Question: I am self-employed and the only employee of my business. While this affords me a lot of freedom and an above average income, I’m not able to invest as much for retirement as I’d like. I’ve been contributing the maximum to my SEP but would like to put away more on a tax-favored basis. Any suggestions?
Answer: You’re in luck. The new tax law provides a jackpot for one-person businesses.
You probably already know the new law provides increased contribution limits to IRAs and 401(k)s for everyone and catch-up provisions for those over 50. But you may not know that businesses that employ only the owners and their spouses can stash even higher amounts into a 401(k).
In the past, a 401(k) has not been the retirement plan of choice for the self-employed because of higher set-up fees and more complicated IRS filing requirements. SEP and Simple IRAs were easier to establish and offered the same investment limitations, for the most part.
With the advent of the new rules, you’ll begin to see special 401(k) programs designed for you. Pioneer Funds offers a “Uni-K” for a $100 annual fee and signature-ready IRS 5500 preparation for $250 per year, a small price for the additional investment it allows.
Under previous rules, there was a 15 percent-of-pay cap that an employee and employer (you are both) could contribute on as much as $170,000 of compensation. That increased to 25 percent of $200,000 in 2002 for an incorporated business, 20 percent for one that is not incorporated.
The bigger change is that in 2002, employee contributions won’t be counted toward the 25 percent cap. That means you can make a large contribution as an employer and still contribute the maximum of $11,000 as the employee.
Over 50? You’ll be able to contribute an extra $1,000 as an employee to your 401(k) or $500 to a Simple IRA. If you’re not incorporated, your percentages will be slightly less. The combined employer and employee contribution cannot exceed $40,000 in 2002.
Ruth Forsyth is an investment advisor associate and registered representative with The Advisors Group. Reach her at (412) 922-4360 or at [email protected].