One-person 401(k)s make a
lot of sense for self-employed
Page 3B, USA Today, 21 May 2002
By Sandra Block
You give up a lot when you go to work for yourself. Paid
vacations. Holiday parties. Free herbal tea. But starting this
year, you don't have to give up a 401(k) plan.
Provisions in last year's tax-cut bill made one-person 401(k)
plans, also known as individual or owner-only plans, less costly
and more attractive for self-employed workers. Financial companies
say the plans offer several advantages over traditional retirement
programs for the self-employed, such as Keogh plans, SEP
individual retirement accounts and Simple IRAs. Among them:
* Higher contribution limits. Self-employed workers can
contribute up to $40,000 a year to a one-person 401(k) plan.
That's more than double the maximum for some traditional
self-employed retirement plans. If you're 50 or over, you can
contribute even more: up to $41,000 in 2002, says Art Creel,
senior vice president of John Hancock Funds.
The amount you can contribute is based on your income, so the
maximum for many business owners will be less than $40,000. But in
most cases, it will still be more than allowed by other plans for
the self-employed (see box). As is the case with regular 401(k)s,
contributions reduce your taxable income. You won't pay taxes on
your contributions or investment gains until you take the money
out.
* Borrowing privileges. You can borrow from a one-person
401(k), just as you can from an employer-provided plan. You must
pay the money back, usually within five years, says Debra Zipp,
manager of retirement sales for Waddell & Reed. Interest is
based on market rates. She recommends making quarterly
payments.
Borrowing from a 401(k) isn't always a good idea: It will slow
the growth of your savings, and if you're unable to pay back the
loan, you'll face taxes and early withdrawal penalties. But if a
big customer is behind on payments and your mortgage is due,
borrowing from your 401(k) beats pawning your guitar.
* Rollover options. You may be able to jump-start your
one-person 401(k) by rolling over other retirement savings into
your plan. For example, if you leave a job to start your own
business, you can roll your employer's 401(k) into your individual
plan, Zipp says. Many financial advisers are recommending
self-employed clients roll their Keogh plans into one-person
401(k)s, says Christopher Guarino, president of BISYS Retirement
Services, which helps financial companies set up the plans.
Rollovers will help you consolidate your savings and increase the
amount you can borrow. Not all retirement plans can be rolled into
a one-person 401(k), so be sure you consult with an adviser
first.
* Low cost. One-person 401(k)s have actually been around for
years, but the administrative hurdles made the cost prohibitive.
The new rules, combined with technology, have knocked down the
price. John Hancock Funds, for example, charges $150 a year. And
many providers require no minimum investment to start a one-person
401(k).
* Protection from creditors. Like regular 401(k) plans,
one-person 401(k)s are covered by the federal Employee Retirement
Income Security Act, which means they're protected from creditors
and bankruptcy claims, Zipp says. If your business goes under,
your creditors won't be able to go after your retirement savings
to pay off your debts.
Who shouldn't invest
For all their advantages, individual 401(k) plans aren't
appropriate for all business owners. If you're planning to expand
your business and add more workers, you should probably stick with
a traditional self-employed retirement plan.
Once you establish a 401(k) plan, you must make it available
to all of your full-time employees, other than your spouse, says
Elise Pilkington, a director for Principal Financial Group. You
must meet these requirements even if you hire just one full-time
employee. If your employee decides not to contribute, you can't
either. In addition, the paperwork and administrative costs will
increase the cost of maintaining the plan, she says.
If you violate the rules, the Internal Revenue Service could
disqualify your plan, forcing you to pay taxes and penalties on
your savings.
But for independent contractors and other one-person
businesses, one-person 401(k)s ''are a great way to maximize
retirement savings,'' Pilkington says.
So far, a handful of financial companies are offering
one-person 401(k)s, but the number is expected to grow as demand
increases. Layoffs and early retirement have forced many workers
to start their own businesses. ''The market opportunity is huge,''
Guarino says.
