401(k) Plans Are Not Just For Big Businesses

A significant portion of the small business market consists of one person businesses. If you have a client whose business is a one person operation, s/he may be a perfect candidate for a Solo 401(k) Plan. A Solo 401(k) plan is a 401(k) plan for a one-person business and may offer your client an opportunity to increase his or her tax-deductible contributions to his/her retirement plan. Additionally, if you have a client who is thinking of establishing a SIMPLE or SEP Plan, a Solo 401(k) may be a better choice that will help enable your client to maximize his or her tax-deductible contributions, and to help meet his/her long range retirement goals.

First, it’s important to understand that Profit Sharing Plans and SEP Plans allow for flexible employer contributions up to 25% of participating payroll. SIMPLE Plans only allow for employee deferral contributions which are limited to $12,000 plus a $2,500 catch-up contribution for participants age 50 or older, as indexed for 2014, but do not allow for flexible employer contributions. Since all 401(k) plans are profit sharing plans with a cash or deferred arrangement (CODA), which allow employees to contribute or defer a portion of their salary into the plan, in addition to the employer profit sharing contribution, a business owner may make both an employer and an employee deferral contribution all in one plan for himself or herself.

This means a business owner with no employees and earning $100,000, could set up a Profit Sharing Plan or SEP Plan, and make a maximum tax-deductible contribution of $25,000. However, since a plain Profit Sharing Plan or a SEP Plan only allows for employer contributions, the business owner may be limiting the amount of money that can be put aside for retirement, as well as the tax savings, with just a plain profit sharing plan or SEP Plan. By adding a 401(k) deferral element to a Profit Sharing Plan, the business owner has just increased the amount that can be contributed on a tax-deductible basis on his or her own behalf.

Let’s look at an example: There is a limit on the overall contribution that can be allocated to any individual in a profit sharing plan or SEP Plan. For 2014, the limit is 100% of compensation up to a maximum of $52,000, as indexed for 2014. The maximum individual deferral amount, as indexed for 2014, is $17,500. In addition, a participant who is age 50 or older, is eligible to make a catch-up contribution of $5,500, as indexed for 2014, for a total salary deferral contribution of $23,000. SEPs do not allow for deferrals nor a catch-up contribution, although a Profit Sharing/401(k) Plan does. So the same business owner described above could establish a solo Profit Sharing/401(k) Plan and increase his contribution amount to $48,000 which is an increase of his or her deductible contribution by 90%. The chart below illustrates a comparison of the maximum contributions applicable to each plan for a 50 year-old business owner at different salary levels.

Business Owner’s Salary

( age 50 or older)

SIMPLE IRA

Plan Max. Deferral

(Including Catch-up Contrib..)

SEP -IRA

Plan

Maximum Contrib. of 25%

Profit Sharing/401(k)

(Including

Deferrals and

Catch-up

Contrib.)

$100,000

$14,500

$25,000

$48,000

150,000

14,500

37,500

57,500

200,000

14,500

50,000

57,500

Here’s more good news: An existing profit sharing plan may be easily amended to become a Profit Sharing/401(k) plan. In addition, contributions previously made to a SIMPLE or SEP Plan, may be rolled over, in most cases, to a Profit Sharing/401(k) plan. Furthermore, there are no reporting requirements associated with a one-participant plan or a one participant and spouse plan, until the plan assets total $250,000 or more. Even then, only a Form 5500EZ is required to be filed.

Another important benefit to establishing a Profit Sharing/401(k) Plan is that the business owner may purchase life insurance on a tax-deductible basis by purchasing it through the Profit Sharing/401(k) Plan Trust as long as the premiums are within the incidental benefit limits. This is not allowed in a SIMPLE or SEP Plan as the funding vehicle is an IRA. Profit Sharing/401(k) plans also have special rules associated with life insurance limits not available in any other type of qualified plan, such as using rollover or seasoned money to buy life insurance.

The foregoing information regarding estate, charitable and/or business planning techniques is not intended to be tax, legal or investment advice and is provided for general educational purposes only.  You should consult with your tax and legal advisor regarding your individual situation.

Contact Connie Dello Buono 408-854-1883 motherhealth@gmail.com to have a free 30-min chat with a financial advisor.

Info expires Dec 2014

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