Solo-401(k) plans, designed for the sole proprietor, the proprietor's spouse, and partnerships whose only employees are self-employed partners and their spouses, are now permitted to offer participants flexible savings accounts with an after-tax Roth option as well as the traditional pre-tax option. Individuals in the plans may direct their savings to both accounts. But only a few of the major investment firms have begun to offer the Roth option.
Solo 401(k) plans are ideal for individuals who can save large sums. "With an individual 401(k), you save both as an employee and an employer", says Kristen Luby, senior marketing manager at T. Rowe Price, according to a report in CNNMoney. "That feature allows the typical business owner to put away more than in most retirement plans."
Contribution limits, elective deferrals and compensation limits are up for 2008 for solo 401(k) plans. Individuals may contribute 100 percent of the first $15,500 in compensation and as the employer make contributions up to 25 percent of income, to a maximum contribution of $46,000. Individuals age 50 or older are allowed a $5,000 catch-up contribution, which does not count toward the $46,000 limit. The annual compensation limit is $230,000, according to 401khelpcenter.com.
A spouse who provides some services for the sole proprietor can also set up an individual 401(k).
In comparison, SEP IRAs permit a 25 percent contribution of business income up to the $46,000 limit, but are less flexible, because they do not allow the catch up contribution or the employee contribution of $15,500 (useful when business income is less than $45,000), according to CNNMoney.
Unlike the SEP IRA, solo 401(k)s allow loans, if the managing company permits. The principal must be paid back with interest in five years, but the interest goes right back into the account. Rollovers and transfers to the solo 401(k) are allowed from traditional IRAs and SEP IRAs, Qualified Plans or Keoghs, 403(b)s and 457 plans.
A good source of information for individuals considering setting up one of these plans is 401khelpcenter.com. It provides general information and calculators as well as links to investment companies and banks that offer solo 401(k) plans.
Setting up a solo 401(k) can be more complicated than setting up a SEP IRA. It requires more paperwork, and it may be wise to consult an accountant or financial adviser for assistance. Setup charges by investment companies range from $100 to $375, and potential 401(k) plan sponsors should always ask about management fees before selecting a plan manager. When accounts grow to $100,000 or more, the participant must file a special tax return, which could add to the cost.
Sole proprietors should also bear in mind that if a company is growing, the solo 401(k) may not be the right choice, because once the business owner hires additional employees he will have to convert the individual plan to one that covers everyone.