A regular 401(k) is offered by an employer to allow an employee to save for his or her retirement. In many cases, the employer may also match a portion of the employee’s contribution. With a solo 401(k), you are both the employer and the employee.

Criterial for solo 401(k)s

To participate in the solo 401(k), you must be self-employed and have no direct employees other than your spouse. There are no age or income limitations.

The IRS defines self-employed as:

Someone who carries on a trade or business as a sole proprietor or independent contractor,
A member of a partnership that carries on a trade or business, or
Someone who is otherwise in business for themselves, including part-time business.

Contribution limits

For 2022, the annual combined contribution limit for both employer and employee to a  solo 401(k) is $61,000. If you are older than 50, you can contribute an additional $6,500 in catch-up contributions.

• Employee contribution limit is $20,500 (+$6,500 if you are older than 50). Note that the total contribution limit for all your traditional 401(k)s is $20,500. Let’s say you contribute $7,000 to a traditional 401(k) at your full time job, then you can only contribute $13,500 to a solo 401(k).
• Employer contribution limit is $40,500 (for all employers)
• Contributions cannot exceed $100% of your compensation

Solo 401(k) contribution deadlines

• Employee contributions – Last day of the calendar year (December 31)
• Employer contributions – tax deadline for the previous year (Apr 15th or later, if extensions are filed)

Solo Roth 401(k)

Just like a solo 401(k), you can set up a solo Roth 401(k)if you prefer to make after-tax contributions.

Be prepared for additional paperwork

Solo 401(k)s have more paperwork compared to an IRA. If your solo 401(k) balance exceeds $250,000 at the end of the year, you need to file IRS Form 5500-EZ.

Higher costs than IRAs

The cost to maintain a solo 401(k) is higher than that of IRAs due to higher compliance requirements.

Where can you open a solo 401(k)?

Discount brokerages usually don’t offer solo 401(k)s but the big players such as Fidelity, Vanguard, and Schwab do. Read the fine print – understand the fees, minimum balances, and inactivity fees before you sign up.

Rolling over solo 401(k)s

You can rollover your solo 401(k) into IRA, just like you would roller over your traditional 401(k) into an IRA.

But in reality, many people can use it as a retirement account similar to an IRA. If you don’t have a lot of medical expenses and if you have a long time horizon, you can invest the funds in the HSA in a mutual fund just like you can in an IRA. Your money will grow tax-free until you withdraw.

Let’s take a look at how HSA works and how you can maximize its benefits.

What is an HSA?

HSA was created to give people with high deductible health insurance plans an incentive to save. That’s because these plans have high deductibles that must be met before insurance pays out claims.

Any money you contribute to an HSA is tax-advantaged – that is all contributions are pre-tax. You also don’t pay any taxes when you take the money out as long as you use it for qualified medical expenses. Simple enough, right.

Take advantage of employer contributions to HSA

Many employers contribute $500 or $1000 every year to HSA accounts if you sign up for a high deductible healthcare plan. Unlike a 401(k), the employer contributions are not matches, so you can contribute as low as $1 as still get $500 or $1000 from your employer.

Investing HSA funds

Most people leave their HSA funds in cash or in a money market account, which pays you a meager interest rate. You can invest these funds in a mutual fund and get much better returns. If you are young and have many years to invest, your money can compound at 7-10%. When you invest in mutual funds, you are exposed to the fluctuations of the market but in the long run, markets have done well.

If you have anticipated medical needs, then you can set some money aside for those expenses and invest the rest in a mutual fund. Some HSAs have some minimum amount (eg. $1000) you need to set aside before you invest in mutual funds. HSA administrators do this to ensure that you have some liquid funds available in case medical expenses come up unexpectedly.

Withdrawing from an HSA

If you have medical expenses, you can withdraw from an HSA. That part is straight forward.

There is no requirement that you should reimburse yourself immediately after a medical expense occurs. For example, if a medical expense comes up, you can pay it yourself and keep the receipts. You can reimburse yourself 30 years later when your account balance has grown considerably.

