With all the procedures involved in just keeping things going, retirement planning often gets put aside. Even when the need for a retirement plan does end up front and center, it appears that the 401K is not often thought of even though specialized Solo 401K and IndividualK plans are available. It is often believed that 401Ks have relatively low limits on contributions and are, in any case, really only suitable for bigger businesses.
However, changes to the original law made by the Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA) have made the choice of a Solo 401K or IndividualK plan a valuable addition to your retirement plans as well as a means to substantially reduce your tax bite as a self-employed person.
When you read up on the contribution limits for 401Ks, the information can be less than explicit and sometimes is not all in the same place. This leads most of us to think that the maximum contribution for 2007 is $15,500, plus, if you are over 50 a possible additional $5000 catch up contribution. There is actually a bit more to it than that. An employee can also receive a 401K contribution made by the company. However, it may not be clear how this can work for you as an entrepreneur.
As an employee, you are entitled to make this $15,500 "elective salary deferral." Beyond the salary deferral, as an incorporated business you can give yourself a "profit-sharing" contribution at the maximum rate of 25% of eligible pay. And there is no deduction for the amount of the salary deferral. The profit-sharing contribution for an unincorporated business follows a somewhat more unfavorable rule since the 25% is based on net self-employment income. Essentially this means that you would need to deduct any elective salary deferral and any catchup contribution which would reduce the maximum profit-sharing amount.
Whichever case applies to your business, a Solo 401K can help you put away a significant part of your earnings. Since the contributions and the interest or other earnings from the 401K are not taxed until withdrawn, you also can substantially reduce your tax liability.
For a little further clarification on the limits related to 401K, we have some more number soup. The $15,500 2007 and 2008 limit on the elective salary deferral is known as the 402g limit. Unsurprisingly, that is the section that specifies that limit. Since this limit is indexed to inflation, it may increase as may the catchup contribution. Both increase in $500 steps. Now, the actual, total possible contribution adding in both the employee and employer contributions is set by section 415. Section specifies the 2007 limit to be the lesser of $45,000 (plus the catchup contribution) or 100% of the employee salary. This will increase for 2008 to a maximum of $46,000 plus the catchup if it applies.
A nice feature of the Solo 401K is that they can be set up as self-directed 401Ks. This would allow you basically total control over your contributed funds in terms of how they are invested. Essentially, with this sort of setup you can invest in nearly anything. With the investment options available and the capability of making substantial pre-tax contributions, investigating how a Solo 401K or IndividualK could be integrated into your planning for retirement makes a great deal of sense for an entrepreneur.
There was a sneak preview of the Dept of Labor's preliminary guidance on setting up 401k default investment options. These situations occur when 401k participants fail to select an investment option for their 401k contributions or a 401k default fund is used in 401k plans with automatic enrollment features. Currently, 401k plan sponsors are rethinking their default fund decisions because they are concerned about the risk associated with their fiduciary responsibility and about the risk of the earnings performance of the default investments of those participants who failed to choose any.
When a participant fails to make a choice, the default fund is the choice made for them by the plan's fiduciaries. And because the participant is NOT making the decision when a default investment is used, the plan fiduciaries are responsible to prudently invest their funds. Many plan sponsors feel that their decision on the default investment is protected by the safe harbor exemption of Internal Revenue Code Section 404c. Section 404c provides an exemption to plan sponsors from liability for investment decisions when participants are given the choice to choose their own investments. Section 404c transfers liability to plan participants for their choices of investment options. Here, sponsors believe that by not making an active choice, the participant has decided to take the default investment.
And if the default investment is a Stable Value or Money Market Fund, the participant does not loose any of his principal. Plan sponsors feel that the participant's funds are not at risk and so neither are they.
Because the participant is not making the decision when a default investment is used, there is no 404c defense for plan fiduciaries. Also, sponsors are required by ERISA to invest with a reasoned, thoughtful process for evaluating risk and returns and for providing investment options that are diversified and prudent.
Under the forthcoming guidance -- which, said a Dept of Labor law specialist in the Office of Regulations and Interpretations, is subject to change ? 401k fiduciaries are given a safe harbor on 401k investment management decisions and any breach that is "the direct and necessary result of investing a participant or beneficiary's account" in a default investment. Investment managers and advisers, on the other hand, are solely responsible for any decisions they make with regard to the 401k investments or any resulting losses and do not get that kind of relief.
In order to qualify for that 401k safe harbor, however, 401k fiduciaries must allow participants:
-the opportunity to move their investments into an alternate account -provide advance notice of the default investment and -invest the assets in a certain kind of qualified default investment.
Moreover, that choice, which can be a lifecycle fund or a managed account, among others, must limit the presence of employer stock in the portfolio, as well as allow funds to be transferred out of the default.
The 401k fiduciary responsibility associated with selecting funds for the default investment options in a 401k plan has now been tempered with this new preliminary safe harbor.
Both Richard G Keir & Lawrence Groves are contributors for EditorialToday. The above articles have been edited for relevancy and timeliness. All write-ups, reviews, tips and guides published by EditorialToday.com and its partners or affiliates are for informational purposes only. They should not be used for any legal or any other type of advice. We do not endorse any author, contributor, writer or article posted by our team.
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