T. Rowe Price now offers an Individual 401(k) Plan that potentially allows self-employed individuals and small-business owners with no employees other than a spouse to save more for retirement than they could with other types of retirement plans.
Unlike a SEP-IRA or profit sharing plan - two common retirement plan options for small businesses - an Individual 401(k) allows the business owner to add salary deferral contributions on top of the permitted employer contribution, which is generally 25% of net business income. As a result, an unincorporated business owner may be able to make higher contributions to an Individual 401(k) Plan than to other types of retirement plans.
The maximum contribution to an Individual 401(k) Plan is $41,000 for 2004 and $42,000 for 2005. This includes both a participant's salary deferral and employer contribution. Plan participants age 50 or older by the end of the year may be entitled to contribute additional catch-up contributions. The salary deferral limit in 2004 is $13,000 for those under age 50 and $16,000 for those 50 or older.
The deadline for establishing an Individual 401(k) Plan for 2004 is December 31.
With its higher contribution limits and the benefits of tax-deferred growth, an Individual 401(k) Plan can help self-employed individuals and small-business owners take a big step toward preparing for a financially secure retirement, while also reducing current taxable income, said Douglas Harrison, Vice President and head of the Tax-Deferred Products Development and Management Group at T. Rowe Price. When we looked at our existing small- business plan customers, we found that approximately one-third could benefit from the higher contribution limits associated with an Individual 401(k) Plan.
Tax Savings and Benefits
Since employer contributions to an Individual 401(k) Plan are generally deductible as a business expense, they can offer significant tax savings potential. For example, an unincorporated small-business owner with net business income of $150,000 in 2004 would pay approximately $37,150 in taxes if no contributions are made to a retirement plan. If the individual maxed out his or her contributions to the Individual 401(k) Plan by contributing $41,000, taxes could be reduced to $26,900, a tax savings of $10,250. Calculations are based on 2004 IRS Tax Tables and assume an unincorporated, self-employed, married individual with two dependent children, filing jointly. The spouse has no earned income. Actual savings will vary.
Because salary deferrals reduce taxable income, an Individual 401(k) Plan may also provide an opportunity to invest more for retirement, assuming the tax savings are invested in a taxable account on the side. Over a 20-year period, for example, a $41,000 annual contribution to a taxable savings account would provide an after-tax balance of $1.57 million, based on an 8% annual rate of return and a Federal tax rate of 25%. If the same amount was contributed to an Individual 401(k), and the resulting annual tax savings of $10,250 from the above example was invested in the side account, the total after-tax amount would be $1.8 million, or 15% more.
An Individual 401(k) Plan is only suitable for a business owner and his or her spouse. Business owners who have, or plan to add other employees who may be eligible to participate in a retirement plan, should consider a SEP-IRA, SIMPLE IRA or profit sharing plan - three options that are also available from T. Rowe Price.
T. Rowe Price charges no set-up fees for its Individual 401(k) Plan and offers more than 65 no-load mutual funds for retirement investing. A $10 annual per mutual fund administration fee is waived for account balances greater than $5,000 per mutual fund, $50,000 per shareholder, or $100,000 per household. An Individual 401(k) Plan kit is available at www.troweprice.com or by calling a T. Rowe Price Retirement Specialist at 800-638-3804.