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 $162,000.
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 $162,000 (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.
