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Contributing to a Solo 401K

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  • Contributing to a Solo 401K

    I have seen many questions in the forum regarding how to determine contributions to a Solo 401k.  Here is an article that I think explains it very clearly and concisely.  Happy reading.


  • #2
    I might be more impressed if the page wasn't riddled with errors.

    1. First, while the first two sentences correctly state the $54K annual addition limit for 2017 and the correct $60K total with the catch-up contribution. The last sentence in the first paragraph, the chart and the second paragraph all incorrectly state $53K and $59K respectively. Pretty sloppy, if updating from one year to the next.

    2. This statement is false when contrasting a SEP IRA to a one-participant 401k; "If your employer has you in a 401(k) plan, you can also open up a Self-Employed 401(k), but it wouldn’t make sense to do it because the total employee contribution is limited to $18,000 across all your 401(k) plans." You can make the same exact employer contribution to a one-participant 401k as to a SEP IRA and the one-participant 401k preserves your ability to do Backdoor Roths.

    3. He refers to withdrawing excess contributions by April 15th, when it is in fact excess employer deferrals that must be withdrawn by April 15th. He doesn't even mention the fact that excess employer contributions made during the tax year can not normally be returned, are subject to a 10% excise tax and require multiyear separate filings by the 401k plan administer (you). He goes on to say that you should round your contributions down to the nearest $1,000. Like that will really help with significant errors. Especially, when you can know to the penny what you contributions can be when you complete your taxes.

    4. He then makes the following statement; "It’s not too late to make a contribution for your 2016 taxes.The employee deferral contribution must be elected by December 31, 2015. However, some 401(k) third party administrators (TPA) may allow you to set up your 401(k) plan now and backdate your election to 2016." Which is a clear violation of IRS regulations and no TPA is ever going to risk being complicit in such a thing.

    5. Another mistake; "Therefore, the contribution for your 2016 401(k) can be made as late as October 15, 2017 if that’s the date you file your tax return." Nope, you can make your contribution up to the extended filing date which by the way was October 16, 2017, even if you filed by the base filing date, as long as you filed an extension.

    6. This statement; "Just remember the money you do contribute to your Self-Employed 401(k) can’t be touched until age 59.5.", is not necessarily true. IRS regulations do prohibit the in-service distribution of employee deferrals prior to age 59 1/2. However, a plan may allow the in-service distribution of transfer/rollover contributions, vested employer contributions (employer contributions are 100% vested in a one-participant 401k) and after-tax contributions. For example, if you have a one-participant plan that uses Ascenus documents, you can do in-service distributions of transfer/rollover contributions at any time. For participants < 5 years, you can do in-service rollovers of of employer contributions aged > two years. For participants >= 5 years you can in-service rollovers of of employer contributions at any time.

    7. He then makes the following statement; "If you are only a W-2 employee, your 401(k) contribution is capped at $18,000 a year + any 401(k) employer match (average is 3% of base salary). Unfortunately, very few employers are generous enough to contribute ~20% of their operating profits to you." It is only self-employed owners whose own employer contribution is 20% of net self-employment earnings (net business profit - 1/2 SE tax). The maximum employer contribution for W-2 employees is 25% of their compensation and has nothing to do with the employers operating profits.

    8. He also makes the following statement; "For those who work at startups or money-losing organizations, you are SOL in terms of receiving any profit sharing." Which might be true if they were true profit-sharing plans. True profit sharing plans have gone the way of the dodo bird, which should be the name of this Financial Dodo Bird website. People may call them the legacy terms, "profit sharing" contributions, but they are 99% of the time non-elective employer contributions which have nothing to do with profits. In fact, many startups are funded by significant capital and have excellent 401k plans with generous matches and or non-elective contributions to attract the best and the brightest. Not to mention that some companies will keep their employer matches/contributions while going through temporary money losing years for the same reason.


    • #3
      Awesome spiritrider!  I was hoping you would comment. Have you ever thought about writing a post on the topic?  Your answer to me over on Bogleheads about simultaneously dividing my t-IRA between a Roth (my non-deductible basis) and my solo 401k (the rest) helped give me the confidence to do it.  I have understood your answers best by far.  Thank you so much!

      One question about #6... Can a solo 401k be accessed without penalty at age 55 like a regular 401k if the owner retires at age 55?

      What I found most useful in the post was his example of how to do the employer contribution which seems to create many questions here at WCI. Did you see any errors there?


      • #4
        To my knowledge the IRS has never issued guidance on the issue of the > age 55 exception to the 10% penalty on < 59.5 early withdrawals from a one-participant 401k. There is disagreement among the professionals at the BenefitsLink forums. Here are some of the issues:

        • in order to receive the exception you must "separate" from service. This is really not the same as "retire", as you can separate from one company >= 55 and still make withdrawals if you go to work for another company.

