If your small business is a sole proprietorship, a smart year-end tax strategy could be to open an individual 401(k) retirement account if you don't already have one. Not only could an individual 401(k) reduce your tax bill, but it could also help you jump-start your retirement savings. Here are nine reasons to open a 401(k) before year's end.
Contributing to an individual 401(k) - sometimes called a solo 401(k) or personal 401(k) - could sharply reduce your taxable income and save you a bundle in federal income taxes (and, in some states, state and local income taxes, as well). One of the advantages of an individual 401(k) is that the contribution limits, which are based on your income, are relatively high. For example, for the 2011 tax year, you can contribute as much as $49,000 to an individual 401(k) (or $54,500 including a catch-up contribution of $5,500 if you are 50 or older). Thus, if your marginal tax rate is 28 percent, you are under 50, and you contribute the maximum amount to a 401(k), your tax bill could be reduced nearly $14,000.
Boost retirement savings
The high contribution limits for an individual 401(k) could allow you to give your retirement savings a significant boost in 2011 and keep you on track for a comfortable retirement.
While these reasons (reduced taxes and higher retirement savings) would be enough to make the case for opening an individual 401(k), there are other reasons that make the argument for this strategy even stronger.
Plenty of time to contribute
For a sole proprietor, the 2011 contribution deadline for a 401(k) is April 17, 2012, so, as long as you open your account by the end of 2011, you will have plenty of time to fund it with 2011 contributions. Thus, you can determine your tax bill for the year and then decide how much to contribute to your 401(k) to minimize your tax bill and/or maximize your retirement savings.
More savings in 2012
If you establish an individual 401(k) account in 2011, you will be set to make ongoing contributions in 2012.
Easy to open
It is simple to open an individual 401(k) account. Most major brokerage or money management firms offer individual 401(k) accounts, and the process to open one is generally relatively quick and easy.
Low-cost retirement plan option
The cost of maintaining an individual 401(k) account is low, and there may be no or only a modest maintenance fee on your account.
Extensive investment options
Investment options for an individual 401(k) are diverse, and you will be able to decide how to invest the money in your account.
Consolidate retirement assets
If you prefer to make your retirement planning easier by consolidating retirement accounts, this is allowed with an individual 401(k).
Take out a loan
If your 401(k) plan documents allow loans, you may be able to borrow up to 50 percent of the account balance from your 401(k). The maximum loan allowed is $50,000, and it will have to be repaid to the 401(k) with interest, usually over five years. Nonpayment of a loan could result in taxes and penalties.
As with any retirement plan, it is a good idea to check with your tax advisor before opening an individual 401(k).
us.etrade.com, Retirement plan contribution limits and deadlines
Jeff Nabers, www.solo401k.com, Self-Directed Solo 401(k) Investment Options
www.individual401k.com, Individual 401(k) FAQs
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