Help w/ the Mechanics of Solo 401k Contributions?

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fcox85
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Joined: Fri Nov 16, 2012 3:13 pm

Help w/ the Mechanics of Solo 401k Contributions?

Post by fcox85 »

My wife is starting a business that is structured as a single-member LLC (a "disregarded" entity with no employees). Depending on how the business does, I am considering setting up a Solo 401k in the near future. I understand that there are a number of issues surrounding the calculation of maximum employer profit-sharing contributions, etc., but I am a little confused as to some more basic "mechanics" of making contributions.

When it comes to making the "employee deferral" contributions up to $17.5k, are there requirements that contributions are made regularly, as they are through a normal 401k payroll deferral program. In other words, if the business has a few bad months followed by a few good months, are there any restrictions or requirements that would prevent only making contributions in the good months? Also, assuming that the business holds onto a lot of cash and profits until the end of the year, to ensure cash flow, is there any reason why both the employee and profit sharing contributions cannot be lump-summed at the end of the year?

Given that this business' profits and losses will be reported on our personal tax returns as a part of Schedule C, and that my wife can pay herself virtually whenever she wants, I know that the accounting of this business is a bit less rigid than a normal payroll situation. Nevertheless, I just want to make sure that by potentially "turning on and turning off" the deferral contributions multiple times throughout the year, there won't be any problems.
Last edited by fcox85 on Mon Sep 08, 2014 9:27 am, edited 1 time in total.
kaudrey
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Re: Help w/ the Mechanics of Solo 401k Contributions?

Post by kaudrey »

My husband just started one this year; similar situation. My understanding is that you can put the money in whenever you want. We are putting in a small monthly amount, but then plan to add more at the end of the year when we figure out the salary/profit issues.
Topic Author
fcox85
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Re: Help w/ the Mechanics of Solo 401k Contributions?

Post by fcox85 »

kaudrey wrote:My husband just started one this year; similar situation. My understanding is that you can put the money in whenever you want. We are putting in a small monthly amount, but then plan to add more at the end of the year when we figure out the salary/profit issues.
Thanks for the input. I hadn't read anything indicating that sporadic and varying contributions are a problem, but I never want to mess around with the IRS.
snowman
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Re: Help w/ the Mechanics of Solo 401k Contributions?

Post by snowman »

It really does not matter when, how often or how much you contribute. Just remember that if you already paid yourself, you cannot come back in some future time and designate part of it as 401k employee contribution. Also, you only have until December 31st to make employee salary deferral contributions. So, if you set up the account this week, you will have only 3.5 months of future earnings to contribute $17.5K. Make sure the contribution is marked correctly when you make it - i.e. employee vs. employer.

If cash-flow is not an issue (i.e. you don't need wife's money to pay the bills), I would set up solo 401k immediately, irregardless of how her business does. There is no downside, it costs nothing. In December, you can evaluate her earnings, and she can pay herself at that time, and defer it all, up to the limit. If she made more than that, she can also make employer profit sharing contribution.
Spirit Rider
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Re: Help w/ the Mechanics of Solo 401k Contributions?

Post by Spirit Rider »

snowman wrote:It really does not matter when, how often or how much you contribute. (1) Just remember that if you already paid yourself, you cannot come back in some future time and designate part of it as 401k employee contribution. (2) Also, you only have until December 31st to make employee salary deferral contributions. (3) So, if you set up the account this week, you will have only 3.5 months of future earnings to contribute $17.5K. Make sure the contribution is marked correctly when you make it - i.e. employee vs. employer.

If cash-flow is not an issue (i.e. you don't need wife's money to pay the bills), I would set up solo 401k immediately, irregardless of how her business does. There is no downside, it costs nothing. In December, you can evaluate her earnings, and she can pay herself at that time, and defer it all, up to the limit. If she made more than that, she can also make employer profit sharing contribution.
I have identified three statements here that are not entirely correct.

(1) A Single Member LLC as a disregarded entity is effectively a sole proprietorship. Any money is effectively earned when it is received. It does not matter when it is transferred from business accounts to personal accounts. The restriction on contributions on previous compensation only applies if there are W2 wages.

(2) You only have until December 31st to make employee deferral elections (retained in personal records, not filed). You actually have until your tax filing (including extensions) to make the employee deferral contribution.