What if you don’t have a lot of medical expenses? You can withdraw from an HSA at age 65 by paying taxes, just like you do with an IRA or a 401(K). Note that the minimum age for withdrawal from an IRA or a 401(k) is 59.5 years, whereas you have to be 65 to withdraw from an HSA. By withdrawing your money for non-qualified expenses, you have converted your HSA into a stealth IRA.

What happens if you no longer have a high deductible insurance plan?

If you don’t have a high-deductible insurance plan, you can no longer contribute to an HSA. But you can still spend the money in your HSA for eligible medical expenses.

HSAs are portable

If you switch jobs, you can rollover your HSA funds into your new employers’ HSA without any tax implications. You can also roll the HSA over into your own HSA (in case your new employer doesn’t offer an HSA). But keep an eye on fees. HSA administrators charge a small fee ($2-$4 per month). Your employer will pick up the fees if they offer an HSA but you will need to pay the fees if you own the account yourself.

Keep an eye on fees

Some HSAs also charge fees if you invest in mutual funds instead of keeping your funds in cash. The monthly charge is small, around $2 to $4 but these things add up. So keep a close eye on fees.

If you are investing in mutual funds, pay attention to the expenses the fund charges. Investment options in an HSA are limited compared to 401(k)s or IRAs. But by keeping fees and mutual fund expenses low, you will still come out ahead compared to keeping your money in cash or in a money market account.

Bottom Line

HSAs can be stealth IRAs for people who don’t have a lot of medical expenses and for people who are young. By moving your money from cash to mutual funds, you can grow your money at 7-10% annually. If you don’t have medical expenses, you can withdraw the money at age 65 by paying taxes on your withdrawals.

Another way of looking at the 4% rule is that you need 25 times your annual expenses to retire.  We generally ignore other sources of income such as social security when we work with this rule.

The great thing about the 4% rule is that it works under most market conditions.  It is also easy to understand and implement.

But there a few problems with the 4% rule, and it may not work under certain conditions.

Asset Mix

The 4% rule assumes that people will invest 60-70% of their portfolio in stocks, and the rest allocated to bonds.  In retirement, many people may not have the risk tolerance to put 60-70% of their portfolio in stocks.  They would rather prefer more stable investments. But a very conservative portfolio will not allow you to withdraw 4% a year for 30 years.

Sequence of Returns Risk

Assume you had just retired, and the stock market crashes.   What happens to your retirement plan? Can you still withdraw 4% per year? This actually happened to people who retired in 2007 and 2008.  The S&P 500 lost 37% in 2008.

If the market crashes in the first or second year of retirement, and you continue to withdraw 4% every year, you are at risk of running out of money earlier than someone who didn’t face a market crash early in retirement.

Even after major market setbacks, stock market returns have typically returned to historical levels and you will probably be fine taking out 4%.  You need to understand that there is some risk involved when you withdraw 4% per year when the returns in the early years are negative.

Low-Interest Rate Environment

In the 1970s and 1980s, inflation was in double digits and so was the yield on bonds.  Retirement planning was much easier when people could plan on getting double-digit returns on bonds.  People could reduce their investment in stocks, and put more money in bonds in retirement.

But since the 2007 financial crisis, the interest rate has been very low.  This has led people to invest a higher percentage of their portfolio in stocks to generate returns.  Since the stock market is more volatile than the bond market, retirees are exposed to more portfolio volatility in retirement years.

Not Everyone Needs 30 years of  Retirement Income

People are working longer than ever.  It’s not uncommon to see people working in their mid-70s. In that case, you can safely withdraw more than 4%.  While some of you will play it safe, some others may want to withdraw more than 4% to live a more luxurious lifestyle in later years.

Early retirement

If you retire early, the 4% rule may not work well for you.  You will likely have more than 30 years in retirement.  You will need other forms of income and need to consider a withdrawal rate lower than 4%.

With all these challenges, how you plan your withdrawals in retirement.  Here are a few strategies that can work well.

Be Flexible With Your Withdrawals

Being flexible with withdrawals goes a long way in ensuring that you don’t outlive your assets.  When the market is in a downturn, reduce your withdrawals.  This allows more of your money to compound over the years.

Work longer. Get A Side Hustle

Consider a part-time job or side hustle that generates income.  Many retirees actually enjoy working on part-time jobs because it keeps them active rather than staying at home all day.  Do not rely on just your assets for income in your retirement years.

