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401k for small business owner

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  • 401k for small business owner

    My wife may become a small business owner of a clinic that has employees. The clinic currently has a 401k plan in place. I was listening to Jim’s podcast and he mentioned a 401k may not be the best plan for a clinic unless employees maximized contributions. He said, as a business owner, you may not be able to maximize contributions if your employees aren’t contributing enough to the 401k plan. Can you guys explain why? How does this work? I want my wife to be able to maximize 401k contributions.

  • #2
    • Unless the clinic's 401k plan is a safe harbor 401k plan it will be subject to anti-discrimination testing. Without going into details; if it fails that testing highly compensated employees (HCEs) will be limited by the average contributions by and to the non-highly compensated employees (NHCEs).
    • A safe harbor 401k plan requires:
      • Non-elective employer contributions on 2% of compensation, or;
      • 100% employer match on the 1st 3% of compensation, plus 50% match on the next 2% of compensation.

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    • #3
      Originally posted by SteffanW View Post
      My wife may become a small business owner of a clinic that has employees. The clinic currently has a 401k plan in place. I was listening to Jim’s podcast and he mentioned a 401k may not be the best plan for a clinic unless employees maximized contributions. He said, as a business owner, you may not be able to maximize contributions if your employees aren’t contributing enough to the 401k plan. Can you guys explain why? How does this work? I want my wife to be able to maximize 401k contributions.
      He's talking about MBR 401k plan. This absolutely does not apply to your situation. I've explained the differences in detail here:

      https://www.whitecoatinvestor.com/me...sa-401k-plans/

      In short, due to testing limitations, she won't be able to contribute even $1 after-tax as her staff has zero incentive to contribute after-tax and convert to Roth (which is a very sophisticated/complex strategy that requires a lot of hand-holding). Of course doing after-tax contributions by staff will significantly lower the cost of doing her own after-tax contributions, but if her goal is to make tax-deferred contributions due to your tax status, doing Roth contributions (including after-tax) might not be what she wants to do.

      This leaves only tax-deferred contributions. As far as what does matter for her, it is the ability to max out the 401k herself.This depends on how many employees she has. And the utility of doing that depends on the cost vs. benefit, which can be calculated from knowing % to owner as far as total 401k contribution. So for example if she puts in $61k, and the cost of doing that would be very large leading to a very low % to owner (say lower than 70%), the cost vs. benefit of doing this is not there (or relatively low). This of course depends on your tax status. I would say that 70% might be a breakeven point for some (it might actually be lower for others). So if you can't max out at $61k, is there a utility to doing a 401k plan? An argument can be made that a SIMPLE IRA can work too in that case (as the costs are zero and matching is 25% lower than for the SIMPLE). However a 401k plan is also a benefit to all of the staff, so the difference between SH 401k and SIMPLE is not that high once your practice is larger (and esp. if she has high participation rate). If her income from the clinic is high enough, and the staff number is not too high (under 20 ideally) she can build up Roth eventually by also utilizing a Cash Balance plan, which allows a massive buildup of tax-deferred assets that can subsequently be converted to Roth (in retirement, ideally).

      As far as doing MBR 401k, she can still do it, but this would require the conversion of tax-deferred assets to Roth (which does not take into account anything the staff does). But for that she has to be able to max out her contribution into the plan using tax-deferred assets as discussed above.
      Kon Litovsky, Principal, Litovsky Asset Management | [email protected] | 401k and Cash Balance plans for solo and group practices, fixed/flat fee, no AUM fees

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