OK to max out 2020 solo 401k now?

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knightrider
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OK to max out 2020 solo 401k now?

Post by knightrider » Mon Jun 29, 2020 12:13 pm

My wife opened a solo 401k last year. Last year she had $130k net profit. She contributed $19k employee contribution and $24k employer contribution in December 2019.

We had a CD mature so have a bunch of cash sitting around. Can we use it to max out her 2020 solo 401k even though we are not sure what her final earnings will be? So far they seem on track to be same as last year.

fabdog
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Re: OK to max out 2020 solo 401k now?

Post by fabdog » Mon Jun 29, 2020 12:18 pm

There's nothing to prevent it... but then she is on the hook to withdraw if something changes during the year... you could put in monthly or quarterly as she has income/expenses

Mike

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knightrider
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Re: OK to max out 2020 solo 401k now?

Post by knightrider » Mon Jun 29, 2020 12:19 pm

fabdog wrote:
Mon Jun 29, 2020 12:18 pm
There's nothing to prevent it... but then she is on the hook to withdraw if something changes during the year... you could put in monthly or quarterly as she has income/expenses

Mike
Is withdrawing a straightforward process? Or does it create some taxable-event mess?

fabdog
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Re: OK to max out 2020 solo 401k now?

Post by fabdog » Mon Jun 29, 2020 12:38 pm

The brokerage likely has a form... have to withdraw the excess, and any earnings... sort of like with an IRA

Here is an earlier thread with more information on this topic

Mike

viewtopic.php?t=242362

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MP123
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Re: OK to max out 2020 solo 401k now?

Post by MP123 » Mon Jun 29, 2020 12:52 pm

You could do the employee deferral now ($19k), but I'd wait until December or even January to do the employer contribution once you know what her total year end compensation will be. It can be difficult to remove excess employer contributions.

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knightrider
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Re: OK to max out 2020 solo 401k now?

Post by knightrider » Wed Jul 01, 2020 11:04 am

MP123 wrote:
Mon Jun 29, 2020 12:52 pm
You could do the employee deferral now ($19k), but I'd wait until December or even January to do the employer contribution once you know what her total year end compensation will be. It can be difficult to remove excess employer contributions.
Ok. But can I do an employER contribution now based on what was earned to-date? Then I can do the remainder contribution in December or January? Is that allowed?

DSInvestor
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Re: OK to max out 2020 solo 401k now?

Post by DSInvestor » Wed Jul 01, 2020 11:11 am

The employer profit share contributions for sole proprietors are based on a percentage of the net business income which isn't known until all the numbers come in for the year. For S-Corp, paying a W-2 salary, employer profit share is a percentage of the W-2 salary and this is easier to work with from the perspective of the employer profit share contribution because if you've already paid yourself 60K of W-2 salary, you're safe to contribute up to 15K (25% of salary) as employer contribution. Your OP mentioned net income so I'm assuming she is a sole proprietor filing Schedules C and SE.

For the sole proprietor, one would want to be very careful about how much to contribute before year end. Contribute only an amount that you know can be supported no matter what happens to the business in the rest of the year. This way you won't have to deal with excess contributions.

There are other types of contributions that you can make with that CD money, like Traditional / Roth IRA contributions and/or HSA contributions.
Wiki

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knightrider
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Re: OK to max out 2020 solo 401k now?

Post by knightrider » Wed Jul 01, 2020 12:05 pm

DSInvestor wrote:
Wed Jul 01, 2020 11:11 am
Your OP mentioned net income so I'm assuming she is a sole proprietor filing Schedules C and SE.
Yes, that is correct. She has earned around $60k to date. So I assume she can make an employER contribution now based on that net income? Then in December or January contribute the rest?

And is $60k enough to go ahead and make the $19.5k employEE contribution now? I can't recall if there is some threshold amount you have to earn before you can max that out?

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MP123
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Re: OK to max out 2020 solo 401k now?

