Major changes to tax laws now allow small business owners to establish 401(k) plans more easily than ever before, and benefit from bigger 401(k) plan deductions than they've ever seen. These 401(k) plans have been dubbed "solo" 401(k) plans because of new rules' popularity among single-owner businesses. Yet, it is possible to have more than one owner and maintain a "solo" 401(k) plan, as noted below. To obtain benefits for 2003 tax year, however, you must act before December 31st. (For more about types of investment services our investment affiliates offer, please visit http://www.marcjlane.com/decisiontree.htm) In contrast, SEP IRAs can be established at same time your individual income tax return is filed (i.e., April 15 of following tax year).
This report highlights some of significant benefits of a solo 401(k) plan.
A solo 401(k) plan allows a small business owner and his or her family to defer and invest tax-deductible (pre-tax) retirement contributions at a fast rate. The importance of maximizing retirement plan contributions cannot be emphasized enough. Over time, compounding tax-deferred investing can significantly increase one's wealth. (For "A Case For Professional Money Management,"and more about this important aspect of growing wealth, please visit http://www.marcjlane.com/decisiontree.htm)
How you might benefit from a solo 401(k).
Eligibility. While a small business owner could establish a 401(k) plan under prior law, administrative hassles might have discouraged you from doing so. Recent legislation makes establishing a 401(k) plan much more attractive for small business owners. Now, a business entity whose only eligible participants are business owners, partners, and/or spouses of owners or partners may establish a 401(k) plan easier and with greater deductions than ever before. Children, parents, and grandparents may also participate as long as they earn income from business. (However, specific plan administrators may have their own guidelines or limitations regarding participants.) Nearly all forms of business entities and ownership are eligible for a Solo 401(k). Sole proprietors, partnerships, corporations (including S-corporations), LLCs, and LLPs may all establish Solo 401(k) plans.
The good news: As long as eligible 401(k) participants are limited to those mentioned above ("eligible solo participants"), solo 401(k) will not be subject to all administrative, recordkeeping, and investment monitoring regulations that traditional 401(k) plans must follow. Full-time employees who are at least age 21 and have one year of service must be offered opportunity to participate in any 401(k) plan. However, for these purposes, a part-time employee working less than 1,000 hours per year can be disregarded and will not affect solo 401(k)'s legal compliance. It may be a good idea to set up a solo 401(k) now, even if you may add an employee who is not an eligible solo participant in future years. At that time solo 401(k) plan can simply be suspended or terminated.
Key benefits. Under new law, you may deduct up to $40,000 for each participant in a solo 401(k), as explained in more detail below. Even more appealing, if you and your spouse are actively involved in your business and have sufficient business earnings, you and he or she may be able to contribute - - and deduct - - up to $80,000 for retirement.
Another benefit under new law is that you can reach maximum deduction of $40,000 at a faster rate than ever before - - with as little as $112,000 of income in 2003. In contrast, at that income level, other retirement plans allow much lower contributions (e.g., a SIMPLE IRA would generally allow about a $11,360 deductible contribution, and a SEP IRA or Profit Sharing Plan would generally allow about a $28,000 deductible contribution. See comparison chart below.)
If I have a side business, will a solo 401(k) benefit me, even if business doesn't make much income?
Yes. In fact, a side business is a prime candidate for a solo 401(k). A traditional employee, if he or she has a side business, may now make additional deductible retirement contributions very rapidly via a solo 401(k) plan. With just $20,000 of income, you may be able to deduct up to $17,000 and only pay income taxes on remaining $3,000. The rapid deductible contribution rate (in this case, 85%) can be very appealing to those wanting to save more for retirement, particularly if income generated from a side business is not required for their immediate needs. What's more, if participant is 50 years or older as of January 1st, "catch up" provisions allow even higher contributions for that year ($2,000 in 2003, and increasing by $1,000 each year to a maximum of $5,000 in 2006 and later years).
What other benefits does a solo 401(k) offer?
Solo 401(k) plans also offer several other advantages:
Roll over other plans. Once your 401(k) plan is established, you may roll over other retirement accounts into it.
Loans. You may borrow up to 50% of your account balance (up to a $50,000 loan) and repay it over five years (or over 10 years, if loan is used for a principal residence).
Brokerage accounts. The plan may include a self-directed brokerage account, allowing maximum investment flexibility.
No tax return. No tax returns for plan are necessary, as long as assets remain under $100,000.
Simplified tax return. If assets exceed $100,000, a simplified tax return may be filed if plan covers only you (and your spouse) or one or more partners (and their spouses).
No FICA tax. The employer contribution portion is not subject to FICA (Social Security) or self-employment taxes (but any salary deferral portion is subject to tax. See "Comparison of Contributions" below for description of methods of contribution).
Extended contribution date. Employer contributions may be made after year-end (by your tax return deadline, including extensions). However, salary deferrals must be made by December 31st, and may only be made from income earned after 401(k) plan is established.