401(k) Investment Plans & Small Businesses

Many self-employed persons felt (and financial advisors agreed) that 401(k) investment plans did not meet their needs due to the high costs, difficult administration, and low contribution limits. But the Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA) made 401(k) plans more beneficial to the self-employed. The two key changes enacted related to the allowable "Employer" deductible contribution, and the "Individual" IRC-415 contribution limit.

Prior to EGTRRA, the maximum tax-deductible contribution to a 401(k) plan was 15% of eligible pay (reduced by the amount of salary deferrals). Without EGTRRA, an incorporated business person taking $100,000 in compensation would have been limited in Y2004 to a maximum contribution of $15,000.

EGTRAA raised the deductible limit to 25% of eligible pay without reduction for salary deferrals. Therefore, that same businessperson in Y2004 can defer $15,000, make a profit sharing contribution of $25,000 (i.e 25%), and — if this person is over age 50 — make a catch-up contribution of $5,000 for a total of $45,000, though this would be limited in 2006 to $44,000, the maximum allowed under the higher IRC-415 limit.

To take advantage of these higher contributions, many vendors now offer Solo-401(k) plans or Individual(k) plans.