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Put
Away More for Retirement
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If your business is essentially a one-person operation,
there's a relatively new option to help you save more money
for retirement: The Solo 401(k) plan.
Ordinarily,
traditional defined contribution retirement plans allow annual
contributions of either 25 percent of salary if you're
employed by your own S or C corporation or 20 percent
of self-employment income
if you operate as a sole proprietor or single member LLC. But
traditional profit sharing plans, Keoghs or SEP plans are
subject to a $44,000 cap for 2006 (up from $42,000 in
2005).
Not bad, but with a Solo 401(k) plan, you can probably make
substantially larger contributions that lower your tax bill
and generate more tax-deferred earnings for retirement.
A Solo 401(k) is made up of two
separate parts. Together, the two parts make the plan
advantageous:
1.
Elective deferral contribution - As much as 100
percent of the first $15,000 of your 2006 salary or
self-employment income can be put into an account. That amount
increases to $20,000 if you are 50-years-old or older at year
end. For later years, the contribution limit rises according
to the following schedule:
2.
Additional employer contribution - Your employer
(your company or you personally) can contribute an additional
25 percent of your salary or 20 percent of your
self-employment income.
The sum of the two
parts is capped at 100 percent of your annual employee
compensation or self-employment income, or $44,000 in 2006
($42,000 in 2005) whichever is smaller. (However, the cap is
higher for people age 50 or older). A Solo 401(k) doesn’t
force you to contribute more than you can comfortably afford:
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Contribution
Cap
Here is the
annual dollar limit on combined elective deferral and
employer contributions:
 For 2006, the cap is $44,000 or
$49,000 if you are age 50 or older (up from $42,000 and
$46,000 for 2005,
respectively). | The plan lets
you rack up major tax savings in good years, by making maximum
contributions, but gives you the option of contributing less —
or even nothing — in lean years when you need to conserve
cash.
Plus, you generally get the benefits of
traditional 401(k) plans, such as the ability to borrow from
your account.
Establishing and operating any 401(k)
plan means some up-front paperwork and ongoing administrative
effort. With a solo 401(k), however, the administrative work
is simplified since you are the only participant.
There are a couple of caveats:
If you earn a very high income and are
younger than 50, the Solo 401(k) may not permit larger
contributions than a traditional plan because of the annual
$44,000 cap in 2006 ($42,000 in 2005). In general, you
should only set one up if it allows significantly larger
contributions because a Solo 401(k) costs more to
operate.
If you have employees (other than your
spouse), you may also have to contribute to their accounts.
In this case, you have a regular 401(k) plan that is subject
to a bunch of complex rules.
Ask your tax adviser to sort out the complexities of
various retirement plans and determine whether a solo 401(k)
is right for you.
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