An Individual(k): Retirement Funding For The Self-Employed

High on the list of challenges that small business owners face in 2004 is how to retire with sufficient assets. Many view qualified plans, like the 401(k), as too expensive, impractical and, because of annual caps on contributions, inadequate.

One solution that financial professionals can offer these clients is the Individual(k) plan. An outgrowth of the Economic Growth and Tax Relief Reconciliation Act of 2001, this investment vehicle provides owner-only businesses with a potentially higher contribution limit and lower administrative costs than qualified plans.

These and other featuresthe option of taking a loan on a portion of the plan’s balance, purchasing life insurance with tax-deductible dollars and the ability to consolidate most other retirement plansmake the Individual(k) attractive for many owner-only businesses.

Under an Individual(k), an employer’s deduction of employee elective deferrals is not subject to the employer general limitation of 25% of payroll. In addition, the amount that can be allocated to any individual (the IRC Section 415 limit) is 100% of pay, up to a maximum of $41,000 for 2004.

Upshot: Many business owners can put more into an Individual(k) than they can into a traditional SEP or profit-sharing plan. Contributions are flexible and purely discretionary.

For those small business owners (and their employees) age 50 and over, an additional catch-up elective deferral contribution of $3,000 can be made in 2004 on top of the general $13,000 limit.

Prospecting for clients

Key prospects for Individual(k) plans include owner-only small businesses, partnerships and sole proprietors. Corporations are also eligible, so long as the owner draws a salary or wage (W-2 income) and there are no other eligible employees.

Individual(k) prospects include:

? Any business with only one employee (i.e. consultants).

? Tradesmen (e.g., landscapers, electricians, plumbers).

? Any business which employs only owners of the business or family members.

? Part-time and home-based businesses. Even if these small business owners work full time for another company and are eligible to participate in that company?s retirement plan, they can participate in their own Individual(k) as well. Nevertheless, they need to ensure that salary deferrals from all plans do not exceed the overall limit.

? A business whose only employees, other than the owner, work less than 1,000 hour per year (i.e. a landscaper who only employs seasonal workers).

With the exception of certain family members, a business must not employ any “eligible employees.” Consequently, owner-only companies that plan on hiring pension-eligible employees in the near future may not be good prospects for an Individual(k). Qualified plan non-discrimination rules require eligible employees to be included in a pension plan.

An Individual(k) may be available to businesses that have employees who are excludable from the plan under federal tax laws governing plan coverage requirements. Examples include union employees, employees working less than 1,000 hours annually and non-resident aliens.

Loans and Consolidation

Loans are an attractive feature of the Individual (k) plan. Individual(k) participants can take loans of up to 50% of their vested interest in the account balance to a maximum of $50,000. This is a relatively new feature for unincorporated business owners and is not available in a SIMPLE IRA, SEP or traditional IRA.

Loans are established by a promissory note between the plan and the participant. Payments are due at least quarterly and must be substantially level. The interest rate of the participant loan must be reasonable compared with interest rates charged by commercial lenders for a loan made under similar circumstances.

The Individual(k) may also allow the financial professional to benefit by controlling more assets under management. Specifically, a client?s former retirement accounts (including traditional IRAs) can be rolled into a new Individual(k) account. Consolidation of accounts may also allow for larger loans under provisions discussed above.

Purchasing Life Insurance With Tax Deductible Dollars

Unlike an IRA, an Individual(k) permits the purchase of permanent life insurance with pre-tax dollars, thereby giving your client additional buying power. Owners in high tax brackets may obtain more protection than they could otherwise receive by paying premiums with the same amount of after-tax dollars.

Keep in mind that purchasing a life insurance policy in an Individual(k) causes current taxation to the participant. The taxable amount is the term cost of the pure insurance amount based on IRS table rates or alternative rates of the insurance company.

Entering the Market

Producers desiring to offer Individual(k)s must work with carriers that offer turnkey marketing kits, including producer guides, plan prototype documents, prospecting letters and marketing materials.

They must also be sure the carrier offers preferred third-party administration. This feature is particularly important if the client plans to utilize the loan provision or purchase life insurance within the plan.

Annuities, among other products, may be an attractive vehicle for funding the Individual(k). If chosen, the annuity should be considered with a non-rolling deferred sales charge schedule, so that subsequent contribution contracts do not lengthen the deferred sales charge period.

Additionally, the insurer should have a 401(k) loan rider available for any annuity contracts used in funding the plan. From the financial representative’s standpoint, the product should also pay full commissions on each subsequent payment. These are particularly attractive features because Individual(k)s generally involve ongoing contributions.

Business owners are looking to financial professionals for solutions to their many qualified plan needs. Offering them an Individual(k) plan may set you apart in this complex and highly competitive marketplace.

Daniel J. Munroe, J.D., CLU, is the director of advanced marketing for MONY Partners, a division of MONY Life Insurance Company. Dan can be reached at dmunroe@mony.


Reproduced from National Underwriter Edition, June 11, 2004. Copyright 2004 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.