Most limits for retirement plans haven’t changed in 2011; they’re exactly the same as last year. But some small business owners can take matters into their own hands with a solo 401(k).
With the usual defined contribution plan used by small business owners, the employer’s deductible contribution for 2011 is capped at the lesser of 25% of compensation or $49,000. In contrast, an employee participating in a traditional 401(k) plan can make an elective deferral contribution within the annual limits and the employer can match part of the contribution.
A solo 401(k) offers even more. For 2011, you may defer up to $16,500 of compensation to your account, plus an extra catch-up contribution of $5,500 is allowed if you’re age 50 or older – the same as with elective deferrals to a traditional 401(k). Limits on deductible employer contributions still apply, but elective deferrals to a solo 401(k) don’t count toward the 25% cap. So you can combine an employer contribution with an employee deferral for greater savings.
Contributions to a solo 401(k) grow tax deferred until you are ready to make withdrawals. The additional amount you can accumulate over 15 to 20 years can be significant.
A solo 401(k) may offer other advantages. For example, a plan can be set up to offer loans or hardship withdrawals. Also, you might roll over funds tax-free from another qualified plan if you previously worked somewhere else. Contributions are discretionary, so you can cut back on your annual contribution if your business is having a bad year.
Despite the obvious benefits, there are also drawbacks to solo 401(k) plans. If your business has any other employees, they may have to be covered by the plan. Plus, you have to deal with the time and cost of running the plan.
Contact your financial advisor to determine whether a solo 401(k) is right for you.