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June 10, 2004 at 08:00 PM
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.
