Confirmation on my calculations for Solo 401k?

Have a question about your personal investments? No matter how simple or complex, you can ask it here.
Post Reply
jwills
Posts: 9
Joined: Sun Jul 31, 2016 9:22 am

Confirmation on my calculations for Solo 401k?

Post by jwills » Sat Jan 13, 2018 3:37 pm

Hi, I’m very new to my Solo 401k, and still slightly paranoid/intimidated by the procedures/rules. As much as I read I always fear there’s something I’ve missed. I had a similar thread last year with some elective deferrals paperwork, (which you all clarified, thank you,) but now I’m hoping someone can confirm that I have my info/math correct for EmployER contributions to my Solo 401k.

I always see that max allowable profit sharing is 25%, but for Self Employed it’s 20%. But it seems to be always worded/explained slightly differently, so I want to make sure I’m coming to the 20% in the right way. Is it basically that I have really elected a plan contribution rate of 25%, but because I am Self Employed, I need to go through the Rate Worksheet for Self-Employed, [x/(x+1)], which is how I arrive at the 20%? If I am understanding that correctly, I would like to ask/confirm:

1. If I have Self Employed profit of $75,000, and I have made $18,000 Elective deferrals for EmployEE side, my maximum plan contribution for the year would be $31,940. (accounting for $5,299 deduction for Self Employment Tax.) Therefore my Max Profit Sharing for EmployER side would be $13,940? (Catchup Contributions do not apply to me.)
2. However, that is merely the maximum allowable, so if I want to only contribute, say, $6,000 in profit sharing on employER side, I am free to choose a lower profit sharing rate. And I am free to change the profit sharing rate every year? (I am the only employee.) And, does that rate need to be declared anywhere formally? Some form of record? Or even better, can I simply contribute the exact dollar amount I like, and not be concerned with declaring a contribution rate, so long as that dollar amount does not exceed the maximum dictated by the 20%?
3. Also, I have until tax filing to make this EmployER contribution? And can do it in one lump?
4. If I’ve got all the above correct, are there any other common potentially overlooked mistakes I should be aware of?

More than four questions in those four bullets, I realize. When I established this Solo 401k a little over a year ago I never imagined that I would even be able to max out the $18,000 elective deferrals any time soon, (if ever,) so the rules for the profit sharing seemed a very distant and unlikely concern. But, sometimes fortune smiles. This could be the only year I’m so lucky, so want to take as much advantage as I can. And obviously want to make sure I’m doing it right.

Thank you so much (again) for any help.

User avatar
Duckie
Posts: 5533
Joined: Thu Mar 08, 2007 2:55 pm

Re: Confirmation on my calculations for Solo 401k?

Post by Duckie » Sat Jan 13, 2018 8:26 pm

jwills wrote:If I have Self Employed profit of $75,000, and I have made $18,000 Elective deferrals for EmployEE side, my maximum plan contribution for the year would be $31,940. (accounting for $5,299 deduction for Self Employment Tax.) Therefore my Max Profit Sharing for EmployER side would be $13,940? (Catchup Contributions do not apply to me.)
Using your numbers I get:
  • Net profit for 2017 is $75,000
    One-half self-employment tax (15.3% / 2 = 7.65%) is $5738
    Profit minus SE tax is $69,262 (available for solo 401k contributions)
    Maximum employEE contribution is $18,000
    Maximum employER contribution ($69,262 X 20%) is $13,852
However, that is merely the maximum allowable, so if I want to only contribute, say, $6,000 in profit sharing on employER side, I am free to choose a lower profit sharing rate. And I am free to change the profit sharing rate every year? (I am the only employee.)
Yes. You are allowed to contribute up to 20%, not required.
And, does that rate need to be declared anywhere formally? Some form of record?
Per IRS Publication 560 under "How Much Can I Contribute?" there needs to be a "written allocation formula". To me that just means a written (typed) statement of the rate for that year kept with your paperwork.
Or even better, can I simply contribute the exact dollar amount I like, and not be concerned with declaring a contribution rate, so long as that dollar amount does not exceed the maximum dictated by the 20%?
Looking at the "Table and Worksheets for the Self-Employed" it appears you have to start with a percentage.
Also, I have until tax filing to make this EmployER contribution? And can do it in one lump?
Yes and yes.

JBTX
Posts: 2985
Joined: Wed Jul 26, 2017 12:46 pm

Re: Confirmation on my calculations for Solo 401k?

Post by JBTX » Sat Jan 13, 2018 10:22 pm

Duckie wrote:
Sat Jan 13, 2018 8:26 pm
jwills wrote:If I have Self Employed profit of $75,000, and I have made $18,000 Elective deferrals for EmployEE side, my maximum plan contribution for the year would be $31,940. (accounting for $5,299 deduction for Self Employment Tax.) Therefore my Max Profit Sharing for EmployER side would be $13,940? (Catchup Contributions do not apply to me.)
Using your numbers I get:
  • Net profit for 2017 is $75,000
    One-half self-employment tax (15.3% / 2 = 7.65%) is $5738
    Profit minus SE tax is $69,262 (available for solo 401k contributions)
    Maximum employEE contribution is $18,000
    Maximum employER contribution ($69,262 X 20%) is $13,852
However, that is merely the maximum allowable, so if I want to only contribute, say, $6,000 in profit sharing on employER side, I am free to choose a lower profit sharing rate. And I am free to change the profit sharing rate every year? (I am the only employee.)
Yes. You are allowed to contribute up to 20%, not required.
And, does that rate need to be declared anywhere formally? Some form of record?
Per IRS Publication 560 under "How Much Can I Contribute?" there needs to be a "written allocation formula". To me that just means a written (typed) statement of the rate for that year kept with your paperwork.
Or even better, can I simply contribute the exact dollar amount I like, and not be concerned with declaring a contribution rate, so long as that dollar amount does not exceed the maximum dictated by the 20%?
Looking at the "Table and Worksheets for the Self-Employed" it appears you have to start with a percentage.
Also, I have until tax filing to make this EmployER contribution? And can do it in one lump?
Yes and yes.


