The Solo 401(k) Plan

Changes to the pension protection act of 2001 created the Solo 401(k) plan. Thanks to these tax-law changes, the Solo 401(k) is revolutionizing the way many self-employed individuals like physicians save for retirement.

Never before have the self-employed been afforded the same advantages and protections that traditional 401(k) participants have maintained. SEP IRAs, SIMPLE IRAs and Traditional 401(k)s were created with the self-employed business owner as a secondary consideration.

Small businesses looking to offer low-cost retirement plans for their employees could use these plans, but found that often these plans were more advantageous for the employees than the employer. Now, with the advent of the Solo 401(k) plan, the self-employed may defer more of their 1099 income while simultaneously saving for their retirement.

Who is eligible?

A Solo 401(k) is available to self-employed individuals or business owners with no employees other than a spouse. Entities such as sole proprietorships, partnerships, corporations and "S" corporations are eligible. This plan offers tax advantages that reduce your current income taxes, allowing you to deduct the entire amount of your plan contributions from your taxable income each year.

What are the benefits?

Traditionally, self-employed retirement plans required small business owners to make a lot of money to reach the maximum contribution limits set by the plan. The Solo 401(k) has higher contribution limits than traditional retirement plans and allows tax-deductible 401(k) salary deferrals to the plan of up to $15,500 for 2008. Additionally, if you are age 50 or older, you can make an additional catch-up salary deferral contribution of $5,000 for 2008. The plan also lets business owners make tax-deductible profit-sharing contributions of up to 25% of compensation, with an annual maximum of $46,000 for the 2008 plan year.

The differences between the maximum Solo 401(k) contribution when compared to the SEP IRA can be substantial. A self-employed business owner who is age 50 with $100,000 in compensation may save up to $20,000 more with a Solo 401(k) than with a SEP-IRA or Profit Sharing Plan, and you may convert many already created retirement plan accounts. Please check with your CPA or attorney to determine if the Solo 401(k) is right for you.

Another benefit of the Solo 401(k) not offered to the SEP IRA are participant loans. If the plan document has a loan provision, participants of the Solo 401(k) may borrow a portion of the account value. Tax-free loans are permitted in a Solo 401(k) up to 50% of the total 401(k) value with a maximum of $50,000.

Who is the administrator?

Solo 401(k) plans are easy to administer and must have a third-party plan administrator—someone who ensures the plan is operating according to the plan document, tax laws and qualified plan rules and regulations. While the employer or spouse usually acts as the plan administrator, another person at the company or your accountant can serve in this capacity. Consult with your attorney, tax advisor or benefits consultant to find out more information on the Solo 401(k) plan.

Once you decide that a self-directed Solo 401(k) is the right choice to achieve your retirement objectives, your self-directed IRA custodian or other advisor can assist in facilitating that decision.

Paul Maxwell is Executive Vice President and Chief Operating Officer for Trust Administration Services, a division of First Regional Bank. He is an expert in self-directed retirement plans, has served as a Trust and Compliance officer for 16 years and actively lobbies for retirement benefits.