Advising Clients since 1980
Individual 401K Plans
The recent Economic Growth and Tax Relieve Reconciliation Act (EGTRRA) of 2001 allows one-person business (and their spouses) to have similar advantages to traditional company 401K plans. Both can put aside more money for retirement and benefit from all the advantages of a 401K plan. The contributions and earnings in a 401K plan grow tax-deferred (tax isn't due until distribution).
The general tax rules described below are the federal income tax rules as of 1 January 2020 and may be subject to exceptions. Always check your state (and local) income tax rules on 401K plans. Finally, since tax laws may (and probably will) change from time to time, always check with your tax advisor before making major decisions regarding your 401K plan.
Roth IRA Alternative
An alternative to the traditional 401K is the Roth 401K in which income taxes are paid on the contributions but all distributions grow on a tax-deferred basis and no taxes are paid on withdrawals. The Roth provision was created effective 1 January 1998 as part of the Taxpayer Relief Act of 1997.
Congress made the Roth option permanent in 2006. These generally offer:
Higher deductible contribution limits
Catch-up contributions
Loan provisions
Ability to consolidate several retirement plans
Low cost administration
Eligibility
Since the Individual 401K was designed for individuals and their spouses, the following can generally be excluded:
Employees under age 21
Employees working less than 1,000 hours per year
Union employees
Non-resident aliens
Contribution Limits
There are several yearly contribution limits. However, you are not required to meet the contribution limits:
1. The employee pre-tax contribution limit may be up to $19,500 in the year 2021 plus an additional $6,500 “catch up” provision for those over age 50.
2. The maximum amount of all contributions from you and all other additions to your account cannot exceed the lesser of:
a. 25% of compensation, or
b. $58,000
In addition, there are special rules if you own 5% or more of the company or you are a highly compensated employee (e.g. compensation in 2021 over $290,000 affects an employee’s contribution limit in the year 2021).
Vesting
Unlike company 401K plans which typically have a vesting period, you will be immediately 100% vested in an Individual 401K.
Tax Advantages
Not only are contributions tax-deductible but they accumulate tax-deferred until taken as a distribution from the plan. Tax distributions are subject to ordinary income tax and, if taken prior to age 59 1/2, may also be subject to a 10% federal income tax penalty.
Loans
Generally limited to 50% of the account balance or $50,000, whichever is less.
Consolidation with Other Retirement Plans
Under the new tax laws, you can consolidate all of your retirement accounts by rolling over or transferring your assets to the Individual 401K.
Low Cost
Individual 401K plans are less administratively burdensome because they generally involve one person (and possibly a spouse) but do not require extensive non-discrimination testing.
Easy Administration
Individual 401K plans are not required to file an annual report with the U.S. Department of Labor until aggregate plan assets exceed $100,000. Once the plan reaches $100,000, the plan is only required to file IRS Form 5500-EZ. These are often provided by the plan administrator in a "signature ready" format at no additional cost.
Beneficiary Designations
Legal and tax advice is useful when determining how to complete beneficiary designations. Properly completed designations can help save estate (death) tax, avoid probate, allow better income tax opportunities and avoid creditor claims on retirement assets.
Extra care needs to be taken in naming trusts as a beneficiary of most retirement assets in case of a death. Sometimes, naming trusts as a beneficiary can trigger income tax sooner than it would otherwise be owed and reduce the amount ultimately shielded from death tax.
Note that many plans require the participant’s spouse to be the beneficiary, unless the spouse provides written permission for another beneficiary to be named.
Creditor Protection
Retirement plans and accounts may have special creditor protection under federal and/or state laws. Different types of plans and accounts may have varying degrees of protection. State protection rules may also vary from state to state.
If you convert from one type of plan to another (e.g., from a traditional IRA to a Roth IRA), you may be changing how much protection you have. This may be also be the case if you move to another new state where the new state rules are different.
Consulting with an attorney for guidance on the creditor protection issue may be helpful.
Estate & Death Taxes
Retirement assets are added to your other assets and may be subject to federal and/or state death (estate) tax. It depends upon the size of your overall estate and the estate planning done for you. Consult with your advisor about ways to defer or avoid estate tax.
Shoreline’s Competitive Edge
We are a network of independent professionals with over 150 years of combined experience in wealth management and advice. Members of this network can be used individually or collectively for a single program or a series of seminars or workshops for your company or organization.
For more information:
If you’d like more information about how diversified investment advisors can help you achieve your financial objectives through personalized wealth or retirement and risk management strategies, please contact us. We welcome the opportunity to discuss your unique needs and how we may best meet them.
This page is updated regularly so check in from time-to-time to see new articles and updates. You can click on any underlined words on each page to view a specific link or in the left margin of each page to explore a specific wealth management topic.
Charles M. Bloom, Registered Principal offers securities and advisory services through Centaurus Financial, Inc. - Member FINRA and SIPC - 775 Avenida Pequena, CA, 93111 (mailing address: 3905 State Street Suite 7173, Santa Barbara, CA, 93105) - CA Life Insurance License No. 0A52786 - Centaurus Financial, Inc. and Shoreline Wealth & Investment Management are not affiliated companies.
The information contained in this web site is neither an offer nor solicitation of any security or service.
All photos courtesy of Shoreline Summit Photography