Tax Tips
The Solo 401(k)…for the Independent Type- November 2006
Richard Scrivanich - Partner
If you're the type who has "gone it alone" and established a small business, you may be looking for the same benefits usually found in big business 401(k) plans but want to forgo the complex rules and administrative expenses associated with them.
The answer for you-as a solo business owner without employees-may very well be the solo 401(k), even over the perhaps more popular Keogh, SEP, or profit-sharing plans. Also referred to in the popular press as "uni(k)," "individual (k)," or "single participant (k)" plans, these plans give owner only businesses the advantages of a traditional 401 (k)-including higher contribution limits and the ability to borrow from the plan-at a relatively affordable price.
Contribution limits vary
The rules governing solo 401(k) plans apply to both incorporated and unincorporated businesses. Any business that employs only the owner (and his or her spouse) qualifies-including C corporations, S corporations, single member limited liability companies, sole proprietorships, and partnerships. Remember that the higher the contribution limit, the larger the tax break. Combined contributions for both salary deferrals and profit sharing may not exceed the lesser of 100% of compensation or $44,000 for 2006 (under catch-up provisions, that amount is $49,000 if you are over the age of 50). The rules limit the employer contribution to 25% of compensation. An employee may make a salary deferral contribution of up to $15,000. Together these contributions may not exceed the lesser of $44,000 or 100% of compensation. Note that catch-up contributions do not factor in when computing this limit. The maximum amount of compensation that can be considered is $220,000. These overall limits ($44,000 and $220,000) apply to self-employed or unincorporated businesses, as well. This two-part contribution structure can yield a rather tidy sum each year.
Other considerations
The solo 401(k) provides you with flexibility to save more in years that you are doing well and hold back in years where the current value of the cash is worth more to you. Your business might be boom in some years and bust in others but, no matter the circumstances, you control whether and how much to contribute to the plan.
Yet another nice feature of the solo 401(k) is that, as a plan participant, you can generally take a tax-free loan from your plan if that plan includes loans as a feature. Note: Loan limits, features, and repayment terms are mandated by IRS rules. No deviations are allowed.
Fees to establish and maintain a solo 401(k) vary widely, and mutual fund companies tend to lead the pack as plan providers. Some solo 401(k) products offer a loan feature, while others do not, and the fees for those that do tend to run higher than for those that do not.
A solo 401(k) plan can allow for rollover contributions, making it an attractive planning tool if you are thinking about leaving a corporate position to start up your own business.
For calendar-year companies, your solo 401(k) accounts must be established by December 31, of the year in which you want to claim a tax deduction, and strict time limits apply to when contributions can be made. Remember that if you are planning to expand, you probably should not be looking to establish a solo 401(k).
If you have any questions regarding this topic or any other tax matter, please feel free to call me at (562) 698-9891.
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