One Person 401k Plan a Viable Alternative to Other Retirement Plans for Small Businesses - March 25, 2004

New Limits

The biggest reason why you might consider opening a one-person 401k plan is that it may offer higher contribution limits than other retirement plans available for small businesses. In this regard, the two most significant changes contained in the 2001 tax bill with respect to retirement plans were:

• Raising the total individual contribution limit, including employer profit-sharing and/or matching contributions, to the lesser of $40,000 or 100 percent of income. Previously it was the lesser of $30,000 or 25 percent of income. 

• Changing the total plan contribution limit. In 2002, employer contributions to the plan may not exceed 25 percent of total payroll. The significance here is that employee contributions are excluded from this limit. Previously, total plan contributions (both employer and employee) could not exceed 15 percent of total payroll of eligible employees. 

The biggest benefits of this plan go to those who earn up to $160,000. This is because 25 percent of $160,000 is $40,000, the maximum limit. If you earn below $160,000 you can contribute 25 percent of your income as the employer, plus up to $11,000 (the maximum employee contribution) to get up to $40,000, rather than simply being limited to 25 percent of salary. A person 50 or older could contribute an additional $1,000 catch-up contribution, for a total of $41,000 in 2002.

Advantages

In addition to the higher limits, the one-person 401k has other advantages. These include:

• All contributions are tax deductible and earnings accumulate on a tax-deferred basis.

• Other retirement plans can be rolled over into the new one-person 401k plan.

• All amounts are 100% vested immediately.

Low paperwork requirements, including being exempt from discrimination testing as long as you have no eligible employees. The only annual paperwork you may be required to file is the IRS Form 5500, which applies when plan assets exceed $100,000. The IRS provides a form 5500EZ that is suited to small 401k plans. 

The ability to take a loan. SEP plans and SIMPLE IRAs, popular retirement plans with small businesses, don't allow loans, although a profit-sharing plan could. The loan is limited to one-half of your account balance or $50,000, whichever is less. 

Annual contributions are not required in the one-person 401k plan. Any amount can be contributed up to the IRS limitation discussed above.

Folks with one-person 401k plans may also take advantage of the new age-50 catch-up contributions, provided they qualify.

Disadvantages

One catch is that it likely wouldn't be cost-effective if your business has any employees who would be eligible for the plan. That's because an employer-employee relationship adds new layers of administrative, fiduciary and financial responsibility. For example, for a very small firm with an owner-employer and a few employees, the employer will likely be required to make mandatory contributions to the employees' 401k accounts in order for the plan to pass its nondiscrimination tests. These tests determine if the plan is offered fairly to all employees.

If you participate in any other plan, with another employer, you must coordinate one-person 401k contributions with that plan so you meet the IRS limits.

Setting One Up

In order to take advantage of this retirement plan for 2002, it must be established by December 31, 2002.

A 401k, like any other financial service, does have a cost. And the cost rises depending on the services you purchase. 

Most one-person 401k plans charge a one-time set up fee. This can range in price from $150 to $300 or more. And you will likely have to pay an annual maintenance fee, with the amount depending on the services you purchase from the plan provider. 

For instance, if you decide you are willing to prepare all the paperwork and do all the record keeping for the plan, you could pay as little as $10 a year. But, if you want another firm to do this job for you it can run $150 a year or more. 

If you are interested in setting up a one-person 401k plan please let us know and we will provide you with a list of providers you can contact.

To contact Feeley & Driscoll, please click here or call us at 1 (888) 875-9770.