The One-Person 401(k) Plan for Self-employed Individuals

One-person 401(k) plans can provide a valuable source of retirement savings for successful entrepreneurs. Given the right circumstances, such plans allow large contributions on behalf of a business owner and maintain flexibility for making contributions in future years.

For 2010, a business owner can make an elective deferral contribution of up to $16,500 (add an additional $5,500 catch-up contribution if he or she is age 50 or older at year-end) plus an employer contribution of up to 20% of self-employment (SE) income or 25% of compensation. In calculating the allowable employer contribution, the owner’s SE income or compensation is not reduced by the owner’s elective deferral contribution.

The total contributions (elective deferrals of up to $16,500, plus the employer contribution) cannot exceed the lesser of 100% of the participant’s compensation, or $49,000 for 2010. Catch-up contributions to 401(k) plans of up to $5,500 can also be made in 2010 for those who have attained at least age 50 by calendar year-end and are not included in the annual additions limit.

Example: Maximizing contributions with a one-person 401(k) plan.

Suzanne, age 50, is the sole owner and employee of Training Solutions, a sole proprietorship. Training Solutions is also the sole source of her earned income. Suzanne earns $162,500 (net of the SE tax deduction) in the current year and wishes to maximize contributions to a retirement account. She believes the business will probably continue to be profitable, but she would like the flexibility of determining on a year-to-year basis how much to contribute. Suzanne does not expect to hire employees and will remain a one-person company.

The following table reflects the maximum amount that can be contributed to a 401(k) plan for Suzanne for 2010.

25% (20% for self-employed individuals) profit-sharing contribution ($162,500 × 20%)	$32,500
Elective 401(k) deferrals	16,500
Contributions subject to annual addition limit	$49,000
Catch-up contributions	5,500
Total contributions for 2010	$54,500

As an additional benefit, a business owner can borrow from his or her 401(k) plan if the plan document so permits. The maximum loan amount is 50% of the account balance or $50,000, whichever is less.

When the business employs someone other than just the owner, 401(k) contributions may be required for the other employees, in which case the plan would become a standard 401(k) plan with all the resulting complications. However, the plan can exclude from coverage any employee who is under age 21 and any employee who has not worked for at least 1,000 hours during any 12-month period. Because this exclusion rule allows the business owner to avoid covering young and part-time employees, the plan may still qualify as a simple and easy one-person 401(k) arrangement.

Also, if the business’s only other employees are the owner’s spouse and/or children, a 401(k) plan covering those individuals may be even more attractive than a one-person 401(k) plan, especially for owners hitting the $49,000 contribution limit.