Did you know that a firm as small as one-person can establish a 401(k)? This is not a new phenomenon. It just never made sense under the old tax law. However, recent changes have made the 401(k) much more attractive for small employers.
How attractive? Consider a sole proprietor at age 50, with Schedule C income of $40,000. Assume this business owner would like to contribute as much as possible to a tax-deferred retirement plan during 2005. By adopting a SEP IRA plan or a Profit Sharing Plan, the owner may contribute a maximum of $7,434. By adopting a Simple IRA plan, the owner may contribute a maximum of $13,108. However, by adopting a 401(k) plan, the owner may contribute up to $25,434 for 2005.
As you can see, the one-person 401(k) plan offers you, the small business owner, the opportunity to make a much larger contribution to your tax-deferred retirement plan. This strategy even works well for small businesses with certain non-owner employees. Since the contribution amount is entirely discretionary each year this savings strategy is very flexible. Furthermore, contributions are tax-deductible and grow tax-deferred to make this savings strategy very effective.
Additional incentives found in the new tax relief act add to the attractiveness of the one-person 401(k) plan. For example, the new tax relief act permits you, the business owner, with the ability to take a loan from your one-person 401(k) plan. Loans are now available to shareholders, partners, and sole-proprietors on a tax and penalty-free basis as long as the loan amount does not exceed the lesser of 50 percent of the account balance or $50,000.
Finally, there is no IRS Form 5500 filing expense associated with the initial years of your one-person 401(k) plan. You may not be required to file an IRS Form 5500 for your one-person 401(k) plan until the assets in your plan exceed $100,000 or a non-owner employee qualifies for the plan. So, any initial administrative expenses will be minimal.
The one-person 401(k) plan savings strategy is most suitable for firms employing only owners (shareholders, partners, and sole-proprietors) and their spouses. An experienced financial advisor, an ERISA attorney, or a retirement plan administration firm can analyze the suitability of this strategy for your firm.