Subject: Retirement Plans - 401(k) for Self-Employed People

Last-Revised: 5 Sep 2003
Contributed-By: Daniel Lamaute, Chris Lott (contact me),

This article describes the provisions of the US tax code for the 401(k) plan for Self-Employed People, also called the Solo 401(k). These plans were established by the Economic Growth and Tax Relief Reconciliation Act of 2001.

A Solo 401(k) plan provides a great tax break to the smallest business owners. In addition to the possibility to shelter from taxes a large portion of income, some Solo 401(k) plans offer a loan feature for cash-strapped small business owners.

Eligibility for a Solo 401(k) plan is limited to those with a small business and no employees, or only a spouse as an employee. This includes independent contractors with earned income, freelancers, sole proprietors, partnerships, Limited Liability Companies (LLC) or "S" corporations.

The key benefits of the Solo 401K plan include:

• High limits on contributions: The limits for elective salary deferrals and employer contributions enable sole proprietors to contribute up to $40,000 ($42,000 if age 50 or older) in tax year 2003, based on salary deferral plus profit sharing (see below).
• Contributions are fully-tax deductible and are based on compensation or earned income.
• Assets can be rolled from other plans or IRA’s to a Solo 401K. There is no limit on roll-overs.
• The account holder can take a loan that is tax-free and penalty free from the Solo 401K, if allowed by the plan, up to the lesser of 50% or $50,000 of the account balance.

The contribution limits depend on how the business is established. Overall, the total of deferred salary and profit sharing that can be put in one of these accounts in one year is limited to $40,000:

• For businesses that are not incorporated, the salary deferral and the profit-sharing contributions are based on net earned income. The maximum contribution limit is calculated based on salary (max deferral of $12,000) and profit sharing up to the current max contribution. Contributions are not subject to federal income tax, but remain subject to self-employment taxes (SECA). The owner receives a tax deduction for both salary deferral and employer contributions on IRS Form 1040 at filing time.
• For corporations, the maximum elective salary deferral amount for 2003 is 100% of pay up to $12,000 ($14,000 if age 50 or older). The maximum employer contribution (profit sharing) is 25% of pay, and is based on the W-2 income. It is not subject to federal income tax or Social Security (FICA) taxes. The salary deferral contributions are withheld from your pay and are excluded from federal income tax but are subject to FICA. The business receives a tax deduction for both salary deferral and employer contributions.

Fees for establishing and maintaining the Solo-401(k) type accounts vary by plan provider and administrator. The plan providers are mostly mutual fund companies with loaded funds. The plan fees are also a function of the features of the Solo-401(k). For example, plans fees tend to be less expensive if they have no loan feature. Plans that allow assets other than mutual funds in the plan would also be more costly to maintain. On average, the cost to set up and maintain a Solo-401(k) is modest for a 401(k) plan; fees on various plans range from $35 to $1,200 per year.

A solo 401(k) offers several key advantages when compared to Keogh plans (see the article elsewhere in the FAQ). The solo 401(k) allows higher contribution limits for most individuals, allows for catch-up salary deferral contributions (for those 50+ years), and allows loans to owners.

Rather than raiding their 401K to finance their business - and paying a big penalty to the IRS - small business owners can take a tax-free loan and keep their hard earned money working for them. This plan offers small business owners all the benefits of a big-company 401K without the administrative expense and complexity.

Small business owners should ask their accountants about this plan and how it may benefit them. Each Solo 401K must be set up no later than December 31 of the calendar year to be eligible for tax deductions in that tax year.

Please visit Daniel Lamaute's web site for more information. There he offers a Solo-401(k) plan with no set up fee and an administration fee of $100 per year. That plan includes the loan feature; plan investments are restricted to mutual funds by Pioneer Investments.
http://www.InvestSafe.com

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