(3) Provided you open the solo 401k by December 31st, you can (and you most definitely should) make the effective date of the 401k opening to be January 1st. This allows you no matter when you open the solo 401k, to base contributions on the entire year's earnings.

Finally,

4. Since the profits of a business are not known until you file, the amount of and the contribution of employer profit sharing can both wait until your tax filing (including extensions).
snowman
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Re: Help w/ the Mechanics of Solo 401k Contributions?

Post by snowman »

I stand corrected, and I apologize for that. Thank you, SR. What I described was the solo 401k mechanics of an S-Corp, not LLC. I cannot believe I missed such an important fact! I apologize to OP as well.
hawkfan55
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Re: Help w/ the Mechanics of Solo 401k Contributions?

Post by hawkfan55 »

Vanguard's Solo 401k has a Roth 401k option available for employee contributions only. Employee contributions can total $17500 a year in either Roth or Deferred 401k. If you are over 50 years of age, you can contribute an additional $5500.

Employer contributions can total up to 20% of Schedule C Profit less half of self-employment taxes and must be contributed in a regular deferred 401k, not into the Roth 401k.

The maximum contribution is applicable to your personal contributions to traditional 401K’s and Roth 401K’s (or a combination of the two, if you have both). It is separate from the employer maximum 401K contribution.

Don't forget to open and fund a Roth IRA Account by December 31st, 2014 as well, as long as you, and your spouse if filing a joint return, are under the 2014 Roth IRA MAGI limits! If you already have a Roth IRA established, you have until the tax year filing deadline to contribute to your Roth IRA.
Forum Library of Investing Advice: https://www.bogleheads.org/wiki/Main_Page
JD
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Re: Help w/ the Mechanics of Solo 401k Contributions?

Post by JD »

snowman wrote:I stand corrected, and I apologize for that. Thank you, SR. What I described was the solo 401k mechanics of an S-Corp, not LLC. I cannot believe I missed such an important fact! I apologize to OP as well.
Does any one know how it works if you hire an employee? Do you have to provide the same benefit while maintaining LLC.
placeholder
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Joined: Tue Aug 06, 2013 12:43 pm

Re: Help w/ the Mechanics of Solo 401k Contributions?

Post by placeholder »

If you have an employee eligible for the 401k then you can't use the cheap and easy solo plans so you'd have to redo the whole thing.
JDDS
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Re: Help w/ the Mechanics of Solo 401k Contributions?

Post by JDDS »

hawkfan55 wrote: Don't forget to open and fund a Roth IRA Account by December 31st, 2014 as well, as long as you, and your spouse if filing a joint return, are under the 2014 Roth IRA MAGI limits! If you already have a Roth IRA established, you have until the tax year filing deadline to contribute to your Roth IRA.

For Roth IRAs It's not necessary to establish the account by December 31. http://www.irs.gov/publications/p590/ch ... 1000230975
Spirit Rider
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Re: Help w/ the Mechanics of Solo 401k Contributions?

Post by Spirit Rider »

JD wrote:
snowman wrote:I stand corrected, and I apologize for that. Thank you, SR. What I described was the solo 401k mechanics of an S-Corp, not LLC. I cannot believe I missed such an important fact! I apologize to OP as well.
Does any one know how it works if you hire an employee? Do you have to provide the same benefit while maintaining LLC.
As placeholder stated, you can not have a solo 401k and have eligible employees (>= 21, >= 1 year, not union or nonresident alien, and >= 1000 hours/year). You must change to a another plan (business 401k, SIMPLE IRA, or SEP IRA).

Regardless of the retirement plan, you must meet the anti-discrimination rules. So no, you can not give yourself the opportunity of a benefit and not your employee(s). However, it is equal opportunity, not equal outcome. If you have a 401k or SIMPLE IRA safe harbor plan, you are allowed to maximize your employee deferral and take opportunity of a company match. This is true even if your employee(s) choose not to. However, any profit sharing or matching percentage must be the same for all employees.
JD
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Re: Help w/ the Mechanics of Solo 401k Contributions?

Post by JD »

snowman wrote: Regardless of the retirement plan, you must meet the anti-discrimination rules. So no, you can not give yourself the opportunity of a benefit and not your employee(s).
Understood. The issue now is if your employee(s) decided not to contribute any thing then you won't be able to contribute as well.
(Slide#8):
http://www.irs.gov/pub/irs-tege/forum08_401k.pdf
Spirit Rider
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Re: Help w/ the Mechanics of Solo 401k Contributions?

