Nothing in the regulations prohibits an employer from establishing a 401k plan that covers only one participant. In fact, because elective deferrals (the maximum elective deferral is also referred to as employee contribution and for 2011 the cap is $16,500) do not count toward the Code Section 404 deduction limit (25 percent of compensation also known as employer contributions), and because that limit is based on compensation before reduction for elective deferrals, a greater amount can be contributed to a one-person 401k also know as a Solo 401k or Self Directed 401k plan that can be contributed to a profit sharing plan.
Example 1. In 2011, The XYZ Corporation has only one employee, Jack, who has annual pay of $110,000. If XYZ Corporation adopts a profit sharing plan, the maximum amount that can be contributed and deducted for Jack is $27,500. On the other hand, XYZ Corporation would be better off establishing a Solo 401k plan to which it can contribute the same $25,000, but to which Jack can also contribute $16,500 of elective deferrals for a total contribution of $44,000.
Example 2.The facts are the same as those in Example 1 except that Jack’s compensation in 2011 is $50,000. If XYZ Corporation makes a contribution for Bill to a profit sharing plan, the contribution would be limited to $12,500 (25% X 50,000). However XYZ Corporation has the option to contribute the same amount to a Solo 401k plan, which would allow Jack to contribute an additional $16,500.
