An Individual (k) is a type of 401(k) plan. It is a product that was created by the Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA), and became available as of January 1, 2002. Basically, it is a retirement plan suited for owner-only businesses (including the self employed) with no eligible common law employees. For certain business owners, this plan offers the maximum in flexibility and much larger contributions than traditional retirement plans.
WHAT MAKES THIS NEW PLAN DESIGN SO ATTRACTIVE?
For this group of business owners the Individual (k) plan offers the same great benefits as conventional 401(k) plans offered by companies with employees. However, because the Individual (k) is designed specifically for businesses that either have no employees, or only have employees that may be excluded from coverage testing, the Individual (k) is less complex, less burdensome to administer and less costly to maintain than its "big brother".
Several separate changes to the tax code come together to allow the unique benefits available for these business owners :
The amount the employer can deduct (the IRC Section 404 limit) for profit sharing plans was increased from 15% of payroll to 25% of payroll.
The amount any individual can be allocated (the IRC Section 415 limit) has increased to $45,000 (excluding catch-up amounts).
Prior to 2002, 401(k) deferrals were counted towards the employer's 25% deduction. In 2002 and beyond, these deferrals are not counted towards that deduction (IRC Sec. 404 limit).
EGTRRA (and acceleration under subsequent tax acts) have increased the deferral limits and catch-up contributions for those age 50 and over.
So what does that really mean? It means that a business owner (with no employees) can make a 25% discretionary profit sharing contribution for themselves plus get an additional $15,500 401(k) deferral as indexed for 2007 (as long as they stay below a total contribution of $45,000 or $50,000 with catch up).
One of the many tax benefits created by recent pension reform legislation was the opportunity for individuals who are age 50 or older to defer amounts in addition to what is normally permitted under a 401(k) type deferral arrangement.
Since Individual (k) plans are a type of 401(k) plan, they qualify for these special catch-up contribution rules. What is perhaps even better news is the fact that both 401(k) plan catch up contribution limits, as well as the general 401(k) plan employee salary deferral limits, will increase annually through 2007. So the benefit starts with the expanded limits for 401(k) contributions for the business owner that employs only owners, spouses and partners (includes corporations, partnerships, sole proprietors, and non-profit entities) without common law employees.
PROFIT SHARING COMPONENT
In addition to this expanded deferral limit, the Individual(k) plan allows for profit sharing contributions of up to 25% of total wages. (For 2007, the maximum amount of wages that may be used for this calculation is $225,000.) This can amount to a significantly larger contribution than that allowed by any other tax advantaged plan.
Traditional IRA, SIMPLE IRA, SEP IRA and Profit Sharing/Money Purchase plans all limit contributions and deferrals as much as $15,000 less than the Individual (k).
As an example, a sole proprietor with a net profit of $100,000 will be able to contribute $34,087 ($39,087 if 50 or older) into an Individual (k) in 2007. By contrast, with the same net profit, a SIMPLE, a SEP or a Profit Sharing Plan may allow less than half that amount.
The Individual (k) contribution is comprised of these two components: the employer profit sharing contribution and the employee salary deferral contribution.
For an incorporated business owner the determination of the maximum individual plan contribution would follow these steps:
Determine the Profit Sharing Contribution
The maximum Profit Sharing Contribution cannot exceed 25% of total wages. (The maximum amount of wages that may be considered for 2007 is $225,000.)
Determine Maximum Salary Deferral
This amount cannot exceed the lesser of the annual maximum deferral limit plus catch-up contributions (if 50 or older) or total wages.
Calculate Total Maximum Individual (k) Plan Contribution
This amount will equal the sum of the first two calculations again limited to $45,000 (for 2007 and exclusive of catch-up contributions) or 100% of total wages.
Owners of Subchapter S corporations must base their contribution on W-2 income and may not base contributions on pass through profits.
The Individual (k) holds a significant advantage for this particular group of business owners to contribute and shelter more money into a retirement plan. Other advantages include the ease of setup, the capacity to self direct funds, and lower administration costs than many other plans.
Tax Facts 2007, National Underwriter Company
PLEASE NOTE: The information being provided is strictly as a courtesy. When you link to any of the
websites provided here, you are leaving this site. Feliciano Financial Group makes no representation as
to the completeness or accuracy of information provided on these sites. Nor is the company liable for
any direct or indirect technical or system issues or any consequences arising out of your access to or
use of third-party technologies, sites, information and programs made available through this site. When
you access one of these sites, you are leaving the Feliciano Financial Group website and assume
responsibility and risk for your use of the sites you are linking to.