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.