One-person 401(k) plans can provide a valuable source of retirement savings for successful entrepreneurs. Given the right circumstances, such plans allow large contributions on behalf of a business owner and maintain flexibility for making contributions in future years.
For 2015, a business owner can make an elective deferral contribution of up to $18,000 (and an additional $6,000 catch-up contribution if he or she is age 50 or older at year-end) plus an employer contribution of up to 20% of self-employment (SE) income unreduced by the elective deferral or 25% of compensation.
The total contributions (elective deferrals of up to $18,000, plus the employer contribution) cannot exceed the lesser of (1) 100% of the participant’s SE income or compensation or (2) $53,000 for 2015. Catch-up contributions to 401(k) plans of up to $6,000 in 2015 are not included in the annual additions limit.
Example: Maximizing contributions with a one-person 401(k) plan.
Kevin, age 63, is the sole owner and employee of Training Solutions, a sole proprietorship. In 2015, Kevin earns $145,000 (net of the SE tax deduction) and wishes to maximize contributions to a retirement account. He believes the business will probably continue to be profitable, but would like the flexibility of determining the amount to contribute each year. Kevin does not expect to hire employees.
The following table reflects the maximum amount that Kevin can contribute to a 401(k) plan for 2015.
Employer contribution ($145,000 — 20%) $29,000
Elective 401(k) deferrals 18,000
Contributions subject to annual limit 47,000
Catch-up contribution 6,000
Total contributions for 2015 $53,000
As an additional benefit, a business owner can borrow from his or her 401(k) plan if the plan document so permits. The maximum loan amount is 50% of the account balance or $50,000, whichever is less.
When the business employs someone other than just the owner, 401(k) contributions may be required for the other employees, in which case the plan would become a standard 401(k) plan with all the resulting complications. However, the plan can exclude from coverage any employee who is under age 21 and any employee who has not worked for at least 1,000 hours during any 12-month period.
Also, if the business’s only other employees are the owner’s spouse and/or children, a 401(k) plan covering those individuals may be even more attractive than a one-person 401(k) plan, especially for owners hitting the $53,000 contribution limit.
John M. Stern, CPA/PFS, is the Managing Partner at PKS & Company, P.A., Certified Public Accountants, a full service accounting firm with offices in Salisbury, Ocean City, MD and Lewes, DE. PKS provides traditional accounting services as well as specialized services in the areas of retirement plan audits and administration, medical practice consulting, estate and trust services, fraud and forensic services and payroll services and offers financial planning and investments through PKS Investment Advisors, LLC. Visit www.pkscpa.com or call 1-800-274-2564.