There are good reasons for one-owner businesses to set up an individual 401(k) plan. That's because the 2001 Tax Act made some major changes to the 401(k) retirement plan rules, including higher contribution limits, simplified administration, and a new tax credit. Plans designed to fit businesses where the owner is the only employee are less complex, less burdensome, and less costly to manage than traditional 401(k) plans.
Both incorporated and unincorporated businesses can set up an individual 401(k) plan. Even if you're self-employed, you're still considered an employee of the business. Since they allow higher contributions than other plans, such as SIMPLE's and SEP's, a 401(k) gives you more opportunity to cut your taxes while building a bigger retirement nest egg.
Under a 401(k) plan, you can elect to have the company contribute part of your earnings to the plan. Though these plan contributions are subject to social security tax, they are not subject to income tax until you withdraw money from the account. This year, you can contribute up to $12,000 of your earnings to a 401(k) plan. Those 50 and over can contribute an extra $2,000 for a total of $14,000. These limits increase over the coming years.
Your business can make tax-deductible matching contributions to your individual 401(k) plan. This year the maximum company contribution is the smaller of 25% of wages or $40,000 (for self-employed's the limit is 20% of net earnings or $40,000). Another important change is that employee contributions no longer count toward this percentage or dollar cap, so you can make a higher combined employer/employee contribution than before.
If you'd like to learn more about an individual 401(k) plan for your business, give us a call.
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important tax tips:
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