A small business 401k might be one of the best tools available to you if you are in business for yourself. In fact it could be one of the key solutions if you want to know how to make a business successful.
For my money, the best plan out there is the Individual 401k (if you qualify). Depending on what financial institution you use, this account might have a different name. For example, it’s often referred to as the Solo 401k, Uni-K Plan or even the Self-Employed 401k. Some refer to it as the 401k plan for Small Business Owners. However you name it, it’s a great small business idea.
It doesn’t matter if your small business is a sole proprietor, a corporation or limited partnership. You can open an Individual 401k. The only restriction is that the participants must be the business owners. (If your spouse works in the business, he’s considered an owner. (So even though you call the shots, he’s allowed to participate in the plan.)
If you have non-owner employees, you may not be able to take advantage of this plan. It depends on the eligibility requirements you set up.
What I’m saying is, if you want to use this plan, you have to exclude any non-owners. You are allowed to exclude employees under age 21 and/or those who haven’t worked one year for you.
If you select these exclusions and an employee non-owner is still eligible, you will have to set up a different type of plan. This plan is really meant for a small business owned and operated by the same people.
If you can clear those hurdles, you are in good shape.
Setting Up the Plan
If you know how to open an IRA, you can open this account. Most financial institutions offer turnkey plans that are simple and inexpensive to set up. Just contact the bank or brokerage you do business with.
There are few elements that make up the total contributions you can make to the Individual 401k. The first is salary deferral. You can defer up to 100% of your income (up to $16,500 in 2010).
The second is profit-sharing. The company can contribute up to 25% of your income (up to $49,000 in 2010). However, both combined (salary-deferral and profit-sharing) can’t exceed $49,000 in 2010.
The only exception is if you are over age 50. In that case, you can kick in an extra $5,500 as a catch-up provision.
Why the Individual 401k Is the Best Small Business 401k
If you qualify, this plan allows you to sock more money away than most other plans. You can also take out a loan against your plan. I actually think this is a terrible idea, but I suppose it’s nice to know it’s available.
On top of that, there is no discrimination testing: for most 401k plans, nondiscrimination testing is required. That’s to make sure the higher paid employees and owners aren’t getting a disproportionate level of contribution compared to the other lower paid staff. These tests are costly.
The good news is, Individual 401k plans don’t require these tests. Sweet-a-kimbo.
Who the Individual 401k Doesn’t Work For
If you have non-owner employees who are eligible to participate in the plan, it doesn’t work. You aren’t allowed to use this plan. Likewise, if you are looking for a plan that covers employees, this isn’t the right choice.
If you own more than one business, it’s tricky. If one qualifies and the other doesn’t, I’d check with your tax advisor. Sorry, it’s too complicated.
What plan do you use for your small business? Would the Individual 401k plan work for you?
Khaleef @ KNS Financial says
Sounds like a great option for individual owners! Once I am out of debt I will definitely look into this option.
Thanks for the info!
Ken @Spruce Up Your Finances says
Nice post. 401k is really one of the best options for a small business to start their retirement plans. With all the tax breaks available for small business, business owners should need to take advantage of them starting with the healthcare, credit for hiring employees, retirement plans, etc.