INDIVIDUAL (K) PLANS

• 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.