Reduce the Cost of Living

Your cost of living in retirement should be lower in most cases.  Look at your expenses and see if there are opportunities to reduce expenses further.

Bottom Line

4% withdrawal rule is a good rule of thumb and works most of the time.  But there are risks associated with withdrawing 4% every year.  Understand the risks, and be flexible with your withdrawals.  Working longer before you retire and working on a side hustle in retirement will give you a safety net and ensure that you will not run out of money.

Here are some simple rules you must follow to be a successful dividend growth investor.

Build A Portfolio

You must own a portfolio of stocks.  The stocks you own must be diversified across industries.  Never own too much of one stock.  Once you build a portfolio, add to it periodically to benefit from dollar-cost averaging.  Reinvest dividends to grow your passive income quickly. Understand the tax implications of reinvesting dividends – you may be liable for paying taxes on the dividends paid.

Look for Businesses With Consistent Profitability

Look for companies in mature industries with consistent profitability.  The company should have successfully navigated multiple business cycles, and have a sustainable competitive advantage in its market.

Strong Balance Sheet

Ensure that the company’s balance sheet is solid.  The company must be able to pay dividends, manage its debt load and also invest in its business.  Financially struggling companies may have highly tempting yield, stay clear of these kinds of companies.

Dividend History

Take a look at how long a company has paid dividends. I look for companies that have paid dividends for at least 10 years.  More years of paying dividends, the better.

Dividend Growth History

I look for companies that have increased dividends for at least 10 straight years.  These companies are sometimes called Dividend Contenders. Companies that have increased dividends for 25 straight years are called Dividend Aristocrats.

Investing in Dividend Contenders and Dividend Aristocrats ensures that you are likely to keep getting increased distributions.  Though no one can predict the future, a long history of increasing distributions shows that the management is willing to share the wealth with its shareholders.

Payout Ratio

This is the percentage of the earnings that the company pays out as dividends. A low payout ratio means that the company has room to raise dividends in the future. On the other hand, if the payout ratio is closer to 100%, it means that the company cannot afford to increase dividends in the future.

Perseverance And Compounding

There are times when growth stocks (which don’t  pay dividends) outperform dividend-paying stocks.  In these times, you need to stay patient and continue with your strategy of investing in dividend growth stocks. It’s only a matter of time before dividend stocks come back in favor.

Persisting with the dividend growth strategy, and reinvesting the dividends will allow the power of compounding to work in your favor.

Own Growth Stocks In Addition to Dividend Stocks

There are plenty of stocks on the stock market that do not pay dividends.  But they are excellent companies as well.  Do you research but own those stocks as well, and not limit yourself to just dividend-paying stocks.

Bottom Line

Dividend growth strategy will let you build a passive income stream that you can live off of one day. The initial income may be small and insignificant, but give it time, and it will grow and give you income and peace of mind that you cannot get with any other passive income stream.

Here are the key provisions of the changes to retirement plans.

Age for Required Minimum Distributions Increases to 72

Individuals now need to start taking required minimum distributions (RMD) at 72. Previously, the age limit was 70 1/2.

Inherited Retirement Accounts Must Be Distributed in 10 years

Current law allows inherited retirement accounts to be distributed over the beneficiary’s lifetime (sometimes called the “Stretch IRA”). But the new law states that the inherited assets must be distributed within 10 years.

This change is likely to have a huge impact on estate and tax planning.  Beneficiaries will receive big payments over 10 years and lose out on the potential to grow the inherited accounts over their lifetimes.

Penalty-Free Withdrawal For Expenses Related To Birth/Adoption of Child

New law allows new parents to withdraw $5,000 from a 401(k) or an IRA to pay for expenses related to the birth or adoption of a child.

Though it may help some people, I am not a big fan of withdrawing funds from retirement plans early.  Most people are better off leaving their money in retirement plans allowing their money to grow and finding other sources for childbirth-related expenses.

Annuities in 401(k) plans

You will start to see annuities in 401(l) plans.  The new law lowers some of the barriers that prevented employer-plans from offering annuities. This will allow employees to convert their assets in 401(k) into income streams.

