- The individual 401k is an excellent choice for self-employed individuals, but it is not suitable for small business owners who have, or plan to have, additional employees. If you plan to bring others on board to help you grow your business, it is a good idea to look at other retirement plan options, including the SEP-IRA and SIMPLE-IRA.
- The individual 401k contribution consists of two parts, the employee portion and the employer portion. The employee contribution part of the individual 401k is exactly the same as the contribution limit for the traditional 401k. That means that for the tax years 2010 and 2011, the employee contribution is limited to $16,500 if you are 49 years of age or younger. If you are 50 years of age or older, you can contribute an extra $5,500 under the catch-up provision. That raises your total allowable employee contribution for the individual 401k to $22,000. The IRS reviews the contribution limits on a yearly basis and changes those limits from time to time. Always check with your tax preparer or accountant before planning your yearly individual 401k contribution.
- When you are self-employed, you act as both employer and employee. That means you are subject to the self-employment tax, which represents the portion of Social Security and Medicare taxes that would be paid by your employer if you worked at a traditional job. It also means that you can contribute to your individual 401k as both employee and employer. For 2010 and 2011, the limit for the combined employer and employee contribution is $49,000 for those 49 and younger and $54,500 for those 50 years of age and older.
- As a self-employed individual, you can use your contributions to the individual 401k plan to lower your tax bill. The high contribution limits for the individual 401k make it a good choice for sheltering a large amount of income. Taxes are a major consideration when you are self-employed, and removing as much income from taxes as possible is a desirable outcome. It is a good idea to consult with a CPA or tax expert to maximize the tax saving potential of the individual 401k program.