Employer + Individual 401k Clarification

[whitecoathusband]

First post here, on a topic that I think I have straight, but I want the WCI community to confirm. Here's the situation regarding my wife, who is a 34-year-old family practice doc:

• Participates in an employer-sponsored 401k plan as a W-2 employee.
  
  
  
  • She maxes out her individual contributions at $18,500
  
  
  • Her employer matches her contributions and profit shares up to the IRS maximum every year, for a total of $55,000 of combined employee and employer contributions.
  
  
  
  


• She is self-employed as an assistant medical director at a hospice and receives a 1099 for that income. We have been doing a SEP-IRA for this, but want to start doing backdoor Roth IRAs since discovering WCI. I'm aware of the pro-rata rule and am working to roll over all of our SEP-IRAs and traditional IRAs into 401ks.

My understanding regarding opening and contributing to an individual 401k is the following:

• She cannot make "employee" contributions in her individual 401k due to maxing out her other plan.


• Her "employer" contributions in the individual 401k are limited to 20% of net business earnings (basically gross earnings minus employer portion of the payroll tax), up to the IRS maximum of $55k. 

Do I have this correct? The part in bold is the main thing I am questioning, but lord knows I might have errors elsewhere. Feel free to correct or chime in.

Thanks to this community and Dr. Dahle for being such an amazing resource. We are doing quite well with our finances, but are always trying to optimize and have learned a lot from WCI. This is one more step toward optimization.

[DMFA]

whitecoathusband wrote:

My understanding regarding opening and contributing to an individual 401k is the following: She cannot make “employee” contributions in her individual 401k due to maxing out her other plan. Her “employer” contributions in the individual 401k are limited to 20% of net business earnings (basically gross earnings minus employer portion of the payroll tax), up to the IRS maximum of $55k.  Do I have this correct? The part in bold is the main thing I am questioning, but lord knows I might have errors elsewhere. Feel free to correct or chime in.

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You're 98.66% right.  It's 20% of net profit after subtracting half of self-employment tax.

Sole proprietors get a 7.65% exemption for SE tax, and SE tax *if* one has maxed income subject to SS tax ($128,400 for 2018) is only the Medicare portion (2.9%).  Hence SE tax is (1 - 0.0765) * 0.029 = 2.68%, half of which is 1.34%, meaning the max contribution would be (1 - 0.0134) * 0.20 = 0.9866 * 0.20 = 19.732% of net profit.

[jacoavlu]

Correct with the slight terminology correction that solo 401k maximum allowed employer contribution is 20% of “net self employment earnings” (business profit minus one half self employment tax)

You can check your math using the link to the spreadsheet in my signature below.

Do you know the match and profit sharing formula for your spouses 401k? It does not seem common to have W2 employed docs getting employer contributions to the max of the annual addition limit. That’s a great benefit. Will they only get the max if they maximize their salary deferral limit into the plan?

[whitecoathusband]

DMFA wrote:

You’re 98.66% right.  It’s 20% of net profit after subtracting half of self-employment tax.

Sole proprietors get a 7.65% exemption for SE tax, and SE tax *if* one has maxed income subject to SS tax ($128,400 for 2018) is only the Medicare portion (2.9%).  Hence SE tax is (1 – 0.0765) * 0.029 = 2.68%, half of which is 1.34%, meaning the max contribution would be (1 – 0.0134) * 0.20 = 0.9866 * 0.20 = 19.732% of net profit.

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DMFA & jacoavlu, thanks. I knew I might not be using the right terminology, exactly, but as long as we calculate that 20% correctly on the individual 401k, we are golden. I'll take a look at jacoavlu's spreadsheet. I'm trying to get all of this done by the end of the year, but if that's not possible (I feel like I was on the phone all day with all kinds of finance people for one reason or another today) we'll make sure everything is in order next year. I stumbled on WCI last week and have been binging trying to find out anything else left to optimize for 2018.

jacoavlu wrote:

Do you know the match and profit sharing formula for your spouses 401k? It does not seem common to have W2 employed docs getting employer contributions to the max of the annual addition limit. That’s a great benefit. Will they only get the max if they maximize their salary deferral limit into the plan?

Click to expand...

Yes, it really is a great benefit. I've told others in the practice that they need to highlight that more when recruiting new docs to the practice. I'm not sure the exact calculation, but the employer matches 50% of all employee contributions, with no upper limit. That leaves $27,250 as profit sharing to get up to the $55,000 max. I know the formula is super complicated with plan cross-testing and the doctors being "highly compensated employees." I talked to the practice CFO, and she basically said that as long as she is in that highly compensated employee tier that she should always get the full IRS maximum.

I'm also not 100% sure what the exact legal structure of the practice is, either. She's a "partner" in the practice, but all the partners receive W2 income like normal employees, no K-1's. This practice has been around for decades, so I assume they know what they are doing from a legal and tax standpoint.

 

[jacoavlu]

^^^ Makes a lot more sense if she’s a partner/owner

To be clear, I get no credit for the spreadsheet linked in my signature. It was created by Harry Sit, a.k.a. the finance buff. I find it very helpful for these situations.