IRS Increases 401(k) Limits
October 27, 2008 – 2:33 pm
Big Jump in 401(k) Contribution Limits for 2009 –
It is never too early — and we are never too young — to be contributing as much as possible to a tax-advantaged retirement account. For self-employed persons, an Individual 401(k) Plan is probably the best option. It provides the greatest savings potential with the lowest administrative overhead of all the available tax-advantaged retirement plans. In my opinion, every self-employed solo professional should be contributing generously into a 401(k) account.
Solo professionals who conscientiously max out their individual 401(k) accounts every year will be happy to learn that the Internal Revenue Service has significantly increased the 401(k) contribution limits for 2009.
This table shows the 401(k) contribution maximums for the years 2008 and 2009:
| Annual Maximums | Year 2008 | Year 2009 |
| Elective Deferral (under age 50) | $15,500 | $16,500 |
| Elective Deferral (age 50+) | $20,500 | $22,000 |
| Total Contribution (under age 50) | $46,000 | $49,000 |
| Total Contribution (age 50+) | $51,000 | $54,500 |
| Compensation | $230,000 | $245,000 |
The maximum elective deferral is the maximum tax-deferred amount that you can deduct from your gross wage (or gross earnings if you are self-employed) and contribute to your 401(k) account. In 2009 the maximum elective deferral increases from $15,500 to $16,500.
If you are age 50 or older, you can deduct an additional $5,500 catch-up contribution for a total elective deferral in 2009 of $22,000.
 If your 401(k) has a Roth option, you can contribute some or all of your elective deferral as after-tax dollars into a separate Roth account. Money you withdraw from your Roth account after retirement age is tax-free.
The maximum annual contribution limit is the maximum tax-deferred amount that your account can receive during the year, including elective contributions plus employer contributions (or profit-sharing contributions from your business if you are self-employed). If you are younger than age 50, the total tax-deferred contribution for 2009 is $49,000. If you are age 50+, the total is $54,500.
Tax deferred contributions to your 401(k) retirement savings plan in 2009 are based on the first $245,000 of annual compensation.
In an earlier post, IÂ showed that a self-employed person would have to generate net revenues (gross revenues after expenses and payroll taxes) of at least $152,500 in order to contribute the 2008 maximum of $46,000 for an individual under age 50.
I then showed that a solo professional operating under the umbrella of Solo W-2, Inc. employment is able to contribute the same $46,000 to their 401(k) with net revenues of only $76,500. That, my friends, is just one-half the net revenues required by a self-employed individual.
Now, let’s see how the new limits for 2009 affect the 401(k) contributions of a self-employed person and a Solo W-2, Inc. employee.
The Amazing Solo W-2, Inc. $81,000Â Advantage
Self-employed PersonÂ
In order to contribute the maximum of $49,000 to an individual 401(k) account, a self-employed person under age 50 will have to generate net revenues (gross revenues after payroll taxes and expenses) of at least $162,500.
Here is why. IRS rules state that an individual may contribute 100% of gross wage up to the maximum allowable deferral, so a self-employed person may defer $16,500 from the first $16,500 in gross earnings as a contribution to their 401(k) account. The self-employed person’s business then contributes an additional $32,500 as a profit-sharing contribution.
IRS rules state that the profit-sharing contribution may not exceed 25% of a business’s total gross wages. Therefore, the gross earnings of a self-employed person must be at least $130,000 to justify a profit-sharing contribution of $32,500. It follows that net revenues (gross revenues after expenses and payroll taxes) will have to be at least $162,500 (see table below).
Solo W-2, Inc. Employee
A Solo W-2, Inc. employee under age 50 may also make a $16,500 voluntary deferral plus an employer contribution of $32,500. The difference is that Solo W-2, Inc. employees are not individually limited by the 25% limit on employer contributions the way self-employed persons are. Therefore, a Solo W-2, Inc. employee can contribute one dollar to his or her 401(k) for every one dollar of gross wage up to the absolute IRS maximum.
