow into your big retirement dream.
Ways to Start Investing Small Amounts With a Solo 401k
Starting out with small money when you have big dreams can be challenging. If you’re considering opening a Solo 401k plan, but you have no rollovers and only a few thousand dollars to invest, you need some big investing ideas.
You’ve heard, “It takes money to make money,” but until you have a significant amount of funds to invest, how do you actually grow your money? The good news is that you have many good options. Just because you have a small amount to invest doesn’t mean you have to sacrifice the opportunity for a reasonable rate of return.
Let’s start with crowdfunding as an opportunity to add your investment to the money of others to make significant investments. With crowdfunding, you can own a piece of a skyscraper, hospital, or shopping mall – all within your Solo 401k. Crowdfunding is about a large number of individuals investing a relatively small amount of money in a large project. A combination of technology and the loosening of some laws by the Securities and Exchange Commission (SEC) has enabled smaller investors to invest in much bigger investments that were previously available only to the already wealthy. When tens or hundreds, or even thousands of people pool their money, there is almost no limit to what they can invest in.
Through a Solo 401k, crowdfunded investments provide the capability to diversify your retirement portfolio in more ways than have ever been available before. The types and scope of investments are almost limitless.
As an example, Fundrise offers a diversified portfolio of institutional-quality real estate with long-term return potential. Real estate has traditionally been one of the most sought-after alternative asset classes. They offer a choice of entry points between $1,000 and $10,000. The average advertised return is 8.7% – 12.4%
Yieldstreet is another. This one specializes in private market investing that is typically only available to wealthy investors that are considered “accredited investors.” Private markets don’t often follow the same trends public markets do, and investing in them can help diversify your portfolio without sacrificing performance.
Other crowdfunding groups that you might want to learn about include:
- Realty Mogul – Minimum investment is $1,000 but varies by project. Realty Mogul invests in REITs, and their projected dividend is 8%.
- Rich Uncles – Minimum investment is $500 and also varies by project. You buy shares in a REIT. Your Solo 401k then receives cash dividends each month from rent collected. The advertised estimated dividend is 10%, which includes a 2% annual property value increase.
- Small Change – Minimum investment is $500, which varies by project. Small Change is known for real estate projects that improve cities. These investments are advertised as high-risk investments but with a higher rate of return.
Venture Capital investing is a type of investing that is very high-risk but can have a remarkably high reward. With VC investing, you’re putting money into a new idea or company that has yet to prove itself. Because of the “newness” factor, there is a high probability that the new idea/company will fail. However, because you’re investing in the very beginning of the idea/company, your rate of return (if they succeed) is much higher than investing in a well-established company.
Here are some venture capital sites with low investment requirements. These allow entrepreneurs to pitch their concepts/new businesses and for investors to select the ones they like.
- WeFunder – $100 minimum investment.
- SeedInvest– $200 minimum investment.
- StartEngine – $100 minimum investment.
- EquityNet– No direct investment. This site connects you with entrepreneurs who are seeking funding.
Opening a Solo 401k will definitely broaden your investment opportunities that include getting started with small investments in large projects that until recently were only available to wealthy individuals. Of course, these are only a few of many possible suggestions. Because a Solo 401k allows limitless alternative investment opportunities, you are always free to make your own investment decisions. A few other low-entry cost ideas include tax liens, which is an excellent way to get into the real estate space without having to purchase a property. Also, precious metals like gold and silver have long been a favorite for holding value during inflationary times and hedging against currency crises.
Now that you have an understanding of the investment alternatives that allow you to make a small investment for big returns, let’s look at other ways you can grow a small Solo 401k investment into big retirement dreams.
The 3 Biggest Factors to Create Big Retirement Dreams From Small Savings
Want a happy retirement? Here’s what experts say you need to do.
Start early. When it comes to retirement planning, it’s never too early to start saving.
The more you invest and the earlier you start means your retirement savings will have that much more time and potential to grow. By investing early and staying invested, you should be able to take advantage of compound earnings.
Minimize taxes. This is what a Solo 401k is all about. We’ve already shown you how to add to your tax-deferred savings by adding a Solo 401k to a retirement plan that includes a day job 401k. This is how you maximize your tax savings while adding to your retirement fund. Not only do you defer taxes, but when that money is not counted towards your annual income, you may find yourself in a lower tax bracket that pays less taxes on the money that you have to spend today.
A different way to save for retirement while minimizing future taxes that you might want to explore is the Tax-Free Roth Solo 401k.
Compound earnings. Albert Einstein described compound interest as the “eighth wonder of the world.” Compound growth means you reinvest your earnings instead of spending them today. Each time earnings are paid out, you reinvest them so that you have a larger investment going forward, which in turn means your next payout should be larger. Rinse and repeat to watch your investment grow huge over a short number of years. This especially makes sense when you are investing with retirement funds since you won’t take dividends personally anyway. Reinvest the money and let it ride! Compound growth is especially powerful over time when you place money in an investment with solid returns.
The Retirement Reality for Too Many People
A group of consumer researchers set out to identify what a dream retirement looks like for folks, but plenty of personal and societal factors could be impeding those dreams. Researchers found a large share of the 2,050 consumers surveyed expects to retire in debt. Plus, many folks are afraid that Social Security benefits will run out or that they’ll face a medical crisis that upends their retirement plans.
- 46% of Americans think they’ll retire in debt. At the same time, 54% have no plans to work on their retirement goals.
- Nearly 30% of Millennials and Gen Zers want to retire before they turn 50. Plus, more women want to retire before 50 than men (21% versus 15%, respectively).
- 43% of Americans fear their retirement dreams could be derailed due to Social Security running out. In addition, 22% worry about losing their savings in a stock market crash.
- 48% of Americans think they can retire with less than $1 million saved. That said, just 31% of Americans plan to stop working entirely after retirement. They will probably have to work part-time because they will likely enter retirement with a lower initial savings balance.
Final Thoughts About Funding Big Retirement Dreams
Whatever you ultimately decide, we admire your sense of adventure. Don’t let that fade. Retirement can be a wonderful new chapter in your life — as long as you plan and protect your finances at the same time that you live your dream. Ultimately, nothing has to be a permanent decision. Your big dream today might be to retire at age 60. With the right planning, your small investment today can finance great adventures during early retirement. But those plans will also change with age. Life can continue to evolve in a positive way, provided, of course, that you continue to carefully think through both your financial and lifestyle choices.
If you want to build wealth, you have to plan for it. According to The National Study of Millionaires, 3 out of 4 millionaires (75%) said that regular, consistent investing over a long period is the reason for their success. Regardless of where their income comes from, they actually save money and invest!