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Financial advisors should think carefully before enrolling self-employed clients in the new one-person 401(k) plans, says Principal Financial Group.

The plans could generate huge tax savings for owners of some one-person businesses, but they could also lead to compliance headaches for owners who expand, says Elise Pilkington, assistant director of retirement and investor services at Principal.

Because operating a two-person 401(k) plan is so much more difficult than operating a one-person plan “you really do have to have no other employees that would be eligible for the plan,” Pilkington says.

Principal, a Des Moines, Iowa, financial services company, is recommending that advisors prescribe one-person 401(k) plans only if they are willing to stay in touch with the purchasers, to make sure users think before they hire.

Financial services companies and their distributors are talking about one-person 401(k) plans, which are also called “owner-only” plans, “mini-k” plans and “individual-k” plans, because of the Economic Growth and Tax Relief Reconciliation Act of 2001. This year, EGTRRA will let many one-person firms put 28% of income included in contribution calculations into their 401(k) plans.

Some owner-employees may be able to use one-person 401(k) plans to defer taxes on as much as $40,000 in income this year, according to BISYS Inc., New York, a company that sells one-person 401(k) administration services to financial services firms.

One-person companies could set up 401(k) plans before EGTRRA came along, but contribution limits were much lower and administrative costs were high. Most one-person firms ended up using Keough plans and individual retirement accounts.

Now, EGTRRA has made one-person 401(k) plans so attractive that financial services firms are using technology to lower the administrative costs. “We expect most of the leading financial services organizations will launch an Individual(k)-type product during 2002,” says Chris Guarino, president of the BISYS retirement services unit.

BISYS says its consulting arm is already helping 50 financial services firms set up one-person 401(k) programs. “Each of the firms we are currently working with has reported demand for this new retirement product is growing exponentially,” he says.

Pioneer Investment Management Inc., Boston, has entered the market by introducing the Uni-K one-person 401(k) program.

“Any business that employs only owners and their spouses–including C corporations, S corporations, partnerships and sole proprietors–is a candidate,” Pioneer says on its Uni-K Web site.

In theory, Principal’s Pilkington says, compliance can be simple for a small one-person 401(k) plan. Owners of plans with less than $100,000 in plan assets can even get away without filing Form 5500EZ, the short reporting form for small benefit plans.

But, if an owner-employee hires someone other than a husband or a wife, and the new employee works more than 1,000 hours a year, the employee must join the plan, too, or the owner cannot contribute, Pilkington says.

The owner must be willing to make an employer contribution equal to at least 3% of the employees pay, and the size of the employees contribution will set an upper limit on the owners contribution, Pilkington says.

If the IRS believes a plan discriminates against the employee or violates other IRS rules, the plan might have to refund all of the owners contributions and pay penalties and back taxes, she warns.

One-person companies could run into additional problems if the owners live in California and other states that have refused to increase their contribution limits to match the federal limits.

Because the rules governing retirement plans are so tricky, owners of one-person companies should talk to their tax advisors before buying one-person 401(k) plans or any other retirement savings plans, Pilkington says.


Reproduced from National Underwriter Life & Health/Financial Services Edition, February 4, 2002. Copyright 2002 by The National Underwriter Company in the serial publication. All rights reserved.Copyright in this article as an independent work may be held by the author.


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