401k-Type Plans for One-Person Businesses

The one-person 401k is now a regulatory reality. Below is information about 401k plans for an individual (and his or her spouse). To read about our one-person 401k plan and plan administration product, which, like all our products, offers that desirable duo of affordability + investment flexibility, see our 401k Census for One section within our Products page.

The 401k plan's popularity lies in that it enables people to shelter a significant portion of their income from current income taxes. In some cases, a 401k plan enables a person to shelter more than twice as much as do other qualified retirement plans (money purchase pension plans, simplified employee pension (SEP) plans and savings incentive match plans for employees (SIMPLEs), more specifically). Until recently, however, a 401k plan needed multiple plan participants. It was not an option for one-person companies and the like — again, that is, until 2002. The one-person 401k plan is now a reality.

An estimated 18 million one-person business owners are eligible to participate in one-person 401k plans. Eligible businesses include corporations, sole proprietorships and non-profit organizations. From the accountant to the lawyer, doctor, software programmer and real estate agent, among others, who hangs his or her own shingle, the one-person 401k is now a possibility.

One-person 401ks are designed for owner-only businesses (including spouse) and businesses with employees who can legally be excluded from participation using federal plan coverage requirements.

The One-Person 401k's Advantages Over SEP IRAs and SIMPLE IRAs

One-Person 401k plans can be used for incorporated and unincorporated businesses, including C corporations, S Corporations, single member LLCs, partnerships and sole proprietorships. Real estate brokers, consultants, attorneys, manufacturers representatives, interior designers, retirees starting a new business and other professionals who work by themselves are prime candidates.

Under rules created by changes in the Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA) that became effective in January 2002, a business consisting of only an owner or an owner and his or her spouse, can make greater tax-deductible contributions in a one-person 401k than under a SEP-IRA or SIMPLE IRA. Contributions are discretionary, so owners can vary them from year to year or skip them altogether.

Total tax-deferred contributions to a one-person 401k cannot exceed 100% of pay, up to a maximum of $41,000 for people younger than age 50. This amount includes salary deferrals of up to $13,000 ($16,000 if age 50 or older) plus an employer contribution of up to 25% of pay (20% for self-employed). While SEP-IRA contributions also max out at $41,000, they are limited to 25% of pay (20% for self-employed). And, SEP-IRAs do not provide for additional catch-up contributions. With a SIMPLE IRA, employees under age 50 can defer up to $9,000 this year, while those age 50 or older can contribute up to $10,500. The employer can make additional required contributions.

Under these guidelines, a business owner under age 50 with earned income of $100,000 who is the sole employee of his business could contribute a maximum of $25,000 to a SEP-IRA, $12,000 to a SIMPLE IRA, and $38,000 to a one-person 401k (consisting of a $13,000 salary deferral plus an employer contribution of $25,000). Someone with $150,000 in W-2 income could contribute as much as $37,500 to the SEP-IRA, $13,500 to the SIMPLE IRA, and $41,000 to the one-person 401k.

The ability to make generous contributions at lower income levels means that business owners who want to catch-up on retirement contributions can do so more quickly than they could with a SEP-IRA or a SIMPLE IRA. Someone in his 50s with $100,000 in income could put away $41,000 for retirement this year with a one-person 401k; that amount of tax-deferral is not possible with a SEP or SIMPLE IRAs.

Retirement plan experts say that investment flexibility, and possible increased protection of personal assets from litigation, in addition to higher contribution levels, are additional the major draws of one-person 401k plans. The plans can accept rollovers from virtually any type of retirement plan, including a corporate 401k or an IRA. Business owners can also borrow the lesser of 50% of the plan balance, or $50,000. Loans are not allowed from SEP and SIMPLE IRAs, or IRA Rollovers.

The one-person 401k loan feature is a powerful advantage for business owners who may need quick, short-term access to their money without incurring the taxes and penalties associated with taking an early distribution from a rollover IRA. A lot of people are using a one-person 401k to consolidate existing retirement accounts, then borrow against the plan.

For someone under age 59 ½ who has left a job and is strapped for cash, the loan feature can be a way to get money out of a 401k without facing the penalties and taxes associated with a premature retirement plan distribution. The only requirement to establish an account is that you have self-employment income; a person between jobs and doing consulting work would qualify. Loans must be repaid according to IRS guidelines, as they would with a corporate 401k, or they become subject to taxes and penalties.

When considering establishing a one-person 401k, look for:

  • A broad spectrum of no-load investment options.
  • The option to use a self-directed discount brokerage account.
  • A loan feature, as that may come in handy in a family emergency.
  • The ability to easily and affordably convert to a standard 401k should your business grow to where you are adding employees and want them to be able to participant in the company 401k plan.

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