An Individual 401(k) plan, also known as a Solo 401(k), is a retirement plan designed for individuals who are the only owner in their small business or someone who owns the small business together with their spouse. The business cannot have any employees other than the owner’s spouse. This type of plan was created as part of the Economic Growth and Tax Relief Reconciliation Act of 2001, which became effective January 1, 2002. The Individual 401(k) is most beneficial to small-business owners who want to make substantial contributions toward their retirement.
The Benefits
Higher Contribution Limits
For 2013, the total contribution limit for an Individual 401(k) plan is $51,000 ($56,500, if age 50 or older). This limit is comprised of two components: salary deferrals and annual profit sharing contributions. Salary deferrals are tax deductible by the employer as employee wages, and are limited to $17,500 in 2013 ($23,000 if age 50 or older). The annual profit sharing contributions are deductible by the employer as business expenses and are limited to 25% of the employee’s wages. The sum of the employee’s deferral and the employer contribution for each employee may not exceed $51,000 for 2013.
For example, Joe is age 40 and his wages are $250,000. He elects to defer $17,500 to an Individual 401(k) plan. Joe’s small business elects to maximize the employer contribution to bring Joe to the maximum funding limit for 2013. The employer contribution for Joe will be $33,500. This is calculated by taking Joe ‘s wages of $250,000 times 25%, equaling $62,500, which exceeds the $51,000 limit for 2013. Since the total contribution is limited to $51,000, subtract Joe’s deferral of $17,500, leaving $33,500—the maximum for the employer contribution.
In comparison to other retirement choices, such as a Roth or Traditional IRA where your contribution is limited to $5,500 ($6,500 if age 50 or older), an Individual 401(k) allows for much larger contributions to be made.
Access to Tax-Free Loans
Most Individual 401(k) plans have a loan provision. You can take tax-free loans from your plan up to 50% of the plan’s total value, with a maximum loan amount of $50,000. The loans generally have a payback term of five years, unless the loan is used toward the purchase of a primary residence. For this scenario, the term of the loan is usually extended beyond five years.
Low Cost and Easy Maintenance
Compared to Traditional 401(k)s, Individual 401(k) plans are relatively easy to setup and inexpensive to maintain. The administration is minimal, and there are no complex nondiscrimination tests to conduct. All you need to get started is an Employer Identification Number (EIN). The plan must be established by December 31st of the year you would like to receive the tax deduction.
It is important to realize that when your plan balance reaches $250,000 or more, you are required by law to file Form 5500, Annual Return/Report of Employee Benefit Plan, (or 5500-EZ), annually.
Standard Rules Apply
Like many other types of retirement plans, assets in the Individual 401(k) grow tax-deferred until they are withdrawn. The 10% premature distribution penalty still applies if you withdraw the funds before the age of 59½. And similar to most other types of retirement plans, when you reach age 70½, there are mandatory minimum required distributions.
How We Can Help You
If you are interested in setting up an Individual 401(k) plan and would like assistance in opening your plan, please give us a call at 770-429-9166. We will be happy to help you through the process. Henssler Financial can also assist you in preparing and filing your 5500/5500-EZ return when required.
Disclosures
This article is meant to provide valuable background information on particular investments, NOT a recommendation to buy. The investments referenced within this article may currently be traded by Henssler Financial. All material presented is compiled from sources believed to be reliable and current, but accuracy cannot be guaranteed. The contents are intended for general information purposes only. Information provided should not be the sole basis in making any decisions and is not intended to replace the advice of a qualified professional, such as a tax consultant, insurance adviser or attorney. Although this material is designed to provide accurate and authoritative information with respect to the subject matter, it may not apply in all situations. Readers are urged to consult with their adviser concerning specific situations and questions. This is not to be construed as an offer to buy or sell any financial instruments. It is not our intention to state, indicate or imply in any manner that current or past results are indicative of future profitability or expectations. As with all investments, there are associated inherent risks. Please obtain and review all financial material carefully before investing. Henssler is not licensed to offer or sell insurance products, and this overview is not to be construed as an offer to purchase any insurance products.
