The Single-Participant 401(k): The Who, What and Why of This New Benefit for Small Businesses

The 401(k) plan has been around for more than 20 years, permitting Americans to amass billions of dollars in retirement assets. With the passage of the Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA) millions more self-employed or small business owners with no employees (other than their spouse) have a new incentive to set up a 401(k) plan and increase their retirement savings. The new rules apply to both incorporated and unincorporated businesses. Any business that employs only the owner and his or her spouse is a candidate including C corporations, S corporations, single member LLCs, partnerships and sole proprietorships. This means sole practitioner CPA firms and clients ranging from consultants, entrepreneurs and lawyers to real estate brokers, electricians and interior decorators are eligible to contribute more to a 401(k) plan than to any other kind of defined-contribution retirement arrangement, depending on their earnings. This article reviews the basics of this retirement savings option and offers some tips on which small business clients CPAs should approach to recommend they set up and contribute to such a plan. TAX BASICS As a result of a provision in EGTRRA, effective January 1, 2002, employers no longer have to reduce their maximum tax-deductible retirement plan contributions by the salary deferrals employees make to a plan. This means an employer can contribute the maximum 25% tax-deductible profit-sharing contribution in addition to any pretax contributions the employee/plan participant makes. As a result, 401(k) plans have become more attractive options than SEP-IRAs, Simple IRAs or profit-sharing or money purchase plans. In addition, most plans accept rollovers of existing retirement plan assets. Example. Mary Smith is the sole employee of an incorporated business. Her earned income is $100,000 in 2003. Under the law Mary can contribute $25,000 to a SEP-IRA, $8,000 to a Simple IRA, $25,000 to a profit-sharing or money purchase plan and $37,000 to a 401(k)--$25,000 employer contribution plus $12,000 employee deferral. If Mary were over age 50, she could also make catch-up contributions of $2,000 in 2003, increasing her 401(k) contribution total to $39,000. Following these changes to IRC sections 404 and 415, mutual fund companies and retirement plan providers are beginning to offer single-participant 401(k) plans that give owner-only businesses the advantages of a traditional 401(k)--including higher contribution limits and the ability to borrow from the plan--at an affordable price. In 2003 the rules limit employer contribution to 25% of compensation. The employee can make salary deferral contributions up to $12,000. Together these contributions cannot exceed the lesser of $40,000 or 100% of compensation. (Catch-up contributions don't count when computing this limit.) The maximum amount of compensation that can be considered when calculating deferrals is $200,000. In some cases 401(k) plan contributions for an unincorporated business may be slightly lower than the above amounts. For unincorporated businesses, compensation is net profit minus half of self-employment taxes minus employer contributions. BE PROACTIVE Phyllis Bernstein is a one-person CPA/PFS firm who has investigated the new single- participant 401(k) plan for herself and her The more the New York City-based planner looks at the new retirement product, the more she thinks CPAs are missing out on a potentially lucrative market. Because it's still so new, not a whole lot of entities make the single-participant 401(k) available, so CPAs are more reluctant to get involved with it, she says. We tend to wait for our clients to ask us questions about new products. Sometimes we're not proactive enough to go out and sell new products to existing clients. Christopher Guarino, president of plan administrator BiSys Retirement Services, agrees. …