Indeed, the 25% limit on employer contributions does apply to all businesses, not just owner-only businesses. However, for businesses with multiple employees, the 25% limit applies to total gross wages across all employees. Therefore, employees who choose not to max out their 401(k) accounts create excess capacity that other employees can use to contribute more money faster to their own retirement accounts.
For this reason, a Solo W-2, Inc. employee can max out his or her 401(k) plan with gross wage of only $49,000 and that employee would require net revenues (gross revenues after expenses and payroll taxes) of only $81,500 to do so (see table below).
| Individual Under Age 50 | Self-employed | Solo W-2, Inc. |
| A. Gross Earnings / Gross Wage | $130,000 | $49,000 |
| B. Elective Deferral (included in gross) | $16,500 | $16,500 |
| C. Profit Sharing / Employer Contribution | $32,500 | $32,500 |
| D. Total Contribution (B + C) | $49,000 | $49,000 |
| E. Net Revenues Required for    Maximum Contribution (A + C) |
$162,500 | $81,500 |
The table above illustrates the amazing fact that a self-employed person under age 50 must generate a whopping $81,000 more in net revenues than a Solo W-2, Inc. employee before they can contribute the same $49,000 maximum contribution to their 401(k) retirement account.
A solo professional over age 50, can defer an additional $5,500 for a total elective deferral from gross wage of $22,000. The table below illustrates that a self-employed person over age 50 must generate $75,500 more in net revenues than a Solo W-2, Inc. employee before they can contribute the same $54,500 maximum contribution to their 401(k) retirement account.
| Individual Over Age 50 | Self-employed | Solo W-2, Inc. |
| A. Gross Earnings / Gross Wage | $130,000 | $54,500 |
| B. Elective Deferral (included in gross) | $22,000 | $22,000 |
| C. Profit Sharing / Employer Contribution | $32,500 | $32,500 |
| D. Total Contribution (B + C) | $54,500 | $54,500 |
| E. Net Revenues Required for    Maximum Contribution (A + C) |
$162,500 | $87,000 |
Clearly, when compared with self-employment, employment by Solo W-2, Inc. represents a huge advantage — both in terms of reduced tax liability and increased retirement savings.
You will find a complete description of the Solo W-2, Inc. Roth 401(k) Retirement Savings Plan, including an explanation of the safe harbor contribution and employer match, in the Solo W-2, Inc. web site at: http://www.solow2.com/401kPlan.html.
James R. Ziegler, Ph.D.
6 Responses to “IRS Increases 401(k) Limits”
question - my tax profsl has said that the profit sharing is limited to W-2 wages, and cannot include the income of the company in calculating how much the company can contribute. My W-2 wages are low ($40,000) but the company profit will be over $100,000. So if I can base the profit sharing contribution on the profit, not on W-2, I could contribute alot more….
So - which is it???
By kim kirk on Nov 11, 2008
As the owner of your company, you receive two types of compensation: Earnings ($40,000 in gross wage) and dividends ($100,000 in owner’s profit). The elective contribution to your individual 401(k) account is deducted from your gross wage and in 2009 may not exceed $16,500 (or $22,000 if age 50+). The profit sharing contribution is made from your profit and may not exceed 25% of gross wage.
If your gross wage is set as $40,000, then your profit sharing contribution will be limited to just $10,000.
As the owner of your company, you have the authority to give yourself a higher wage and a lower dividend. The down side is you will pay more in Social Security and Medicare taxes. The up side is you will have a higher wage base and, therefore, be able to contribute more money to your individual 401(k) account.
If your tax professional is having a hard time getting his/her head around this concept, I strongly suggest that you find another tax professional who understands how to maximize the contributions to your retirement plan.
On second thought, why not run your revenues through Solo W-2, Inc. Then, as I explained in the above post, you will be able to load your 401(k) account up to the IRS maximum on approximately one-half the revenues of a self-employed person. For example, if you are under age 50, you can run your first $81,500 in revenues after expenses through Solo W-2 and in 2009 contribute the IRS maximum of $49,000 to your 401(k) account. That way, you will max out your 401(k) account early in the year, as opposed to waiting until the end of the year, which will further increase the tax-deferred investment potential of your retirement account.
