Solo 401K Plans and IndividualK Plans

For the self-employed business person, particularly in sole proprietorships, the early standard 401K plans tended to be a poor match for their needs. A combination of relatively high costs and complex administration plus the relatively low contribution limits made the plans fairly unattractive for the small business person. Despite the changes which were made in the 401K plans by EGTRRA (the Economic Growth and Tax Relief Reconciliation Act of 2001), many self-employed entrepreneurs still do not realize that what are referred to as Solo 401K or IndividualK plans now provide significant benefits that are well worth investigating.

With standard 401K plans before the enactment of EGTRRA, 15% of eligible pay was the limit for tax deductible contributions. EGTRRA increased the deductible limit to 25% of eligible pay without any reduction for salary deferrals. To see how this works to your advantage, consider the example of an incorporated business owner with a salary of $100,000. Previously his or her maximum contribution would have been $15,000. Now, however, by making an elective salary deferral contribution of $15,500 (2007 and 2008) and a profit sharing contribution of $25,000, the allowable tax deductible contribution is $40,500. If he or she can also make a 'catch-up' contribution because of being 50 years of age or older, the maximum contribution would now be $45,500. Note that these are pre-tax contributions, meaning that the taxable salary has now been reduced from $100,000 to $54,500. Not only are you looking at socking away a significant amount in retirement savings, but a good part of it may be paid for by tax savings.

For the unincorporated self-employed business person, the rules are somewhat less favorable and the 25% profit-sharing contribution is based on net self-employment income. In the case above the salary deferral and catch up contribution amount to $20,500, so the profit sharing contribution would be limited to 25% of $79,500, which would be $19,875 making for a total allowable contribution of $40,375.

There are, of course, absolute maximum contribution limits also. For 2007 and 2008 the total yearly employee pre-tax salary deferral is $15,500. This is referred to as the 402g limit. The catch-up contribution is limited to $5000 for 2007 and 2008. Both of these limits are subject to adjustment based on inflation in $500 increments. The overall limit which is set by section 415 is the total amount that can be contributed between employee and employer (i.e., the 'salary deferral' and 'profit-sharing' used in the example above) and is the lesser of 100% of the employee's wages or $45,000 in 2007 and $46,000 in 2008 (plus the $5000 'catch-up' contribution if it applies).

These changes have made the 401k a far more attractive vehicle for retirement saving for the self-employed. "Solo 401K" or Individual(k) plans can be purchased which can be run as a self-directed 401K. A self-directed 401K permits nearly any type of investment, from mortgages and real estate to tax liens and stock. If you've been putting off setting up a good retirement plan for yourself, haven't looked into using a solo 401K or IndividualK plan as part of your retirement investment planning or figured that it wouldn't apply to you as self-employed entrepreneur then you may want to reconsider your options.
Wed, Mar 10, 2010 06:18


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