e owner is over age 50, that number grows to $14,000 thanks to a catch-up provision. Now the fun begins: The owner can then combine a profit sharing plan with the 401(k) and put even more money away.
Yes, a profit-sharing plan does require that you put away money for all employees. That is why if you are the only employee, or if the business is family run, this plan is optimal.
That profit sharing plan will allow you to defer another 25% of salary up to a maximum of $40,000.
For the business owner who is taking too much income, accelerating them into too high a tax bracket, this is a way to defer a huge chunk of income pre-tax. Some examples:
Example 1: John Jones had compensation of $116,000 in 2002.
®′ SEP contribution – $29,000 (25% of compensation)
®′ 401(k) profit sharing plan contribution – $40,000 (25% of compensation + 401(k) elective deferral)
Difference – $11,000 more in qualified plan program
If an individual earns $116,000 or less, the qualified retirement program will always have at least an $11,000 advantage.
Example 2: Bob Davis is 25 years old, and had $160,000 in compensation in 2002.
®′ SEP contribution – $40,000
®′ 401(k) profit sharing plan contribution – $40,000 ($29,000 profit sharing + 401(k) elective deferral)
®′ Defined benefit plan contribution – $11,000
Difference – $11,000 more in qualified plan program
The individual 401(k) plan works for anyone who is self-employed, regardless of the legal form of their business – corporation, partnership or a sole proprietorship.
Ease of Use
Aside from tax and retirement savings, you may also choose to allow plan participants to take out personal loans from their accounts – including yourself. And, all of these benefits can be reaped without having to shell out any of the added expense of having a classic 401(k) plan.
Also, as far as filing and testing requirements, as long as the plan is a one-person plan and the assets are under $100,000, testing and 5500 filing are not required. That means no third-party administrator and the fees and hassles that go along with them.
If you add a person or the assets exceed $100,000, you will need to file a 5500 tax form. If the person you have added is someone other than your spouse, your plan will then have to be tested. In most cases, though, the benefits in tax and retirement savings far outweigh the cost of the administration of the plan.
Although this qualified plan strategy will benefit any type of individual business owner, regardless of income level, it is especially useful for individuals who want to shelter substantial amounts of taxable income while maximizing their retirement savings. Take advantage of the revolution and make today the first day of the rest of your financial life.
James Ernst is a partner and vice president with Mangan, Ernst, & Rankin Wealth Management Group in Marlton, N.J., and is both an Accredited Asset Management Specialist and a Chartered Mutual Fund Counselor. He can be contacted at [email protected].
