The IRS estimates there are more than 20 million sole proprietors in the United States, and some business owners may not be aware that they can realize immediate tax benefits by setting up an Individual 401(k) plan. As the year-end approaches, it can be an opportune time to discuss setting up an Individual 401(k), which may help you tap into the small business owner market and expand your network of clients.

By funding an Individual 401(k) by the end of the year, clients can receive a tax deduction on the contributions they make to the plan. The plan can also help clients maximize their tax-deductible contributions. For a sole proprietor, the maximum contribution limit is $49,000 for 2010 or $54,000 if he or she is age 50 or older. Contribution limits on other retirement savings options are lower.

Individual 401(k) high contribution limits compared to other plans

Business owner’s
2010 wage
SIMPLE IRA SEP IRA Individual 401(k)
$50,000 $13,000 $12,500 $29,000
100,000 14,500 25,000 41,500
150,000 16,000 37,500 49,000
200,000 17,500 49,000 49,000

Source: Putnam research based on 2010 IRS limitations.

Chart assumes compensation is W-2 income. Lower limits may apply to SEP and Individual 401(k)s where compensation constitutes self-employment income. Chart also assumes no catch-up contributions are made. SIMPLE IRA contribution amounts reflect a 3% match formula.

An Individual 401(k) is available only for sole proprietors who have no employees. There is an exception, however, for spouses to contribute to the plan if they earn income from the business.

In addition, when setting up an Individual 401(k), clients may choose between a Traditional and a Roth account. Similar to IRAs, the traditional version allows you to save money on a pretax basis, and the money accumulates tax deferred. The Roth option requires that contributions be made with post-tax money. The funds grow tax free and are not taxed when withdrawn in retirement.

Individual 401(k)s also allow you to take out loans against your savings. And these accounts can also accept rollovers from other qualified retirement accounts.

Reach out to your sole proprietor clients and prospects before year-end to discuss how they can maximize their retirement savings while taking advantage of valuable tax benefits.

For more information about how the Putnam Individual 401(k) can help your self-employed clients save for retirement, download a product fact sheet.