NFIB

A 401(K) for the Independent Business Owner
08/ 27/ 2002

Consultants, independent contractors and owner-only businesses can now have their own 401(k), enabling greater savings than SEPs and Keoghs, regardless of whether the business is incorporated or unincorporated.

Since the 1099 personnel obtain these plans on their own, there is no cost to the company hiring them. For approximately $100 per year, an Individual 401k plan can be established. Other retirement accounts can be rolled into this one account (excluding Roth IRAs) so that account holders with retirement accounts from former employers can consolidate. There is no complex administration or discrimination testing because the plan is for one person.

Since this is a 401(k), it is possible for the small business owner to take a loan from the account, without tax or penalty if repaid according to IRS guidelines. This is a major advantage over SEPs, which don't allow loans to sole proprietors.

Each year, the account holder has the choice whether or not to invest and how much to invest. There is no required minimum contribution. Individual 401k contributions are tax-deductible by the business and grow tax-deferred until withdrawn. Plans can be obtained from a financial consultant and, depending on the plan used, may contain mutual funds only or may be self-directed plans, giving a choice of investments (stocks, bonds, mutual funds, etc.). Vesting is 100 percent immediate.

In addition to making a full company contribution of up to 25 percent of compensation, an owner may contribute $11,000 in salary deferrals to the plan, or $12,000 if over age 50. The maximum combined amount an individual may receive per year is $40,000, or $41,000 if over age 50. The business receives a deduction for both the salary deferral and employer contributions. Contributions are not subject to federal tax but are subject to self-employment taxes.

When the account value reaches $100,000, an annual IRS 5500 filing is required. But no filing is required until such time. Account withdrawals are taxable and, if made before age 59, may be subject to a 10 percent penalty.

If you are planning to add employees in the near future, the Individual 401k is probably not your best option. But if you have part-time employees who work less than 1,000 hours per year, they can be excluded. Be sure to discuss retirement plan options with an investment professional to determine which plan is most suitable for your business.

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Clare Mertz-Lee is a financial consultant at Janney Montgomery Scott in Albany, N.Y. She can be reached at cmertzlee@jmsonline.com.

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