The new rules of the Tax Relief Act of 2001 provide enough reason to cheer about for small business owners. It makes sense to open a Self-Employed 401 (k) Plan that not only provides tax breaks and savings for the future like most retirement plans do, but also provides the following additional benefits:
• The self-employed 401 (k) plans are easy to set up with no administrative hassle and are not expensive to maintain.
• You have the freedom to decide whether to make contribution and the amount of contribution.
• You get the benefit of tax-deferred contributions, going up to three times the amount available with other types of retirement plans.
• The loan option of 401 (k) can be used to get loan amount of up to $50,000 or one-half of the account balance in 401 (k). One can spend the loan amount for any purpose and no penalty is charged if the amount is repaid back on time.
• The facility to consolidate assets into Self-Employed 401 (k) from the traditional IRA or other retirement plans.
The 401 (k) can be opened by business of any type, and with no employees, and is known as Self-Employed 401 (k) or Solo 401(k). The business can be a newly started one or an old business and can be of sole proprietorship, partnership, LL.C or a corporation. The plan has to be set up within 31st December for availing tax deductions for that tax year.
A Solo 401 (k) plan can be established by a self-employed business owner with one-person administration. This type of plan helps self-employed businesses with no employees except spouse to start a structured retirement plan.
Self-employed 401(k) plan could be established by any sole proprietor, corporation, partnership or S Corporation. Anybody owning a business can make contribution into a Solo 401 (k) plan, the amount being 100% of total compensation or $42,000, whichever is less. There is the option whereby participants can defer a maximum compensation amount of $14,000 along with 25% of the total profit sharing amount into the plan.
Owners of Self-employed business which is 50 years or more old can also become eligible for 401 (k) plan by contributing an additional $4,000 every year through catch-up provision. Both Solo 401 (k) and Self-employed 401 (k) provide high contribution limits with practically no administration and no costly tests of discrimination. The rules for both Solo 401 (k) and Self-employed 401 (k) are quite relaxed.
If before starting your own business, you were having an IRA or some other 401(k) plan, there is the rollover option for these plans into a Solo 401(k). The plan provides one to decrease or completely stop their contributions at any time.
However, the eligibility requirements are quite strict for establishing self-employed 401(k). Most investment companies do not offer self-employed 401(K) Plan and those who do provide this type of plan offer limited investment options.
The rules are such that the moment a single employee is added to the business other than the spouse, you have to convert your Self-employed 401 (k) plan into the traditional or the simple 401I (k) plan.