In all of the noise and hoopla about the new rules for retirement plans, something has not been getting all the attention it deserves.

One person "employers"---the smallest of the small—have great opportunities for funding their retirement plans. The "one man" 401(k) plan is being marketed, but I haven’t seen the response I would have expected. Most of what you’ve read about one-man 401(k) plans is true.

Background Qualified retirement plan rules generally require that contributions for owners and the highly paid employees be proportionate, based on compensation, for the rank and file employees. The more rank and file employees, the greater the cost for funding benefits of the owners.

If having fewer employees helps the business owners fund their own retirement plans, then having no employees is the best. The new tax law underscores this basic concept.

Let’s take a look at the retirement plan options for sole proprietors and one-person corporations.

Choices The one-person employer can use a 401(k) plan, a profit sharing plan, a money purchase plan, a SEP, or a SIMPLE plan.

The one-person 401(k) plan is, by far, the best choice for the one person business. It is my favorite.

The one-person 401(k) plan works because the "elective deferral" of the owner can now be 100% of compensation. This means that the first $11,000 of earnings ($12,000 if you’re over 50 and eligible for the "catch-up" contribution) can go into the plan.

Thereafter, the plan works like a conventional profit sharing plan. The new rules permit deductions up to 25% for total profit sharing contributions.

The calculations get a little complicated. However, a sole proprietor who has a net earnings of $155,000 can get a contribution of the maximum $40,000 in a one-person 401(k) plan. And, if the owner adds his or her spouse to the payroll at a salary of $11,000, all of that can be deferred by the spouse into the plan as well (with some adjustments for payroll taxes.)

The plans that come in tied for second are the money purchase plan, the profit sharing plan, and the SEP. The sole proprietor making $155,000 could get a contribution of $29,532 in each of these plans.

The distant last choice is a SIMPLE plan, where the sole proprietor with $155,000 of earnings gets a contribution of $11,294.

The "Dark Horse" Choice: The One Man Defined Benefit Plan Oops! We cannot forget this option.

Defined benefit plans have been off our radar screen for years. Since the mid-1980’s, defined benefit plans have been shunned by most employers. In some circumstances, however, a defined benefit plan can be a home run under the new tax laws.

The advantage of the one-person defined benefit plan is that contributions much greater than $40,000 per year can be made. But, the situation has to be "right." Defined benefit plans turn on actuarial hocus pocus. The business owner must have a large income (at least $100,000 per year), he or she must be at least 45 year old (for once, older is better), and ---- here’s the hard part --- that income must be sustainable for several years, at least five or more. A defined benefit plan is not a "one shot" item to be used when the owner has a single huge year. In my experience, the people who best fit the profile for one-man defined benefit plans are professionals, sales people, or consultants.

If your client meets these criteria, you will need a licensed actuary to design and administer the plan. Mere mortals, such as CPAs, lawyers, and financial consultants, can’t do this. The good news, however, is that very capable actuaries are available locally. When the situation is right, the one man defined benefit plan is pure magic.

How to Set Up the One Person 401(k) Plan Getting the one-person 401(k) plan off the ground is easy. There are 401(k) vendors that have plans and products specifically designed for this market. At this time, however, I am a little surprised that there are not more of them. I expect, however, that as the concept catches on the marketplace will be filled with them. The pricing and the product choice will shake out at time goes on.

Two Roadblocks One person 401(k) plans are terrific. The hard part, however, is qualifying for such a plan.

Generating significant income as a one-person business is hard enough. Moreover, there are two significant roadblocks. They are (i) the controlled group rules, and (ii) the affiliated service group rules. These hurdles have been in the pension laws for years, but they have a new significance in the one-man plan arena.

The "controlled group" rules apply to commonly owned businesses in both parent-subsidiary and brother-sister circumstances. If the same people "control" more than one business, those businesses are treated as a single employer for retirement plan qualification. The sole proprietor or one person corporation cannot use the one-man 401(k) if the owner controls another business that has its own employees. The controlled group rules have these characteristics:

They turn solely on ownership. It makes no difference if the businesses are in different industries or are geographically dispersed.

The rules are purely mathematical. There are no touchy-feely considerations based on "intent" or "materiality."

Complex (and I mean very complex) attribution rules apply.

The second roadblock is the "affiliated service group" rules ("ASG" rules). They are the kissing cousins of the controlled group rules. The ASG rules have the same effect: they force the aggregation of businesses into a single "employer" for retirement plan purposes. Even if you can tap dance around the controlled group rules, the ASG rules can still catch you.

Some of the features of the ASG rules are:

They only apply to "service" businesses, such as consulting, sales, law, accounting, medicine, etc.

The common ownership thresholds are much lower than those for controlled group rules. In some cases no common ownership is required. The complex attribution rules apply.

They include some non-mathematical criteria. This makes their application fuzzy in each particular case.

Many plans violate the ASG rules unknowingly.

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