By James R. Ziegler, Ph.D. on Nov 12, 2008
In your article you state:
“The difference is that Solo W-2, Inc. employees are not individually limited by the 25% limit on employer contributions the way self-employed persons are.”
How can that be possible? with $81,500 how can I contribute $49,000 to 401k account? I am an employee to my own corporation. How can I run my revenues thru Solo w-2 Inc., if I wanted to?
By Monika on Feb 22, 2009
Hi Monika,
You quoted from my post the following: “The difference is that Solo W-2, Inc. employees are not individually limited by the 25% limit on employer contributions the way self-employed persons are.”
Then you asked: “How can that be possible? With $81,500 how can I contribute $49,000 to 401k account?”
Let’s look again at what I wrote in my post, including the content immediately before and immediately after the sentence you quoted:
Now, refer again to my post and the table with the heading Individual Under Age 50. In order to contribute the IRS maximum of $49,000, a self-employed person must contribute an elective deferral from gross earnings of $16,500 plus a profit sharing contribution of $32,500. Because the profit sharing contribution can be no more than 25% of gross earnings, gross earning must be at least $130,000.
If all the employees of a business wanted to contribute the IRS maximum to their 401(k) accounts, the average salary for the entire organization would have to be at least $130,000. However, this is rarely the case. Many Solo W-2, Inc. employees choose not to max out their 401(k) accounts because they need the money to pay their mortgage or for college tuition for their children or, simply, to pay their bills and support their current lifestyle.
To the extent that individual employees opt to contribute less than allowed by IRS guidelines, these employees create excess capacity, making it possible for employees with salaries less than $130,000 to contribute individually more money to their 401(k) accounts than would be possible if they were the only person in the business.
Another factor that creates excess capacity is high wages. Many highly compensated consultants earn more than they need to max out their 401(k) accounts. Therefore, even through they do max out their 401(k) plan, the employer match is less than 25% of their gross wage, creating additional excess capacity.
In fact, the excess capacity in Solo W-2, Inc. is such that any employee who wants to max out his or her 401(k) plan can contribute one dollar for every one dollar of gross wage up to the absolute IRS maximum.
Here is how that works. The employee’s division of Solo W-2, Inc. pays a gross wage to the employee equal to $49,000. The employee elects to defer $16,500 of that gross wage as tax-deferred dollars to his or her 401(k) account. The employee’s division also contributes $32,500 as a tax-deferred employer contribution to the employee’s 401(k) account. To review:
Now, with respect to the second part of your question, you wrote: “I am an employee to my own corporation. How can I run my revenues thru Solo w-2 Inc., if I wanted to?”
One possibility is that you discontinue your own corporation and become an employee of Solo W-2, Inc. Instead of being the sole employee of your own one-person corporation, you will become the sole employee of your own one-person division within a much larger corporation consisting of many one-person divisions.
However, you may wish to continue your own corporation. For example, you may have rental property or other business ventures for which you require the protection of a corporate veil limiting your personal liability. In that case, you can still join Solo W-2, Inc. for the superb back-office support you will receive with contract negotiations, timely invoicing and assertive collection of accounts receivable from your Solo W-2, Inc. clients. You will also enjoy first-tier corporate group benefits and many tax-advantages available to Solo W-2, Inc. employees, including our remarkably generous Roth 401(k) plan with the $81,000 advantage over individual plans.
I encourage you to review the many valuable services and benefits of Solo W-2, Inc., http://www.solow2.com/BenefitsServices.html
I trust you will agree that:
All the best,
By James R. Ziegler, Ph.D. on Feb 23, 2009
I am in a corporate 401K plan and the online reports for my account don’t match what I would think they should for contributions. I am taking out $750 and 10 months have passed so $7,500 should be listed. Instead a lower number is shown and a portion of that number is described as “Deferral Receivable”. What does this mean?
By Aaron on Nov 17, 2009