Published March 2003
Can
you benefit from
an ‘owner only’ 401(k)?
If
you own a business where you and your spouse are the only employees, you
may think that your retirement plan options are somewhat limited. But
that’s no longer the case. Thanks to recent tax-law changes, it may now
make sense for you to establish one of the most popular retirement plans
of all — a 401(k).
Up until 2002, you
might not have considered setting up a 401(k). Even though this type of
plan offers some important advantages, it also had some drawbacks for
owner-only businesses.
For one thing, the
money you might have placed in a 401(k) would have been included as part
of your total allowable contributions to most business retirement plans.
Furthermore, you might have found it somewhat burdensome to administer
a 401(k), which had traditionally been designed for larger companies.
However, thanks to
the Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA),
things have changed. As of last year, you can now establish an “owner-only
401(k)” (sometimes referred to as an “Individual (k) plan”) and receive
some big benefits.
The biggest of these
benefits is the high contribution limit that now applies. Before the tax-law
changes, the most you could contribute to all “defined contribution” plans,
such as profit-sharing and 401(k) plans, was 15 percent of your total
compensation.
However, now that
the new laws have gone into effect, you can contribute up to 25 percent
of your compensation to a profit-sharing plan, plus up to $12,000 (in
2003) in 401(k) contributions (provided you earn at least $12,000). This
means you could actually contribute more than 100 percent of your compensation
to your retirement plans — an extremely attractive concept if your spouse
works in your business.
If you’re 50 or older,
you can even make an extra $2,000 “catch-up contribution” to your 401(k).
Furthermore, both the 401(k) and age 50-plus “catch up” limits will be
increasing over the next several years, so you’ll be able to put away
even more money for retirement.
Apart from the new
contribution limits, your owner-only 401(k) offers you other key advantages.
First, of course, you get the same benefits offered by traditional 401(k)
plans, including tax-deductible contributions, tax-deferred earnings and
a variety of investment options.
Also, you’ll find
that an owner-only 401(k) is quite easy to set up and administer. And,
unlike other types of retirement plans for small-business owners, a 401(k)
offers you a loan feature, so if you need money in a hurry, you can simply
borrow from your account and pay yourself back. (Keep in mind, though,
that your 401(k) is designed to help you pay for retirement; any loans
you take out may slow the overall growth of your account.)
You don’t even have
to start an owner-only 401(k) from scratch. That’s because you can transfer
most retirement plan assets — profit-sharing and money-purchase plans,
traditional IRAs and SEP-IRAs — into your new owner-only 401(k).
If you’ve looked
on enviously for years at your friends and relatives with 401(k) plans,
your time has come at last. The owner-only 401(k) can be a great tool
to help you build the resources you need for the retirement lifestyle
you’ve envisioned. So, give this plan some serious consideration. It could
reward you when you finally make the transition from “business owner”
to “retiree.”
Eric Cumley is an
investment representative with Edward Jones Investments at 1201-C SE Everett
Mall Way in Everett. He can be reached at 425-353-2322. Edward Jones is
an NYSE-member investment firm with more than 8,000 locations nationwide.
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