Post by Spirit Rider »

JD wrote:
snowman wrote: Regardless of the retirement plan, you must meet the anti-discrimination rules. So no, you can not give yourself the opportunity of a benefit and not your employee(s).
Understood. The issue now is if your employee(s) decided not to contribute any thing then you won't be able to contribute as well.
(Slide#8):
http://www.irs.gov/pub/irs-tege/forum08_401k.pdf
If you have a safe harbor plan, then the ADP and ACP testing does not apply. In this case it does not matter if the employee(s) do not contribute.

All SIMPLE IRA plans are safe harbor plans. They require either a 3% elective match, or a 2% non-elective contribution. Employee deferrals (including the boss) can be up to $12K (+$2.5K >= 50) in 2014.

A safe harbor 401k plan has similar requirements. It requires either an elective match of 100% of the first 3%, plus 50% of the next two percent for a total of 4%, or a non-elective contribution of 3%. Employee deferrals (including the boss( can be up to $17.5K (+$5.5K >= 50) I 2014.

Like all things administered by the IRS, there are additional details such as all employer contributions must be immediately vested, etc...
JD
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Re: Help w/ the Mechanics of Solo 401k Contributions?

Post by JD »

Spirit Rider wrote:
JD wrote:
snowman wrote: Regardless of the retirement plan, you must meet the anti-discrimination rules. So no, you can not give yourself the opportunity of a benefit and not your employee(s).
Understood. The issue now is if your employee(s) decided not to contribute any thing then you won't be able to contribute as well.
(Slide#8):
http://www.irs.gov/pub/irs-tege/forum08_401k.pdf
If you have a safe harbor plan, then the ADP and ACP testing does not apply. In this case it does not matter if the employee(s) do not contribute.

All SIMPLE IRA plans are safe harbor plans. They require either a 3% elective match, or a 2% non-elective contribution. Employee deferrals (including the boss) can be up to $12K (+$2.5K >= 50) in 2014.

A safe harbor 401k plan has similar requirements. It requires either an elective match of 100% of the first 3%, plus 50% of the next two percent for a total of 4%, or a non-elective contribution of 3%. Employee deferrals (including the boss( can be up to $17.5K (+$5.5K >= 50) I 2014.

Like all things administered by the IRS, there are additional details such as all employer contributions must be immediately vested, etc...
Appreciate that Spirit Rider, I hope that I don't come back in the future asking the same question again!!
One final question: Suppose that I establish a safe harbor plan and I contribute the max as an employee; if I contribute also the max as an employer, do I have to do the same for the employee(s). Thank you...
Sorry to the OP that I hijacked this thread.
Spirit Rider
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Re: Help w/ the Mechanics of Solo 401k Contributions?

Post by Spirit Rider »

JD wrote:Appreciate that Spirit Rider, I hope that I don't come back in the future asking the same question again!!
One final question: Suppose that I establish a safe harbor plan and I contribute the max as an employee; if I contribute also the max as an employer, do I have to do the same for the employee(s). Thank you...
Sorry to the OP that I hijacked this thread.
The short answer is yes, you must treat the Non-Highly Compensated Employees (NHCEs) as generously as yourself and any Highly Compensated Employees (HCEs). Remember what I said about all the little details. They are all anti-discrimination provisions to level the playing field.

One of the additional details is that while there is a minimum employer match/profit sharing to qualify for the ADP/ACP safe harbor, there is also a maximum employer match also to receive the ACP safe harbor. The maximum safe harbor match is 6%.

What this means, is if you set a match higher than 6%, you are subject to ACP testing and you can contribute no higher than the average match received by the NHCEs. The excess contributions must be returned or the employer make up the difference with non-elective contributions.

There are steps you can take to mitigate this. For example, you can set an employer match of 100% of the first 6%, and a non-elective contribution of 6%. Only the first 4% match is safe harbor with immediate vesting. The "other" 2% match and 6% profit sharing could use say a 5 year vesting schedule.

As you can see, there are many little details. I only know a few of the major details as a consumer of retirements plans (SEP, Solo 401k, and small business 401k). If you are serious about a small business 401k, you really need to talk to a professional. It also helps you understand why small business 401k plans incur a significant additional administrative cost over Solo 401k plans. The compliance requirements can be tricky.
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