401(k) Growing Pains

Q: I became a partner in a 5-partner LLC this January. We have one employee. We are thinking about creating a company-sponsored 401(k) plan, but are concerned that the partners' contribution limits will be affected by how much profit sharing the employee gets. What exactly are the rules here, and is the profit-sharing contribution limit for my individual 401(k) also affected by this?
Christian

There are two issues here: your own eligibility to make individual 401(k) contributions, and what to do with the employee...

Note: This answer has been edited since its original posting.

The self-employed, or individual, 401(k) can be set up for any type of business structure (sole proprietorships, partnerships including LLCs, corporations, and S-corporations).  These are a great deal, because the owner (in this case, you as the partner) can contribute the annual elective deferral limit ($15,500 in 2008) plus 20% of net earnings (25% of salary in the case of corporations and S-corporations), limited to the combined cap ($46,000 in 2008).  In addition, those over age 50 can make a "catch-up" contribution of $5000.

Problem: self-employed 401(k) plans can only have two eligible employees: the owner, and his spouse.  Unless this employee you mention is a spouse of one of the owners, the individual 401(k) would seem to be out if you want the employee to participate.  The employee can always decline participation, but it's up to the employee--not you.  You could always bring the employee into a full-blown 401(k) plan, but these tend to be expensive and the matching percentages must be uniform.

My suggestion would be to set up a SIMPLE IRA or SIMPLE 401(k) plan (they are very similar).  You can read more about them here.