Finally, a Break for the Small Fry Or, Get $50,000 Tax Free

TaxMama.Com
Tax Information With A Mother's Touch

Published by Eva Rosenberg, MBA, EA

Click Here to get 4 weeks of The Wall Street Journal for
free

Important Business Links
	Saving for College
	Printing Resource
	Go Shopping
	Host your Website
	Best free Web tools

Finally, a Break for the Small Fry
Or, Get $50,000 Tax Free

By Eva Rosenberg, MBA, EA
(Your favorite TaxMama)

I can feel your pain. You've done all the right things. Socked away a bunch of money in your 401(k)'s, IRAs, etc. Now, you're out of work, or setting out on your own, or wanting to buy your first home.

» Why are you being punished for being good?

And you can't touch any of that money without dire tax consequences.

Dire, she says? Oh, yes, When you try to tap into that money, to your chagrin, you learn that you will face IRS's 10% early withdrawal penalty, your state's little, old addition AND taxes on all the money you draw. That's the real shock. The taxes.

Most people think all they have to pay are the penalties. I've heard people say, OK, it's worth paying the 10% or 15% to get my money. Only, adding up IRS and state penalties and IRS and state tax rates – the draws cost around 50%. Ouch, that really hurts. Especially when you don't learn about it until you've spent the money.

Same thing with that misconception about being able to draw $10,000 from your IRA for a down payment on a new house. Is that ever a rip-off! Sure, you get the money without penalties. But you still have to pay all the taxes. So, you've drawn the $10,000. It knocks you into a higher tax bracket. Now, with Federal and State taxes, it costs you around $3,000. You don't really get $10,000 for that down payment. I hate it when people get that bewildered, despairing whipped puppy look and start that quiet, high-pitched whine.

» Magical Mystery Cure

So, what's a clever tax pro to offer you? Congress's best kept secret in the Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA) – the solo 401(k). This is the greatest invention since sliced bread. I'm not kidding. (OK, you've got me. You used to be able to do exactly what this does with the KEOGH accounts until Congress took that away around 1998.)

» But, you ask. What does this do?

Here's the scoop. If you (and your spouse) have your own business, you can open up one of these solo 401(k) accounts and put as much as $41,000 a year into it and take a pension deduction for that contribution.

This only applies to owners of businesses.
Your business can be in any form – corporation, partnership, LLC, proprietorship.
Spouse owners of businesses are eligible. (Both of you must be owners.)
You can't have this account if you have employees.

How do Contributions Compare to an IRA, a KEOGH or a SIMPLE?

Well the folks at Pioneer Funds have a terrific chart that compares the contributions in each of the plans at income levels from $10,000 to $150,000. In each case, the contributions to the solo 401(k) plan are between 30% and 400% higher. And none of the other plans let you borrow money. (Click Here for the Chart)

One thing you do need to understand, though, is that if you're incorporated, the contributions are based on your wages, not your business's profit.

» What's all the Excitement About?

Aside from the fact that you can put a big chunk of money into it, what's the big deal? (Hint: Read #3 twice.)

The annual fees are nearly as low as those for KEOGHs (about $100 per person/per year.)
Even if you have nothing to contribute, it's still worth opening. You can transfer money from all your present 401(k)'s and IRAs into it.
You can borrow up to $50,000 or half the money in the account whichever is lower. TAX FREE!
You can borrow that money immediately.
You pay yourself back at a low interest rate.
And as long as you stay in business (uh, are you planning to fire yourself?), you don't have to worry about the loan being called.

» I'm Not Self-Employed. My Eyes are Glazing Over

Now, let's say you're not self-employed. What do you care? This doesn't apply to you at all. Or does it?

Suppose you are going to continue to look for a real job. Getting hired, often, it takes 6 months to a year to qualify for the company's 401(k) plan. They won't always let you roll other money into it. They may not let you borrow for another six months or so.

Is there anything to prevent you from starting your own business on the side? You do a little freelance work. Pick up some money or keep food on the table while you're looking for work. Even if your profits only let you contribute a small amount of money to your solo 401(k), you can roll your whole retirement savings balance into the account.

» Aaaah! The Light Dawns

Get it? You just got access to your own money, through a legal loophole, without paying a dime in taxes. You can borrow what you need to cover your bills, pay your credit cards, buy that new house, or make the investment you've been itching to make. Many people are using this plan to free up money to tap into today's excellent real estate market.

Sounds great, doesn't it? Don't try to do this alone. Definitely, sit down with a good tax professional who understands the nuances of this program. You don't want to get this one wrong. It's worth spending a couple of hundred dollars to save over $20,000 in taxes, penalties and interest – on your own money.

Copyright © Eva Rosenberg 2002
For reprint prices and rights, please mailto:taxwriter@taxmama.com?subject=Reprint401k
and provide full details about how you want to use it, with links to your site, if applicable.

TaxMama's
Other Sites
TaxMama's Secrets
The Help Desk
PhotoMasterpieces
I-Laugh

Site design by Serenata Design.