Solo 401(k)   A “Solo 401(k)” is a regular 401(k) plan that covers only a business owner, or the business owner and his or her spouse. In such a plan, the business owner plays two roles, that of employee and that of employer.   How It Works   • As an “employee,” the business owner can choose to either receive cash (salary or bonus) or defer the funds into the 401(k) plan. If the 401(k) plan is chosen, these “elective deferrals” are not subject to current income tax, but are subject to FICA and FUTA payroll taxes.   1.  For 2004, employee deferrals are limited to $13,000. Additional deferrals of $3,000 may be made if the individual is age 50 or over.   • As the “employer,” the business owner may also contribute to the plan. For 2004, the employer’s deductible contribution is limited to 25% of the employee’s compensation.
2.  Employer contributions are not currently taxed to the employee.   • In 2004, total 401(k) contributions (from both employer and employee) are limited to the lesser of 100% of the employee’s compensation or $41,000. Assets in the plan grow on a tax-deferred basis. Distributions are generally taxed as ordinary income.   • All 401(k) plans must meet prescribed nondiscrimination tests. Plans in which the business owner, or the business owner and spouse, are the only employees, effectively avoid this issue. Just one additional eligible employee, however, can trigger these nondiscrimination requirements, increasing the administrative complexity and cost.   How Much Can Be Contributed?   A key attraction of a 401(k) plan is the significant amount of money that can be contributed to the plan, as well as being deducted from taxable income. This amount will vary with the level of income and the form of business ownership.   Other Points to Consider – Pros and Cons   • Pros   �� Flexible contributions: Contribution amounts may vary from year to year. �� Loan provisions: A 401(k) plan may allow for participant loans.   • Cons   �� Law “Sunsets”: The provisions of the Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA), which make the substantial contributions to a 401(k) possible, expire after 12/31/10. After that date, allowable contributions to a 401(k) plan will return to their lower, pre-EGTRRA levels.   �� Co-ordination with other plans: If a business owner is also a participant in another 401(k) plan,2 the overall elective deferral limits apply to deferrals made to both plans.     How a Solo 401(k) Plan Works   1. For 2004, the allocation total of employer contributions, forfeitures and employee deferrals to a participant’s account may not exceed the lesser of 100% of compensation or $41,000.   2. The total deduction is limited to 25% of covered payroll.   3. Plans covering only the business owner (or the owner and spouse) effectively sidestep the nondiscrimination issue.   4. In 2004, for those age 50 and older, additional “catch-up” contributions of $3,000 may be made.   5. This assumes they are provided for by the plan. Under Treasury regulations, financial hardship is defined as “immediate and heavy financial need where funds are not reasonably available from other sources.”   6. For more than 5% owners, distributions must begin by April 1 of the year following the year in which the participant reaches age 70½.   Seek Professional Guidance   Setting up a qualified plan involves a number of complex issues. The guidance of qualified financial professionals is highly recommended.     1.  Equals 25% of “net” self-employment income, i.e., gross income less the contribution and one-half the self-employment tax, subject to the overall $41,000 limitation.   2.  For example, this would include someone who works full-time for one employer, but who also has a side business from which he or she earns self-employment income.   "It's a Beautiful Story"
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