Many successful entrepreneurs have long wished for a way to save more for retirement. Now, owners whose only employees (if any) are family members or part-time non-family can use a new micro-breed 401(k) plan to do it.

The so-called owner-k, an unintended child of the Economic Growth and Tax Relief Reconciliation Act of 2001, first became available this year. It lets entrepreneurs with net self-employment income under $200,000 (under $160,000 for incorporated owners taking salary) save more for retirement on a tax-deductible basis than other defined-contribution arrangements, including the popular Simplified Employee Pension plan. (Above those income thresholds, a business owner can save the maximum with any one of several plans.) Owner 401(k)s, which can be adopted by multi-owner enterprises, permit borrowing (a further distinction from SEPs), accept rollovers (opportunity for the advisor to grow managed assets), do not require contributions in down years, and offer fantastic planning opportunities for family working in the enterprise.

The absence of common-law employees in the plan is both blessing and curse. Discrimination testing is obviated-easing administration, lowering cost-but you don't get the federal creditor protection routinely associated with qualified plans, says Jeffrey Cairns, a shareholder in the Minneapolis law firm Leonard, Street and Deinard. Title I of the Employee Retirement Income Security Act-which spares qualified plans from creditors-does not apply to plans without common-law employees, although sometimes that is challenged, Cairns says. "Technically, the answer (in a bankruptcy case) ought to be that owner-only plans are not protected by ERISA. You have to look at state law to determine what protections would be available."

Estimates of the market for the newfangled-k range from 11 million to 17 million businesses-big numbers. "The opportunity for advisors is huge. They should be going through their books, 'Which (clients) are sole practitioners?'" says Matthew P. Mintzer, director of retirement products at Putnam Investments, which launched its Internet-based offering, the Individual 401(k), in November.

Entranced by the siren of market size, saucer-eyed vendors are tripping over themselves to introduce all manner of owner-k products in time to gather entrepreneurs' eleventh-hour contributions for 2002. Advisors, for their part, need to carefully shop the burgeoning micro-plan market, guided by several criteria (discussed later), to find the right programs for clients.

Nothing prevented this genre of retirement plan in the past. But under old laws, a one-person business could achieve full contribution with a simple profit-sharing contribution, so the owner-k concept never gained currency, according to David F. Crutcher, a benefits attorney at Thelen Reid & Priest in San Francisco.

Then the 2001 tax act decreed that an employee's pre-tax 401(k) contributions (called elective deferrals) no longer count toward the limit on the employer's deduction for making retirement-plan contributions. Therefore an owner, being both employer and employee, can now effectively maximize each's limit, up to the combined cap of $40,000 or 100% of pay, if lower (another key improvement, vs. 25% under old law). Throw in relaxed loan rules for owners, and the EGTRRA's changes "provide incentive for a one-person business to have a 401(k)," Crutcher says.

The Math

For 2002, elective deferrals may be as much as $11,000, with an additional $1,000 allowed for those 50 and older. Deferrals do not skirt self-employment tax, only income tax, and their limit is per person, not per job, says CPA/planner Gerald Townsend, president of Townsend Asset Management in Raleigh, N.C. "If a client, in addition to his business, has a job where he participates in a 401(k) to the max, he can't make deferrals under his business's plan. But his business can still contribute employer money"-a discretionary profit-sharing contribution-toward the owner's retirement, Townsend says.

The employer contribution is calculated on the first $200,000 of each plan participant's earnings; the maximum is 25% of W-2 wages for corporations, 20% of income (net of half the self-employment tax) for unincorporated business owners. Therefore, a 44-year-old sole proprietor with net earnings of $125,000 in 2002 can use an owner-k to save $36,000-$25,000 as an employer contribution (20% of $125,000 earnings), plus $11,000 in employee deferrals. A SEP, on the other hand, would only allow the 20% contribution, Townsend says.

Owners of S corporations benefit handsomely from the new math, says Marcy L. Supovitz, an executive vice president at Pioneer Investment Management, the first firm to bring an owner-only product to market. "Historically, S corporation owners have desired to keep W-2 salary low in order to keep Social Security taxes low, but because retirement-plan contributions are also based on the W-2 figure, there's been a trade-off-lower social security taxes, or a higher retirement-plan contribution? Now it's possible to save more at lower W-2 amounts," Supovitz says.

