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Individual 401(k) Plans Shelter More Savings With Less Income

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People that are self-employed have always been able to save a lot through their retirement plans. Someone in the government must have realized how hard it is to become successful, or even just get by as a small business, and in a rare moment of charitable thought, given the little guy a break with limits on retirement savings that are well above what conventional employees can sock away tax-free. This year, one of the plan structures I was using became obsolete, and with the help of the folks at Vanguard, I realized by that my best choice was probably an Individual 401(k) Plan.

(Thanks to astute reader Ross Marino, chief executive of CEO of 401(k) Rekon, a firm that assists financial advisors with 401(k) issues. He also teaches a course on this complex area to the UNC-Wilmington Certified Financial Planner program. It's not my specialty and I appreciate him setting me straight on several points.)

Individual 401(k) plans are not exactly new; they came about in 2002 as part of the Economic Growth and Tax Relief Reconciliation Act of 2001. They're available to companies that have no employees other than the owner and their spouses, or to partners in a partnership. And it costs nothing, or very little, to switch from some other type of plan.

"With a SEP-IRA account, you are making contributions only as your own employer, but with the Individual 401(k), you can make two contributions, one as an employer and employee," explained Brian Kazanchy, a wealth manager with RegentAtlantic Capital, a wealth management firm in Morristown, NJ.

Someone making a few hundred thousand a year will max out either way, Brian says, but for the rest of us, it's a way to increase their contributions at lower income levels. "I wonder why anyone would find a SEP-IRA account attractive, given the higher limits of the Individual 401(k). There's more flexibility."

The employee limit for 401(k)s is $16,500 per year, with a catch-up provision of $5,500 if you're age 50 or over. That contribution has to be made during 2010. (With SEP-IRA accounts, there is no catch-up available, because employees, not employers, are the ones making the extra contributions.)

With a SEP-IRA, you need about $250,000 of gross income to max out, while someone doing the Individual 401(k) might have the $16,500 already put in, but they can get to the $49,000 limit with less income, says Kazanchy.

One drawback of 401(k)s, says Ross Marino of 401(k)Rekon, is that they require more reporting paperwork, in a Form 5500 to the IRS, if assets are greater than $250,000.

And you should consider the possibility of moving cash sitting in a taxable account into something tax-advantaged, such as an Individual 401(k). I'll be coming into some cash this year, and while I haven't got it all figured out, I'll probably apply some to my new Individual 401(k) account to take advantage of the limits, up to whatever my income allows.

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