The "Mini(k)Plansm Advantage" - Pension Protection Act and Roth 401(k) Increases Owner-only Plan Limits
January 1, 2009 (update of article originally published on January 11, 2006)
By Barry R. Milberg
Considering the increases in the 401(k) maximum contribution and defined benefit pension benefit limits for 2009 and the increase in the combined plans deduction limit, a business owner who is old enough and earns adequate taxable earned income can contribute and deduct up to $333,700 in year one, then 234,700 per year thereafter into a combination of a defined benefit pension plan and profit sharing plan with a 401(k) feature. Adding and contributing to a Roth 401(k) option, in lieu of the pre-tax 401(k), lowers the ongoing deductible contribution to $212,700 but effectively increases the combined plans contribution to $246,546 ($345,546 year one!). Learn more about the 2009 limits
The chart below outlines the 2008 maximum contribution/benefit limits to an owner-only plan as compared to a SEP. These figures do not reflect the additional savings leverage provided by contributing to a Roth 401(k) account. Learn more about increased savings provided by Roth 401(k).
Mini(k) Plan is a service mark of ERISA Expertise LLC which represents an optimally designed qualified retirement plan program for an owner-only business or a very small business (an employer with 1-25 employees).
Compliance Requirements for Owner-only Plans
As the chart above indicates, it is the establishment of a defined benefit pension plan and/or a plan with a 401(k) feature that permits a higher deductible contribution at any age or income level as compared to a conventional plan such as a SEP or SIMPLE IRA. However, what may not be apparent is that an owner-only "401(k)" plan (aka Solo 401(k) or Individual 401(k) plan) is a qualified retirement plan.
As the employer/plan sponsor of a qualified retirement plan, the owner-only business must comply with strict governmental guidelines to retain the plan's "qualified" status. And, believe it or not, these governmental guidelines are nearly as complex for a plan that provides benefits to an owner-only business as the ones that a company like Microsoft must follow. Failure to follow these rules may subject the plan to "disqualification" which means that all plan contributions and income on the plan investments may be retroactively taxable, and the business owner loses the ability to rollover the plan assets to an IRA at such time that he retires.
The key question that one should ask is: "Is this plan type appropriate for the individual's situation?" Meaning, does the business owner need/desire the higher tax deductible benefit that is gained by starting one of these plans versus a conventional plan. If a SEP or SIMPLE plan fulfills the business owner's needs (from a level of contribution/benefit perspective), he/she is typically better served using one of those plan types in that they require little if any governmental compliance.
Commentary The advent of the Roth 401(k) provides yet another opportunity for owner-only businesses to increase benefits at retirement and may be a valid consideration for stepping up to a 401(k) from a SIMPLE or SEP. If you are considering one of these plans, be mindful that once a SIMPLE plan is active for the 2009 plan year, no other plan may be established by that employer until 2010. And don't let anyone convince you that these plans are not complex to establish and administer. While the Roth provides additional benefits at retirement, it also adds another set of rules to follow to maintain compliance.
Ask yourself why many of the more savvy mutual fund companies like Vanguard, and investment vendors like Schwab have yet to offer standardized plans with the Roth feature? In fact, last we checked, Vanguard does not offer any ancillary services for owner-only plans (they do provide investment services for these plans).
We routinely represent small business owners with non-compliant plans who are subsequently audited by the IRS or Department of Labor. In most instances, these individuals have been misled into thinking that their plans did not require sophisticated compliance services.
You know the old saying: "You get what you pay for." It really does apply here, so proceed with caution and educate yourself before you recommend a low cost plan that leaves it up to the business owner alone to comply with all of the complex rules necessary to maintain their plan's qualified status. I can assure you that these clients wind up paying more to fix their broken plan than it would have cost to establish and administer it properly in the first place.
Bottom line The fees an owner-only business might pay to a competent pension compliance services provider are minimal compared to what may be lost by adopting an improperly designed and/or non-compliant plan.
View article: "Odds are Against You Choosing the Optimum Owner-only Plan"
Access Knowledgebase: Owner-only Retirement Plans
View Case Studies for Owner-only Businesses
View more articles on the Roth 401(k)
Learn more ERISA Expertise's Roth 401(k) Tools & Technology
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The information provided is intended as a general resource, not as investment or retirement planning, or legal plan compliance advice or counsel. If you consider any actions discussed in this update, we suggest that you consult a qualified planning, tax or ERISA professional. ERISA Expertise LLC and Barry R. Milberg do not warrant and are not responsible for any errors and omissions from this update. Any tax advice included in this written or electronic communication is not intended or written to be used, and it cannot be used, by the taxpayer for the purpose of avoiding any penalties that may be imposed on the taxpayer by any governmental taxing authority or agency.