If you are self-employed, you may take advantage of IRS rules that permit a single participant to set up and contribute to a 401(k) tax-deferred retirement savings plan. The account is governed by the same rules and restrictions as a traditional 401(k), but in the case of a self-employed 401(k), only one person contributes to the plan, as both employer and employee. For a 2010 401(k), you may make contributions until the tax filing deadline of Oct. 15, 2011, if you request an extension of time to file and if the IRS grants that request.
Self-employed 401(k)s are available to sole proprietorships, S corporations, C corporations and partnerships, as long as there is only one employee (your spouse may also be an employee). You may also have employees that you can legally exclude from the plan, including employees younger than 21, independent contractors, and part-timers who work less than 1,000 hours a year.
IRS Rule Changes
A change in the tax law in 2002 made 401(k) plans more attractive for self-employed people. Before this change, the IRS limited contributions from both employer and employee to 25 percent of the employee's compensation. After the rule was changed, the IRS no longer combines contributions to figure the limit. The 25 percent limit applies to the employer, and it does not apply to contributions made by an employee.
For the tax year 2010, the IRS limits tax-deferred contributions to a self-employed 401(k) to $49,000 in 2010, and $54,500 if you are 50 or older. There are two components to this limit. As the employee, you can contribute up to $16,500 (or 100 percent of your self-employment income, whichever is less), plus an additional $5,500 "catch-up" contribution if you are at least 50. As employer, you can contribute an additional 25 percent of your net income, up to the IRS limit for all contributions. This allows you to defer a much greater amount of your own money when contributing to a solo plan.
It's important to remember that your contribution limit applies to all of your 401(k)s, so if you have a regular employer as well as self-employment, you may defer up to the limit for all plans. If your self-employment business expands and you hire employees other than yourself, you must convert the self-employed 401(k) to a traditional 401(k) and include them in the plan as well.
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