The retirement plan options available to sole proprietors have expanded in recent years. Case in point: If you file taxes as a self-employed individual, you can take advantage of a 401(k) plan the same as a corporation with hundreds of employees. Many of the obstacles to this arrangement, including the high costs for administering such a plan, have been eliminated.

With a “solo 401(k) plan,” you can make contributions on your own behalf, up to the allowable tax law limits. What’s more, these contributions can be combined with contributions by your employer—namely, yourself. Thus, you may be able to build up a nest egg for retirement in a relatively short span.

Background: The maximum deductible contribution an employer can make to a defined contribution plan in 2008 is the lesser of 25% of compensation or $46,000. The maximum compensation that may be taken into account for these purposes in 2008 is $230,000. For individuals who are not incorporated, the 25% cap is replaced by a limit of 20% of self-employment income.

The tax law also imposes a dollar cap on 401(k) elective deferrals. For 2008, an employee can defer up to $15,500 of compensation to his or her account, plus a “catch-up contribution” of $5,000 if the employee is age 50 or older. Thus, an employee participating in a traditional 401(k) plan can make elective deferrals within these annual limits. Plus, the company may match a portion of the contributions (usually, up to a set percentage of compensation).

Key point: A company must deal with strict nondiscrimination rules in this area. As a sole proprietor, you generally do not have the same problems. Although the limits on deductible employer contributions still apply, there is a distinct advantage for sole proprietors. Thanks to a recent tax law change, elective deferrals to a solo 401(k) plan do not count toward the percentage cap on overall contributions. So you can combine contributions for even greater retirement savings.

For example, if your annual self-employment income is $100,000 and you are age 50 or older, you can defer the maximum $20,500 ($15,500 + $5,000) to your account in 2008 and combine it with an employer contribution of $20,000 (20% × $100,000). The total contribution for 2008 is $40,500 ($20,500 + $20,000).

Generally, the contributions to a solo 401(k) plan grow tax-deferred until you are ready to retire. At that time, distributions are taxed at ordinary income rates. Alternatively, you may roll over part or all of your account to an IRA without paying current tax.

Note: If you have other employees, they must be covered by the plan as well. In addition, there are administrative costs associated with the arrangement.

Of course, other retirement plan alternatives for self-employed individuals—including Simplified Employee Pensions (SEPs), Savings Incentive Match Plans for Employees (SIMPLEs) or traditional Keogh plans—may be more suitable for your situation. Consult with your professional advisers.