401(k) for Part-time Workers

Part-time workers are now eligible for 401(k). The new law states that employees who worked at least 500 hours per year for three consecutive years are eligible for a 401(k) plan.

Contribution to Traditional IRA After 70 1/2

If you have earned income beyond 70 1/2 years, you can contribute to a Traditional IRA. This is currently prohibited for Traditional IRA though it’s allowed for Roth IRAs. There are no age limits for Roth IRA contributions.

Lifetime Income Disclosures

The law mandates the Labor Department to provide disclosures to plan participants showing the project monthly income in retirement based on their current assets. The rules will take a couple of years to take effect.

This report will allow people to see whether they are saving enough to live off their retirement accounts without having to run complex calculations.

Bottom Line

As you save for retirement, it is important to stay on top of the changes.  When rules are changed, employers don’t implement all the changes right away.  Look for guidance from your employers informing you of changes, so you can plan, and grow your retirement nest egg.

These amounts don’t include employer matches. Defined contribution limit from all sources (employer + employee) is $57,000 for 2020. If you are 50 or older, the maximum defined contribution limit is $63,500.

When creating the retirement plan system, Congress included tax benefits as an incentive for employers to put plans in place and for employees.  The goal was to offer retirement benefits to a broader group of employees and not just the higher paid individuals. To achieve this objective, Congress established a series of nondiscrimination tests that retirement plans must satisfy each year in order to preserve their tax benefits.

These nondiscrimination tests ensure that the average benefits provided to two groups of employees—highly compensated employees (referred to as HCEs) and key employees—and compare them to the average benefits provided to the non-HCEs or non-key employees.

Key Employee

A Key Employee is a person who met the following conditions in the prior plan year:

• An officer of the company earning $180,000 or more annually;
• A 1% owner with a salary of $150,000 or more; and,
• A 5% (or more) owner regardless of salary.

Highly-Compensated Employees

A Highly-Compensated is a person who met the following conditions in the prior plan year:

• An officer in the prior year;
• A 5% (or greater) shareholder in the current or prior year;
• An employee paid $125,000 or more in the prior year; and,
• An employee whose salary is in the top 20% of all employees.

How To Get The Most Out of Your 401(k) Plan

Save Early and Save Often

Time is the secret to compounding money. Your investments grow over time.  So invest early, and save as much as possible.  It sounds like a cliche but I am surprised by how many young people do not participate in their company’s  401(k) plans.

Contribute At Least Enough To Get Company Match

At least contribute enough to get the company match. If your company matches 4% of your contributions, that is like getting a 100% return on your investment on day 1.

Choose Investments Wisely

Your risk tolerance will change as you grow older.  Choose an investment that aligns with your goals and risk tolerance.  I take a look at my investments once a year and re-balance my asset mix if necessary. Otherwise, I leave them alone.

Most people make the mistake of changing their portfolio allocation based on market fluctuation and trying to time the market. Your portfolio is like a bar of soap. The more you mess with it, the smaller it gets.

Know Your Costs

Investing in your 401(k) involves costs.  Mutual funds have expense ratios, and your plan may have administrative expenses.

Review your expenses periodically. If your mutual fund has an expense ratio of more than 1%, you are likely paying too much.

The larger your company, the lower your administrative costs will be as the company will be able to spread the cost across more employees

Set Up Automatic Escalation of Contributions

Most plans allow you to set an increase in your contribution amount every year. I set up mine to go up by 1% every March since that’s when I get my pay raises.  This way, my savings go up automatically every year without me having to do anything.

Avoid taking loans, early withdrawals

When you lose your job or have a cash crunch, taking money from your 401(k) either through loans or early withdrawals may be tempting.  Even if you can avoid paying penalties on early withdrawals, in the long run, it’s not worth it.

The money you withdraw will not be compounding for you, and you are likely to end up with a smaller nest egg.  Having adequate savings outside of 401(k) in an emergency fund will help you avoid dipping into your 401(k) when you encounter tough times.

Take Advantage of Catch-Up Contributions

You can contribute $6500 more to your 401(k) if you are over 50.  Take advantage of this if you fall into that category.