Solo 401(k)

If you are self-employed and donot foresee hiring employees in future for your small business, the Solo or Individual version of 401(k) retirement plan may be just right for you. Recently, a growing number of financial Services firms have started offering individual 401(k) plans, boasting many of the same features as their corporate counterpart. And it has truely become quite popular.

Just like the corporate 401(k) or SEP-IRAs designed for the self-employed, Solo 401(k)s also allow you to invest a part of your income on a pre-tax basis - and the contributions grow tax deferred. But unlike SEP, one can borrow against one's account and also the contribution limits are a lot higher.

With a solo 401(k), annual contributions consist of two parts. In 2006 can contribute up to 100% of the first $15,000 of your 2006 compensation or self-employment income ($20,000 if age 50 or older) . And there's more: the profit sharing contribution just like what you can do with a traditional small-business retirement plan like SEP-IRAs . You can contribute and deduct an additional amount of up to 25% of your compensation income, or 20% of your self-employment income. Combined contributions (both salary deferrals and profit sharing) cannot exceed the lesser of 100% of compensation or $44,000 in 2006 or $48000 if one is 50 or older.

Now let us crunch some numbers. If your corporation pays you $100,000 this year, the maximum deductible contribution to your solo 401(k) account would be $40,000 [$15,000 + (25% of $100,000)]. That's a lot more than the $25,000 you could contribute to a traditional plan (25% of $100,000). If you earn $100,000 from your sole proprietorship. The maximum solo 401(k) contribution would be $35,000 [$15,000 + (20% of $100,000)]. With a traditional plan, your maximum contribution would have been a mere $20,000 (20% of $100,000).

However, if you are planning to expand your business by hiring employees, the individual 401(k) is not a right plan for you. In that case you will have to convert to the more complicated employer's 401(k). Also, remember that, even though the law allows you to take loan upto 50% of your individual 401(k), upto a limit of $50,000, not every provider offers such an option. So, be careful in selecting a right provider for you. Also, do not forget to compare set-up fee, annual fee and other charges of different providers.