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Self-employed? Consider a solo 401(k)

If you're an entrepreneur trying to maximize your retirement savings, consider opening an individual 401(k).

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A 401(k) plan used to be only for someone who worked for a corporation, but no more. Owners of very small businesses now can open 401(k)s and shelter thousands more dollars than they could have in other kinds of self-employment retirement accounts.

The plans, often called individual or solo 401(k)s, are available to businesses that have no other employees beyond an owner and a spouse, although some partnerships can qualify. That means sole proprietors, owners of mom-and-pop companies, even people who work for someone else but have a side business, can open one.

They are becoming so popular that virtually every mutual fund and investment management company is offering them or plans to very soon. 401khelpcenter.com, a Portland, Ore.-based clearinghouse of plan information and analysis, maintains a lengthy document that lists providers of these plans.

A solo 401(k)'s big advantage? The opportunity to set aside much more tax-sheltered retirement money than allowed by other self-employed retirement options.

But it's not just the added money you can shelter from taxes that makes the plan so appealing. It's also the account's flexibility. Solo 401(k) accounts offer new investment options and loan opportunities.

More retirement money
The annual solo 401(k) contributions consist of two parts.

First, you, as the employee, can put in up to 100 percent of the first $12,000 of your 2003 net self-employment income. As with major-corporation counterparts, this is a deferred-salary contribution, meaning that the Internal Revenue Service does not tax the money you put in the account. Other plans limit contributions to a much smaller percentage of self-employment income.

The contribution limit is scheduled to increase $1,000 a year until it hits $15,000 in 2006. Similar to other tax-favored retirement plans, you can contribute extra if you'll be 50 or older by Dec. 31. For 2003, the catch-up amount is $2,000 and it increases by $1,000 a year for the next three years.

Then there's the company component. You can contribute an additional 25 percent of your compensation income if your business is incorporated, or 20 percent of your self-employment income if you are a sole proprietor.

The maximum total contribution allowed to an individual 401(k) this year is $40,000; $42,000 if you are 50 or older.

If your spouse is part of your incorporated business or provides your sole proprietorship some services for which you pay him or her a fee, each of you can open a solo 401(k).

"That's the beauty of this," says Shannon McLaughlin, vice president of retirement technical services for Pioneer Investment Management, the first company to market the plans. "Whether you're a full-time real estate agent or someone who just picks up a little consulting income, you're eligible to set one of these up."

The accounts, however, are not for extremely successful entrepreneurs. McLaughlin says that if your self-employment income is above $200,000, some other plan types could help you shelter even more.

Solo 401(k)s do work particularly well, though, for people who have full-time jobs and also run a business on the side.

 
 
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