An owner-only 401(k) plan is a way to combine the tax advantages of an employer-sponsored retirement plan with pre-tax personal retirement savings.
Reaching a Financially Sound Retirement
The Social Security Administration estimates that less than 20% of retirees have an income of more than $75,000. This means that 4 out of 5 people who are 55 or older will not be financially secure during their retirement years.
Small business owners and those who are self-employed find it very difficult to save for retirement. With fluctuations in business profits, many owners see that they have to dip into their savings to ride out storms that occur in their industry.
Fortunately, with an owner-only 401(k) plan, these same hard working business owners can now ensure a well-deserved, prosperous retirement.
Contributions to an Owner-Only 401(k) Plan
Although employee 401(k) plans have been around for over 20 years, only after the turn of the millennium were those who owned a business that employed only the owner and a spouse attracted to this option for retirement savings.
Essentially a profit sharing plan that allows contributors to contribute before taxes are taken out of their paychecks, but for business owners, the option is even more tempting. The business can make a tax-deductible profit sharing contribution to the 401(k) plan up to 25% of the owner’s compensation. Also, as an employee, the owner may also contribute up to $18,500 in 2018 as long as the maximum amount does not exceed 100% of income for the year.
Additionally, “catch-up” contributions of $6,000 per year are allowed for owners age 50 and older.
Highlights of Owner-Only 401(k) Plans
- Higher contribution limits make the plan attractive to successful business owners whose goal is to save substantial amounts for their retirement.
- Pre-tax contributions made by the business are tax deductible as a business expense.
- Tax-deferred growth means that any gains and earnings on a 401(k) plan are not taxed until the funds are actually distributed.
- Flexible contributions allow the business and the employee to defer or change the contribution amounts from year to year.
- Easier administration with an exemption from discrimination testing and a streamlined IRS reporting form make the plan appealing.
- Access to funds that allow a business owner to take a loan against the plan without penalty taxes will enable owners to borrow funds to weather business storms.
Comparing Contributions from Different Plans for Unincorporated Businesses
The maximum contributions that can be made to an owner-only 401(k) plan are more attractive to business owners who own unincorporated business, especially when compared to other types of retirement savings plans. Based on a $100,000 yearly compensation with a 20% compensation amount from the company, a maximum elective employee salary deferral amount of $18,500, and a maximum allowable contribution amount of $55,000, a comparison was made. Comparing an owner-only 401(k) plan against a SEP IRA plan, money purchase or profit sharing plan, and a SIMPLE IRA plan shows how the owner-only 401(k) plan is more appealing than other methods.
- Employer Contribution Amounts: The owner-only 401(k) plan, SEP IRA plan, and money purchase or profit-sharing plan allow for an employer contribution of $20,000. The Simple IRA plan only allows a $3,000 yearly contribution amount.
- Elective Employee Salary Deferral: The owner-only 401(k) plan allows for the highest amount at $18,500, while the SIMPLE IRA plan provides for $12,500. The SEP IRA plan and a money purchase or profit sharing plan do not offer this option.
- Total Initial Contribution: The owner-only 401(k) plan allows almost twice the amounts of other programs for an initial contribution amount of $38,500. SEP IRA plans and money purchase or profit sharing plans only allow $20,000, while a SIMPLE IRA Plan only allows $15,500.
- Catch-Up Contribution: The owner-only 401(k) plan allows participants who are age 50 or older to contribute an additional $6,000 per year. The SIMPLE IRA plan only allows $3,000 yearly while the SEP IRA plan and a money purchase or profit sharing plan do not offer this option.
- Total Allowable Contribution: With twice the total allowable contribution amount of $44,500, the owner-only 401(k) plan outshines the other programs. The SEP IRA plan and the money purchase or profit sharing plan allow for a total of $20,000, while the SIMPLE IRA plan only allows $18,500.
When comparing the different retirement savings plans, the owner-only 401(k) plan continues to leap to the front of the pack. As with any significant financial decision, you should discuss any changes to your retirement savings plan with a qualified financial advisor.