If you own a business, and 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 invest in 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 offered 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.
And 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. Now that the new laws have gone into effect, though, you can put in up to 25 percent of your compensation in a profit sharing plan, plus $12,000 (in 2003) as 401(k) contributions, provided you earn at least $12,000. That 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. (You can't contribute more than $40,000 per year, or 100 percent of your compensation - whichever is less.)
If you're 50 or older, you can even put in an extra $2,000 to your 401(k). Furthermore, both the 401(k) and 50-and-over "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" IRA and SEP-IRA - into your 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've made the transition from "business owner" to "retiree".