With an owner-only plan and modest W-2 wages of $50,000, an S corporation owner can sock away $23,500 (25% of $50,000, the employer contribution, which equals $12,500, plus $11,000 of employee deferrals). To sock that much away in 2001 under plans then available, an S corporation owner needed a $156,667 W-2-and payment of an additional $6,800 in payroll taxes.

Pioneer reports high interest in its Uni-K product from second-income spouses, and for good reason. At lower incomes, the upgrade from the prior law's restrictive 25%-of-pay limitation works wonders. A sole proprietor earning $25,000 net can elect deferrals of $11,000 to accompany the business's 20% contribution ($5,000) for $16,000 in total retirement savings. The complementary tax savings are nothing to sneeze at, either. Second incomes are decimated by the couple's marginal tax rate. An owner-k can relieve much of that irritation.

The effect of the new rules at low incomes can be leveraged in a family context. Townsend advises one client who earns a good living from a primary job but has an even better sideline business.

"Taxes are absolutely killing him," Townsend says. "The wife works in the business, and a couple of the college-age kids are doing some part-time work there, so we're going to create a family limited liability company" and have it adopt an owner-k plan. Everyone in the family will be an LLC member. "They'll all get some earned income, which shifts income out to the family, for starters. Then the individuals can save $11,000 each as a deferral," Townsend says, "and on top of that, the (unincorporated) company is contributing the maximum 20% for each." (All plan participants must be treated equally.) If a child's share of the entity's earnings, net of half the self-employment tax, is $14,000, $13,800 can be put toward her retirement-deferrals of $11,000, plus $2,800 (20% of $14,000 net earnings) by the business. "We're going to the hilt on this one," Townsend says.

You Better Shop Around

Although the micro-k market is new, advisors nevertheless must discern between a flood of "me too!" products and differentiated offerings. Evaluate owner 401(k) plans on several fronts, chief among them: cost/services included, investment selection, loan support, and ease of transitioning the plan when adding common-law employees, says Gary E. Lineberry, a senior vice president at AXA Financial.

An owner-k should be easy to implement, but that isn't always the case. Some vendors ask you to complete the same thick adoption agreement that a large corporation would. Forget that. Seek a streamlined product (Putnam, for instance, says its point-and-click application takes mere minutes to complete) and scrutinize how loans are administered.

Regarding cost, it's a blizzard of pricing structures out there. "There are full-service products and low-fee products. The important thing is to compare apples to apples," says Ben Norquist, strategic development director for Bisys Retirement Services, a leading prototype-document manufacturer. Ask whether there's a charge to establish the plan. There isn't with Pioneer's Uni-K or the Owner's 401(k) from Equitable.

What about a fee to roll in assets from another plan? Equitable charges $100 for that. What costs are associated with borrowing from the plan? Does the plan's annual fee cover all owners and family? With some products, multiple participants cost more. Does the annual fee include preparation of the plan's tax return, IRS Form 5500? If not, does the vendor offer tax prep? The $250 yearly cost for North Track Funds' Plan4One includes a signature-ready return (required when plan assets exceed $100,000, and for corporations with multiple nonspouse owners). Pioneer and Putnam charge $250 for a completed Form 5500, above the annual fee.

To some, mass providers' low-cost, off-the-shelf products actually come at a cost. "You have to use their funds," says planner Eileen Dorsey, president of Money Consultants Inc. in St. Louis. Dorsey had a client who was put off by the investment choices of one fund company's product, so she engaged a local outfit to draft a prototype plan "for about $600. And then it's a couple hundred dollars per year," says Dorsey. Townsend, meanwhile, ponied up $1,240 to become a sponsor of Bisys Retirement Services' Individual(k) (and also another Bisys plan).

There's a $600 annual fee, plus incidental charges, and the costs aren't necessarily passed on to clients. "If we're managing their assets, this is just a service to provide," Townsend says. "We've also talked to some other advisors in town who may want to use our owner-only plan for a small fee. If I can collect just a few (fees), it pays for the cost."

Before committing a client to an owner-k-especially if she or he harbors dreams of growing the enterprise-query about the process of transforming the plan into one that can accommodate workers. Is it a seamless process? Is there a charge? What are the providers' fees for a larger-scale plan?

Clearly, owner 401(k) plans are a winner-for business owners, for advisors, and for financial-services companies. Washington may never have intended owner-only plans, says Putnam's Mintzer, "but I bet there's a couple of folks patting themselves on the back for their brilliance."