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March 8, 2002/Adar 24, 5762, Vol. 54, No. 25
Tax law changes benefit self-employed
LEE C. EISINBERG
Special to Jewish News
The self-employed now are able to almost double the contributions they make toward retirement thanks to recent changes in federal tax laws.
Until the Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA) was passed by Congress last year, it didn't make sense for owner-only businesses to establish 401(k) profit-sharing plans. Small-business owners could sometimes save just as much money through a SEP or Simple IRA without the costly setup and maintenance fees and complex rules associated with a 401(k).
The new law allows owner-only businesses to take advantage of the new, higher contribution limits for 401(k)s and is designed to help them put away more money for retirement than previously allowed by other tax-deferred plans. One retirement fund company, Pioneer Investments, has created a new 401(k) plan that incorporates the new laws. The Pioneer product is for businesses consisting only of owners and their spouses.
Under the previous law, employers and employees couldn't contribute more than 15 percent of their annual income to a 401(k) profit-sharing plan, which was based on a maximum compensation of $170,000. However, the new law raises the contribution level to 25 percent with a maximum compensation of $200,000. In addition, the new law no longer requires that employee deferrals be counted toward the 25 percent-of-pay limit. This now makes it possible for an owner-only business to make a larger profit-sharing contribution, and then also make a maximum $11,000 per person 401(k) - increased from last year's $10,500 - salary deferral.
For example, Elizabeth, who owns a S-Corporation business, can set aside the lesser of either 25 percent of her compensation or $40,000 to a 401(k) profit sharing plan. If she hasn't already exceeded her annual contribution limit of $40,000, she also can make an additional pre-tax 401(k) salary deferral contribution of up to $11,000. Individuals who are age 50 or older also may make "catch-up" contributions of $1,000 in 2002.
Therefore, Elizabeth, 54, with an annual income of $125,000 may now be able to make a profit-sharing contribution of $31,250, along with a 401(k) salary deferral contribution of $8,750. She also can make a "catch-up" contribution of $1,000 for a combined total of $41,000.
The new retirement plan for self-employed business owners has many other benefits beyond the previous mentioned contribution limits including:
- Flexibility - Individuals decide each year whether to contribute to the plan and how much they should invest.
- Loans - Individuals can take loans tax-free and penalty-free, under the same guidelines available to large corporate 401(k) plans.
- Minimal cost and administration - Unlike traditional 401(k) plans, there are no complicated discrimination tests or administrative requirements.
- Convenience to rollover assets - Retirement assets from various plans can be consolidated to create one convenient, low cost account.
This new plan, designed specifically for owner-only businesses, should become one of the more attractive concepts in 401(k) plans. It offers great value to real estate and insurance agents, attorneys, consultants and dozens of other self-employed professionals.
Eisinberg is a financial consultant at RBC Dain Rauscher in Phoenix. RBC Dain Raus-cher does not provide tax advice. RBC Dain Rauscher is a member of the NYSE and SIPC. For further information please contact Eisinberg at 602-508-7863 or toll free at (888) 595-4166.
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