Is a Solo 401K for You

For the busy entrepreneur with a small business, planning for retirement tends to get lost among the day-to-day details involved in staying on top of things. Even when the thought does make it to the surface, the business person rarely considers the possibilities of a 401K despite the availability of what are known as Solo 401K or IndividualK plans. Some believe that the 401k plans only allow fairly low contributions and are also too complicated and expensive for the sole proprietor.

The Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA) made some changes to the law which enhanced the option of an IndividualK or a Solo 401K for the entrepreneur, making them potentially excellent choices for part of your retirement planning. And, of course, they can be used to reduce your taxes.

Unless you are careful with your fact checking you may find yourself believing that the 401K maximum contribution for 2007 is $15,500 (not counting the catch up contribution of $5000 for those over 50). There is actually a bit more to it than that. A company contribution for an employee can also be made to a 401K. However, it may not be clear how this can work for you as an entrepreneur.

The base contribution that you make yourself, as an employee, is called an "elective salary deferral." Next, with an incorporated business, you can, as employer, give yourself as an employee a "profit-sharing" contribution which can be as much as 25% of your eligible pay and there is no deduction for your salary deferral. If you are unincorporated, the rule is slightly less favorable and limits you to a 25% profit-sharing contribution on net self-employment income which means the $15,500 (plus, if applicable the additional $5000) salary deferral would reduce your net income.

However your business is set up, you can use a Solo 401K as a valuable addition to your retirement planning. Since the contributions and the interest or other earnings from the 401K are not taxed until withdrawn, you also can substantially reduce your tax liability.

For a little further clarification on the limits related to 401K, we have some more number soup. The $15,500 2007 and 2008 limit on the elective salary deferral is known as the 402g limit. Unsurprisingly, that is the section that specifies that limit. Since this limit is indexed to inflation, it may increase as may the catchup contribution. Both increase in $500 steps. Now, the actual, total possible contribution adding in both the employee and employer contributions is set by section 415. Section specifies the 2007 limit to be the lesser of $45,000 (plus the catchup contribution) or 100% of the employee salary. This will increase for 2008 to a maximum of $46,000 plus the catchup if it applies.

Being able to establish a Solo 401K as a self-directed 401K allows a wide range of investment options giving you a great deal of control and flexibility in how you apply your funds. Since you would have the ability to make fairly large pre-tax contributions as well as enjoy considerable freedom in making your investments, checking into a Solo 401K or an IndividualK plan to see if it fits into your retirement funding program is a good idea for any self-employed person.

Focused on retirement planning and options, 401K-and-IRA.com provides additonal information on 401K rules for retirement plans and the 401K limits on tax deferred contributions.