Money Management - June 2002

Good News for the Self-Employed

Tax Changes Improve Retirement Planning

by Geoffrey VanderPal

Did you know that a firm as small as one person can establish a 401(k)? This is not a new phenomenon. It just never made sense under the old tax law. However, recent changes in the Economic Growth and Tax Relief Reconciliation Act of 2001 have made the 401(k) much more attractive for these small employers.

How attractive? Consider a small business owner at age 50, with $50,000 in income. Assume the business owner would like to contribute as much as possible to a tax-deferred retirement plan during 2002. By adopting a Simple IRA plan, the owner can contribute a maximum of $9,000. By adopting a profit sharing plan, the owner can contribute a maximum $12,500. However, by adopting a 401(k) plan, the owner can contribute up to $24,500 for 2002.

As you can see, the one-person 401(k) plan offers the small business owner the opportunity to make a much larger contribution to a tax-deferred retirement plan. This strategy even works well for small businesses with certain non-owner employees. Since the contribution amount is entirely discretionary each year, this savings strategy is very flexible. Furthermore, contributions are tax-deductible and grow tax-deferred to make this savings strategy very effective.

Additional incentives found in the new tax relief act add to the attractiveness of the one-person 401(k) plan. For example, the new tax relief act provides small business owners with the ability to take a loan from the one-person 401(k) plan. Loans are now available to shareholders, partners and sole-proprietors on a tax- and penalty-free basis as long as the loan amount does not exceed the lesser of 50 percent of the account balance or $50,000.

Another advantage of the one-person 401(k) plan is the ERISA (Employee Retirement Income Security Act) protection. With the onslaught of litigation, the ERISA protection can assist in protecting retirement assets from creditors, judgments and liens in many cases, with a few exceptions. Some retirement plans such as SEP IRAs, traditional and Roth IRAs and SIMPLE IRAs are protected under most state laws, which provides limited protection instead of the federal protection under ERISA.

Finally, there is no IRS Form 5500 filing expense associated with the initial years of the one-person 401(k) plan. The holder of a one-person 401(k) plan is not required to file an IRS Form 5500 until the assets in the plan exceed $100,000 or until a non-owner employee qualifies for the plan. Therefore, the initial administrative expenses will be minimal. The one-person 401(k) plan savings strategy is most suitable for firms employing only owners (shareholders, partners and sole-proprietors) and their spouses. An experienced financial advisor, an ERISA attorney, or a retirement plan administration firm can analyze the suitability of this strategy for your firm.

Geoffrey VanderPal
Geoffrey VanderPal MBA, CFP, CFS, RFC is branch manager and financial advisor with Raymond James Financial Services Inc. in Las Vegas.