Solo 401k And Individualk For The Sole Proprietor

Retirement planning for the small business person has an unfortunate tendency to be forgotten under the press of seemingly more urgent concerns. When the issue does come up, it seems that, for entrepreneurs, the 401K is not a strong contender despite the existence of the Solo 401K and IndividualK plans. It is often believed that 401Ks have relatively low limits on contributions and are, in any case, really only suitable for bigger businesses.

Solo 401K and IndividualK plans were made more useful when EGTRRA (Economic Growth and Tax Relief Reconciliation Act of 2001) modified the legislation. So if you are self-employed these plans can now constitute a worthwhile addition to your retirement funding as well as helping reduce your taxes.

Reading about 401K plans can lead you to believe that the allowable contribution limit for 2007 is $15,500 (plus an additional $5000 if you are over 50 and are eligible for a catch up contribution). This is not the full story. A company contribution for an employee can also be made to a 401K. However, it may not be clear how this can work for you as an entrepreneur.

The base contribution that you make yourself, as an employee, is called an "elective salary deferral." Beyond the salary deferral, as an incorporated business you can give yourself a "profit-sharing" contribution at the maximum rate of 25% of eligible pay. And there is no deduction for the amount of the salary deferral. However, if your business is unincorporated, you would need to deduct the salary deferral from your self-employment income before calculating the potential 25% maximum. If you were eligible for, and made, a catchup contribution that also needs to be deducted since the 25% applies to net self-employment income.

However your business is set up, you can use a Solo 401K as a valuable addition to your retirement planning. Using a 401K you can reduce your taxes because the contributions are made pre-tax and all interest, capital gains or other earnings will not be subject to taxes until you begin to withdraw funds.

There are, naturally, other contribution limits involved. The 2007/2008 limit of $15,500 for the elective salary deferral is called the 402g limit. The limit is indexed to inflation and is adjusted in $500 increments. The same holds true for the catch up limit which is currently set at $5000. The section 415 limit sets the total amount that can be contributed adding together the employee, or elective salary deferral, and the employer, or profit-sharing, contributions. For 2007 that limit is set as the lesser of 100 per cent of the employee salary or $45,000 (plus, if it applies, the $5000 catch-up). In 2008, the section 415 limit increases to $46,000.

A nice feature of the Solo 401K is that they can be set up as self-directed 401Ks. This would allow you basically total control over your contributed funds in terms of how they are invested. Essentially, with this sort of setup you can invest in nearly anything. With the investment options available and the capability of making substantial pre-tax contributions, investigating how a Solo 401K or IndividualK could be integrated into your planning for retirement makes a great deal of sense for an entrepreneur.