If you are self-employed, the passage of the EGTRRA tax act in 2001 may make a single-person 401k plan a viable alternative to other retirement plans for owner only small businesses. You can even add a spouse who you employ.
Individual 401k (aka, Solo 401k)
Like traditional 401k plans, individual 401ks have many of the same guidelines. If you own an incorporated business, and you're the only employee, you may want to look into the individual 401(k), often referred to as a solo 401(k). Like other 401(k)s, these plans allow you to defer salary up to the maximum - $15,000 in 2006 — plus the annual catch-up contribution of $5,000 if you're 50 or older. Keep in mind, the catch up contribution can be made as long as you will be age 50 by the end of the calendar year.
In addition to your contributions, your business which is your employer, can contribute up to 25% of your earnings. The combined cap is $44,000 in 2006, plus the catch-up contribution if you qualify to take it.
To compare, a SEP-IRA — another retirement plan that's available to sole owners and other small businesses won't allow you to defer salary. So unless your compensation is $220,000 or above, the total that could be contributed to your SEP-IRA would be less than the total you could put into an individual 401(k).
An individual 401(k) may offer several other advantages as well:
*It is relatively inexpensive to set up and administer (generally $75-$150 / year).
*It allows rollovers from other qualified plans and tax-deferred traditional IRAs, so you can consolidate your retirement assets and invest them as you see fit. This may provide a benefit if you are investing in loaded mutual fund shares as it may help you qualify for a breakpoint
With most individual 401ks, you can take a loan from your account, which isn't possible with a SEP-IRA or regular IRA.
Since there aren't other participants, except possibly your spouse or business partner, there are no ADP/ACP testing requirements to demonstrate that the plan is being administered fairly.
Rules for contribution limits and distributions are the same as ordinary 401k plans.