An Overview Of Self Employment 401k Plans

Also referred to as solo 401ks, uni-ks or solo-ks, a self-employed 401k is nothing new. It is a basic 401 k plan that applies to a single small-business owner with no employees and perhaps their spouse. The 2002 change in the EGTRRA tax law made some changes in how salary deferral contributions affect the maximum deduction limits for contributions to a 401k plan. The government intended this change to assist the self-employed to put more money away for retirement, and it has generally achieved its goal.

In effect, self employed retirement plans allow a small business owner to shelter a higher percentage of his or her income from taxation. The law raised contribution limits and allows a person to roll over money from existing IRA or other retirement accounts. Money put away in these 401ks can be pre or post tax. Money that a self-employed person feeds into one of these accounts will be less-taxed, thereby increasing the amount of money they will be able to access upon retirement.

A self employed 401k plan is intended for businesses with a single employee or co-owners and perhaps their spouses. Even taking on a single employee may cause a person to become ineligible. Freelancers, independent contractors, sole proprietors, or co-owners in a partnership, Limited Liability Company (LLC) or corporation (FREE QuickBooks Simple Start with your LLC or Incorporation filing), if they have no employees, are best served by these plans.

Self employed 401k contribution limits change each tax year based on inflation. In 2009, the maximum contribution amount for a sole proprietor was $49,000, $54,500 if they are age 50 or above. Participants can choose to donate pre-tax, post tax, or a combination of the two. The advantage to making after-tax contributions, otherwise known as tax once and done, is that neither the principal not the growth will be taxed when withdrawn. It can also be beneficial to make a before-tax, or tax-deferred contribution. These will be tax deductible in the year in which you put the money aside and will grow without your having to pay taxes, though you will have to pay taxes upon withdrawal when you retire. The advantage of one over the other depends on the amount you are putting away and your overall financial picture. Specific contribution amounts, limits, and regulations are based on net earned income.

Another interesting change made to some individual 401k plans is that often, a business can take out a tax-free loan from a solo 401k. This can be helpful in many situations, but must be approached carefully, as a misstep in repayment can mean costly penalties.

Self-employed 401k plans are a great option for many people. As always, it is best to consult with a professional in order to determine which plan is right for you and your situation. These plans are intended to help a small business owner plan for retirement and can be very effective if appropriately used.