401k Retirement Plans For The Self Employed

An individual 401(k) may be the best retirement plan option for a self-employed person with no other full-time employees other than their spouse. If those qualifications are met, the restrictive and costly 401(k) nondiscrimination rules do not apply, saving on both contribution expenses and administration fees.

The key to maximizing the benefit of an individual 401(k) plan is to couple it with a profit sharing plan. That way you'll get the benefit of contributing your own money through the 401(k) deferrals, plus the company will add its matching and profit sharing contributions. In addition, the company can usually deduct the contribution as a business expense, saving you taxes both on the business and personal sides of the transaction.

These contribution totals can quickly add up if maximized over a period of several years. The individual 401(k) deferral limit for 2006 was $15,000 for those under 50 at the end of the calendar year and $20,000 for those age 50 or older. A corporation may also contribute 25% of total compensation for the owner and spouse. This limit is slightly less for unincorporated companies or sole proprietorships, based on the individual's compensation amount. The 401(k) contribution does not count against the company's profit sharing contribution and vice versa. There is a total aggregate limit, however, of 100% of total compensation or $44,000 in 2006.

There are other advantages to setting up an individual 401(k) and profit sharing plan. The contribution amount is discretionary, not fixed, allowing you to reduce contributions during lean times. Loans and hardship withdrawals are also allowed under most 401(k) plans. Rollovers from other retirement accounts (IRAs, employer-sponsored plans) can usually be transferred into the 401(k), making recordkeeping and investing easier by consolidating everything in one account.

Despite these benefits, there can be some disadvantages to setting up an individual 401(k) plan. It can become significantly more expensive if you ever hire any full-time employees in the future. You would then be required to contribute on their behalf, as determined by the 401(k) non-discrimination rules. Be sure you will not need additional full-time help as your business grows before committing to an individual 401(k) plan.

There is also a significant amount of paperwork involved with setting up a 401(k) or any type of retirement plan. Most companies simply pay an administration fee to a third-party pension firm or financial institution to handle the administration and tax filings for them. The fees for an individual 401(k) plan are usually only a couple hundred dollars since the owner and possibly a spouse are the only participants.

If you are a small business owner who does not plan to have any full-time employees, you should strongly consider setting up an individual 401(k) plan. Adding a profit sharing plan can boost the amount of your maximum contribution each year and will let you build up your retirement savings very quickly. The contributions are tax-deductible to your business and tax-deferred on the individual side, giving a double tax benefit to business owners who save for retirement with a 401(k) plan.

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