        • If you close a business, then there is no plan sponsor, the 401k must also be terminated and no > 55 withdrawals permitted.

        • Inactivity does not generally require the closing of a business. You must formally dissolve an S-Corp, an LLC and a partnership. The IRS considers a sole proprietorship open until the owner dies. However, it may be ill-advised to keep a business open. For example, in CA there is an $800/year minimum franchise tax.

        • The Substantial and Recurring rule does not effect one-participant 401k plans, because the remedy is only partial termination (100% vesting) and you are always 100% vested.

        • Not exactly on point, but certainly very relevant. The IRS has allowed beneficiaries to inherit one-participant 401k accounts and RMDs. They determined that if the business was inherited and not closed, it still existed as a plan sponsor. The inactivity of the business did not require termination of the plan sponsor and the lack of contributions did not require termination of the plan.

        Based on the arguments I have seen, I do not feel comfortable giving advice, but I can say that I might feel comfortable myself doing it, if and only if all of the following we're true.

        I had a formal way to document the separation of service >= 55 (e.g. resignation letter, etc...) that I could provide to the custodian, I could guarantee that the plan sponsor would not close < 59.5, I could guarantee the plan would not terminate < 59 1/2 and most importantly, the custodian would issue 1099-Rs with Box 7 Code 2 Early Distribution, Exception Applies.


        • #5

          most importantly, the custodian would issue 1099-Rs with Box 7 Code 2 Early Distribution, Exception Applies.
          Click to expand...

          Always more questions

          1.  So, the custodian would be the company with which the participant invests such as Schwab, Vanguard, or Fidelity?  Have you seen them issue the 1099R you mentioned correctly?

          2.  What I found most useful in the original post was his example of how to do the employer contribution which seems to create many questions here at WCI. Did you see any errors there?  I had hoped with this article and your answers that some of the calculation questions and arguments could be addressed.

          Thanks again!


          • #6
            I have really learned from this thread and hope others are following - really good stuff. Thanks, spiritrider and thanks to Dr. Mom for provoking the conversation.
            Our passion is protecting clients and others from predatory and ignorant advisors. Fox & Co CPAs, Fox & Co Wealth Mgmt. 270-247-6087


            • #7
              For those of you who have argued about if you can put 20% or 25% employer contribution, here is the best description I have found which BTW is spiritrider's...




              • #8
                1. Yes, the custodian is the financial institution holding the assets. I have no personal knowledge of anyone who has actually done an >= age 55 withdrawal. I was referring to what the 1099-R should look like for you not to get hit with a 10% early withdrawal penalty. Why don't you ask a retirement specialist at your custodian this hypothetical question. This is such an out in the weeds question, I wouldn't necessarily want to rely on a tier one CSR. I wonder whether they would ever have received such a question before.

                2. The actual employer calculation table was almost correct. There was just a small typo/math error. The employer calculation should be $13,011 instead of $13,010.

                However, he only covered the default situation. There is a common exception situation he didn't cover, which really demonstrates the importance of following the Deduction Worksheet for Self-Employed in IRS publication 560 and Schedule SE. Neither of which he mentioned.

                Note: If you let your tax software do your contribution calculations it will handle exception conditions properly. However, be aware that most 401k contribution calculators can not handle this exception properly and many do not handle other ones either. I guess since I have gone this far, I might as well describe this common exception situation in detail.

                This exception situation happens very often for white coats. If you have W-2 Social Security (SS) wages in addition to net business profit, and the total of those wages and 0.9235 of your net business profit >= the SS maximum wage base (2017 = $127,200), the 1/2 SE tax from his default formula will not be correct. If the W-2 SS wages < $127,200 then you will have to complete Schedule SE to calculate the SE tax and 1/2 SE tax. While you should use Schedule SE, if the W-2 SS wages are >= $127,200, then the effective 1/2 SE tax formula will be net business profit * 0.9235 * 0.029 * 0.50.

                In all cases the net self-employment earnings will be net business profit - 1/2 SE tax and the maximum calculated employer contribution will be 20% of that amount. If your employee deferral is > 60% of your net self-employment earnings you must use the Deduction Worksheet for Self-Employed to calculate a reduced employer calculation.


                • #9
                  Just set up a fidelity individual 401(k) for my wife’s business ( sole proprietor). She has no other 401k, so we are planning on putting all of her after-tax profits in as employee contribution ( she made less than $18,000 ).
                  My understanding is that we can make the employee contribution at tax time, as long as the “election” to do so is made by end of the year. Is this correct? Also, in terms of making this election can it just be done in our personal records or does it have to be notarized or something else?


                  • #10
                    As a sole prop yes the contribution deadline is tax filing deadline

                    you simply need to complete and save on file a deferral election form, no notary required

                    one point. Be sure you do not own >50% of a business yourself with employees. Spouse solo 401k can create a mess in this situation