Individual 401(k) Part 1

Self-Directed IRAs are becoming more and more popular, but not very many people have heard of Individual 401(k)s.  I think it might be beneficial if I take a few days to help explain the basic ideas and functions of the Individual 401(k).

The Individual 401(k) or i401k (sometimes called Solo 401k) may be the perfect retirement plan for you.  To qualify for an Individual 401(k), you must be a self-employed business owner with no full-time employees, other than possibly a spouse.  There are a few ways that you can have employees, but exclude them from the plan.  For instance, employees under the age of 21, employees who work less than 1,000 hours per year, non-resident alien employees and union employees can all be excluded from your plan.

There are several advantages to the Individual 401(k) over other types of small business retirement plans.  First, you are able to take loans from the plan.  You may borrow up to $50,000.00 or 50% of your 401(k) balance, whichever is less.  The loan must be re-payed within five years with interest.  Depending on how you structure the loan process in your 401(k) Basic Plan Document, you can make it possible to take loans for any purpose.  You may take loans for things such as, educational purposes, home improvement projects, down payment on a home, etc.

Another advantage is the higher contribution limits. For 2010,  if you are under the age of 50, you may contribute up to $16,500.00 per year as a salary deferral ($22,000 if you are over the age of 50).  There is also a profit sharing component to the Individual 401(k).  Your company can contribute between 0-25% of their profits to your plan with a cap at $49,000.00 ($54,000.00 if you are over the age of 50).

You may also make Roth contributions to your Individual 401(k) plan.  The salary deferral contributions that you make can either be Roth, Traditional or a combination of both.  You will need to keep good records to make sure you know what portion of the money is Traditional and Roth.  The Profit Sharing Contributions made from your company will always be Traditional.

Please remember that this is an extremely simplified explanation of the Individual 401(k).  To get more information on the Individual 401(k) and find out if it is the right retirement plan option for you, make sure to contact a CPA or tax professional.

Tomorrow we will talk about Trustees and how to administer the plan.

To be continued…