I guess I’d like a more definitive ruling on the need for a prescribed percent. For better or for worse I’ve always just contributed a particular amount (both employee and employer contribution) that I am sure is well under the max. I did go to your link and it did talk about self employment contribution percents but I didn’t see anything that says you absolutely have to pick a percent and apply that percent in the solo 401k instance. If this is the case that is a bit of a pain because I’ve always found that computation to be somewhat complex and I have found discrepancies between tax software and other online calculators as well as using the worksheet. Seems like there is a high percentage of error and needless complication if you have to pick an exact percent and you have to get the calculation exactly right.

DavidRoseMountain
Posts: 121
Joined: Sun Nov 30, 2014 3:27 pm

Re: Confirmation on my calculations for Solo 401k?

Post by DavidRoseMountain » Sat Jan 13, 2018 10:30 pm

To calculate the self employment, I think you first have to multiply the net business profit by .9235.
Then you can multiply that by .0765 in order to get the self employment tax that is deducted from the profit to determine the employer profit sharing number.

nolesrule
Posts: 557
Joined: Thu Feb 26, 2015 10:59 am

Re: Confirmation on my calculations for Solo 401k?

Post by nolesrule » Sat Jan 13, 2018 11:53 pm

Duckie wrote:
Sat Jan 13, 2018 8:26 pm
jwills wrote:If I have Self Employed profit of $75,000, and I have made $18,000 Elective deferrals for EmployEE side, my maximum plan contribution for the year would be $31,940. (accounting for $5,299 deduction for Self Employment Tax.) Therefore my Max Profit Sharing for EmployER side would be $13,940? (Catchup Contributions do not apply to me.)
Using your numbers I get:
  • Net profit for 2017 is $75,000
    One-half self-employment tax (15.3% / 2 = 7.65%) is $5738
    Profit minus SE tax is $69,262 (available for solo 401k contributions)
    Maximum employEE contribution is $18,000
    Maximum employER contribution ($69,262 X 20%) is $13,852
I got the same number as the OP for employER contribution.

Duckie, I think you forgot to multiply the Net profit by 0.9235 before calculating the SE taxes.

TwstdSista
Posts: 744
Joined: Thu Nov 16, 2017 4:03 am

Re: Confirmation on my calculations for Solo 401k?

Post by TwstdSista » Sun Jan 14, 2018 4:53 am

The 20% calculation has been mind boggling for me. Unfortunately, the IRS examples seem to all be incorrect since they simply use a straight 20%.

I understand the 1/2 of self-employment tax being subtracted out. But what is this 0.9235 ?

Also, do HSA contributions or SE health insurance deductions affect this in any way?

User avatar
Duckie
Posts: 5533
Joined: Thu Mar 08, 2007 2:55 pm

Re: Confirmation on my calculations for Solo 401k?

Post by Duckie » Sun Jan 14, 2018 4:40 pm

DavidRoseMountain wrote:To calculate the self employment, I think you first have to multiply the net business profit by .9235.
nolesrule wrote:I think you forgot to multiply the Net profit by 0.9235 before calculating the SE taxes.
My mistake. I forgot about that calculation.

nolesrule
Posts: 557
Joined: Thu Feb 26, 2015 10:59 am

Re: Confirmation on my calculations for Solo 401k?

Post by nolesrule » Sun Jan 14, 2018 10:26 pm

TwstdSista wrote:
Sun Jan 14, 2018 4:53 am
The 20% calculation has been mind boggling for me. Unfortunately, the IRS examples seem to all be incorrect since they simply use a straight 20%.

I understand the 1/2 of self-employment tax being subtracted out. But what is this 0.9235 ?

Also, do HSA contributions or SE health insurance deductions affect this in any way?
The 0.9235 multiplier is used to calculate your taxable income. Since the employer-side of the SE taxes is a deductible business expense, the multiplier removes that amount so you aren't paying incomes taxes or SE taxes on the employer SE taxes.

As for the 20% for employer contributions, it's just short hand for a more complicated view of the whole thing. I hope the following is clear.

The employer contribution is 25% of net income. However you have a bit of a recursive issue in that with a sole proprietorship, the contribution comes from the net income pot (unlike a salaried employee where the contribution comes from business profit but is calculated from W-2 wages). If you take a straight up 25%, you are including the contribution amount in the net income, so you are making a contribution on a contribution. So in order to calculate the actual 25% contribution, you have to exclude the 25% contribution from the profit before performing the calculation (this is where it gets recursive). So that means the net income is really 125% of the amount you can calculate the 25% on. 25/125 = 20%

TwstdSista
Posts: 744
Joined: Thu Nov 16, 2017 4:03 am

Re: Confirmation on my calculations for Solo 401k?

Post by TwstdSista » Mon Jan 15, 2018 5:47 am

Thank you! I knew there was a difference re: 20% vs. 25% with my SEP, but it's nice to have it spelled out in plain old English!

Post Reply