Post by MP123 » Wed Jul 01, 2020 12:40 pm

The danger here is that the $60k she's "earned" to date will shrink if revenue goes to zero and expenses continue for the rest of the year. Then at the end of the year it turns out she's only earned $30k on which to base her contribution, for example.

You'd know best how possible that scenario is.

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knightrider
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Re: OK to max out 2020 solo 401k now?

Post by knightrider » Wed Jul 01, 2020 1:14 pm

MP123 wrote:
Wed Jul 01, 2020 12:40 pm
The danger here is that the $60k she's "earned" to date will shrink if revenue goes to zero and expenses continue for the rest of the year. Then at the end of the year it turns out she's only earned $30k on which to base her contribution, for example.

You'd know best how possible that scenario is.
Interesting, I had not thought about that angle. The good news is her expenses are very low. If income went to zero, then expenses would go to zero.. So seems little risk of putting in half the employER contribution now?

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MP123
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Re: OK to max out 2020 solo 401k now?

Post by MP123 » Wed Jul 01, 2020 1:30 pm

knightrider wrote:
Wed Jul 01, 2020 1:14 pm
MP123 wrote:
Wed Jul 01, 2020 12:40 pm
The danger here is that the $60k she's "earned" to date will shrink if revenue goes to zero and expenses continue for the rest of the year. Then at the end of the year it turns out she's only earned $30k on which to base her contribution, for example.

You'd know best how possible that scenario is.
Interesting, I had not thought about that angle. The good news is her expenses are very low. If income went to zero, then expenses would go to zero.. So seems little risk of putting in half the employER contribution now?
It sounds like the risk is less than, say, a restaurant owner who needs to keep paying rent with no customers allowed to be served.

For sole proprietors the only number that really matters is what's on the Schedule C at year end, and you're really guessing at this point. For S-Corps there's no way to "un-earn" the wages you've paid yourself on W2, so for them it's safer to make the employER contribution along the way if they choose to.

It's hard to say that it would be great idea to make the contribution now, but probably the risks (as long as you understand them) are small.

mattsm
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Re: OK to max out 2020 solo 401k now?

Post by mattsm » Wed Jul 01, 2020 2:58 pm

I learned this the hard way. Don't do ER (employer) deferrals until as late as possible.

Dealing with overcontributions is a PITA, dealing with obscure forms that your CPA might not want to touch. Plus the penalties...

-M

Spirit Rider
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Re: OK to max out 2020 solo 401k now?

Post by Spirit Rider » Wed Jul 01, 2020 4:51 pm

knightrider wrote:
Mon Jun 29, 2020 12:19 pm
Is withdrawing a straightforward process? Or does it create some taxable-event mess?
mattsm wrote:
Wed Jul 01, 2020 2:58 pm
I learned this the hard way. Don't do ER (employer) deferrals until as late as possible.

Dealing with overcontributions is a PITA, dealing with obscure forms that your CPA might not want to touch. Plus the penalties...
Unlike 401k excess employee deferrals or SEP IRA excess employer contributions. As @mattsm is alluding to, excess 401k employer contributions made during the tax year can not normally be returned. They must be reported as a non-deductible contributions, subject to a 10% excise tax and reconciled with future available employer contribution space.

My usual recommendation is to follow the quarterly estimated tax calculations. Make 20% employer contributions based on 90%* of quarterly net earnings from self-employment (business profit - 1/2 SE tax) on the estimated tax due dates.. In a normal year this would be on 4/15, 6/15, 9/15 and 1/15.

The beauty of this is that you have held back profit during the year and even more important, made the final deposit in the following year. This allows any excess contributed in the following year to be simply reallocated to that year by not deducting it on your tax return. Then when you have competed your tax return any remaining employer contributions can be made at that time.

*If you have variable income, you might want to lower this percentage. Remember, self-employed individuals have until their tax filing deadline including extensions to make both employer deferrals and employer contributions provided the election for the former occurs on or before 12/31.

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