The benefits of individual 401(k) plans.

• Author: Wollenberg, John

As more taxpayers become self-employed during these difficult economic times, more face the important decision of choosing the most advantageous retirement plan for themselves. This item highlights the features of the still relatively new individual 401(k) plan and shows how, in certain circumstances, this type of plan can provide for a more powerful contribution.

The Economic Growth and Tax Relief Reconciliation Act of 2001, P.L. 107-16, authorized self-employed individuals to add a 401(k) feature to their profit-sharing retirement plans. This change astutely recognized the dual roles every self-employed person plays, one as the employer and the other as the employee.

As the employer, a self-employed 40 l(k) owner can make a profit-sharing contribution of up to 20% of earnings (25% of net earnings). As the employee, the self-employed individual can make elective deferrals of up to $16,500 in 2009 ($22,000 if age 50 or over). By combining these two contribution components, some self-employed 401(k) plan owners (or members of LLCs) may be able to reach the maximum 2009 total contribution of $49,000.

By comparison, simplified employee pensions (SEPs) or profit-sharing Keogh plans would allow 2009 contributions for the self-employed to the extent of the lesser of 20% of earnings or $49,000.

Illustration

As a comparison, the exhibit above demonstrates the increased contribution and corresponding deduction available to those self-employed taxpayers who select an individual 401(k) with Schedule C income (after expenses) of $100,000.

With a Schedule C net profit of $100,000, a self-employed individual choosing an individual 401(k) type retirement plan instead of a SEP will be in a position to contribute $35,087 rather than $18,587, an increase of...