Solo 401k - elective deferral agreement question

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baffledinvestor
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Solo 401k - elective deferral agreement question

Post by baffledinvestor » Wed May 27, 2020 7:17 pm

I'm self employed and have a traditional IRA from a previous job. I now make enough to contribute and want to transfer to a Solo 401k for the higher contribution limits. Unfortunately, I'm confused about the Elective Deferral Agreement, which sounds as if I have to commit to sending a certain percentage of income or dollar amount each year. As a self employed individual with income that can fluctuate, I was hoping I could simply open a Solo 401k and mail checks throughout the year as my savings piled up. I'm not certain if I'm misinterpreting the Elective Deferral Agreement - but can anyone confirm if I can simply add money to my 401K throughout the year without committing to a specified amount in contributions for the year in advance?

My apologies if this is obvious to most but it's very new to me. Any input is very much appreciated.

CFM300
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Re: Solo 401k - elective deferral agreement question

Post by CFM300 » Wed May 27, 2020 9:26 pm

baffledinvestor wrote:
Wed May 27, 2020 7:17 pm
My apologies if this is obvious to most but it's very new to me. Any input is very much appreciated.
The answer to your question is not obvious and I had the same question when I started my own 401k years ago. Here's your answer, from one of the forum's most knowledgeable member about such things:

viewtopic.php?t=204717#p3138501

Welcome to the forum!

Spirit Rider
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Re: Solo 401k - elective deferral agreement question

Post by Spirit Rider » Wed May 27, 2020 9:50 pm

From IRS regulation 26 CFR § 1.401(k)-1 - Certain cash or deferred arrangements
  • a, 3, iii, "A cash or deferred election can only be made with respect to an amount that is not currently available to the employee on the date of the election."
  • a, 6, iii, "a sole proprietor's compensation is deemed currently available on the last day of the individual's taxable year. Accordingly, a self-employed individual may not make a cash or deferred election with respect to compensation for a partnership or sole proprietorship taxable year after the last day of that year."
This means you have until 12/31 to execute a Elective Deferral Agreement. That agreement is both retroactive to the later of 1/1 (or the effective date of adoption) and prospective until your tax filing deadline (normally 04/15) including extensions (10/15).

Since all of your compensation is deemed currently available on the last day of your taxable year. You can make any employee deferrals during the calendar year and make the elective deferral election match them on 12/31. On the other hand, any contributions after 12/31 until your tax filing deadline including extensions must be deterministic based on your compensation and elective deferral election.

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MP123
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Re: Solo 401k - elective deferral agreement question

Post by MP123 » Wed May 27, 2020 9:51 pm

The boilerplate form from Schwab at least has a checkbox for a one time deferral, as well as recurrent ones. You could use that multiple times if you want. The completed and signed form stays in your records, you don't send it in. You don't need to commit to anything in advance, and can modify it along the way.

When you send checks you'll need to designate whether it's an employee deferral or employer contribution. It's probably best to wait until you're sure what your income will be for the year before you do the employER contribution since it's limited to either 20 or 25%.

Welcome!

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baffledinvestor
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Re: Solo 401k - elective deferral agreement question

Post by baffledinvestor » Wed May 27, 2020 11:11 pm

Thank you to everyone for your detailed responses. While I'm still a bit confused, please let me know if my understanding is correct:

Can I open a Solo 401k now and rollover my existing IRA into it (between 10k-15k, from years ago back when I held a w2 job). Then I can begin making contributions throughout the year as finances allow, and at the end of the year if I contributed say, $14,500, I can just draft my Elective Deferral Agreement to read something like "I elect to contribute an amount up to and not exceeding 15k"? Is it really that simple? I guess it just seems bizarre to me that I have to declare any amount beforehand rather than simply adding money when I have it.

Along those lines - is it best to notate my contributions as employee contributions? Not sure where the benefits fall between contributing as employee or employer - but if it matters I expect to take in about $46k before taxes/expenses and I usually only have about $2-3k of expenses to claim.

Also, out of curiosity if the above is correct, then what is the purpose of this form for self-employed people? I guess I'm not understanding what the form actually achieves since it sounds like we can simply fill in the amount at the end of the year and then just file it in our paperwork? It sounds like it's not sent off anywhere for verification, unless I'm mistaken, so I'm not seeing what purpose it actually serves. I feel like I'm missing the reasoning for this form. :confused

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gasdoc
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Re: Solo 401k - elective deferral agreement question

Post by gasdoc » Thu May 28, 2020 11:10 am

Following- thanks for posting... I am in the process of setting up a solo 401k also, for the first time.

gasdoc

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MP123
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Re: Solo 401k - elective deferral agreement question

Post by MP123 » Thu May 28, 2020 11:30 am

baffledinvestor wrote:
Wed May 27, 2020 11:11 pm
Can I open a Solo 401k now and rollover my existing IRA into it (between 10k-15k, from years ago back when I held a w2 job). Then I can begin making contributions throughout the year as finances allow, and at the end of the year if I contributed say, $14,500, I can just draft my Elective Deferral Agreement to read something like "I elect to contribute an amount up to and not exceeding 15k"? Is it really that simple? I guess it just seems bizarre to me that I have to declare any amount beforehand rather than simply adding money when I have it.
Yes, it's that simple.
baffledinvestor wrote:
Wed May 27, 2020 11:11 pm
Along those lines - is it best to notate my contributions as employee contributions? Not sure where the benefits fall between contributing as employee or employer - but if it matters I expect to take in about $46k before taxes/expenses and I usually only have about $2-3k of expenses to claim.
Your employee deferral is limited to $19,500 (plus $6,000 if over 50). Your employer contribution is limited to 20% of net income if you file on schedule C. So what you don't want to do is start making employer contributions and then find that your income is unexpectedly lower at year end leaving you with an excess contribution that may be difficult to remove. Best to make employee deferrals throughout the year, and then the employer contribution at year end, or even the next year prior to your tax deadline. But keep in mind the maximum allowable amount for each type.
baffledinvestor wrote:
Wed May 27, 2020 11:11 pm
Also, out of curiosity if the above is correct, then what is the purpose of this form for self-employed people? I guess I'm not understanding what the form actually achieves since it sounds like we can simply fill in the amount at the end of the year and then just file it in our paperwork? It sounds like it's not sent off anywhere for verification, unless I'm mistaken, so I'm not seeing what purpose it actually serves. I feel like I'm missing the reasoning for this form.
You might possibly be asked to show it at some future point, but not likely. For the regular employees it serves as an understanding between the employee and employer, since you're both it's a bit superfluous but still important to keep.

HomeStretch
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Re: Solo 401k - elective deferral agreement question

Post by HomeStretch » Thu May 28, 2020 11:33 am

Choose a Solo 401k provider that allows IRA rollovers in (Vanguard does not).

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gasdoc
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Re: Solo 401k - elective deferral agreement question

Post by gasdoc » Thu May 28, 2020 2:09 pm

HomeStretch wrote:
Thu May 28, 2020 11:33 am
Choose a Solo 401k provider that allows IRA rollovers in (Vanguard does not).
Fidelity would be the next best thing- that's where my new solo 401K is going.

gasdoc

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gasdoc
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Re: Solo 401k - elective deferral agreement question

Post by gasdoc » Thu May 28, 2020 2:10 pm

MP123 wrote:
Thu May 28, 2020 11:30 am
baffledinvestor wrote:
Wed May 27, 2020 11:11 pm
Can I open a Solo 401k now and rollover my existing IRA into it (between 10k-15k, from years ago back when I held a w2 job). Then I can begin making contributions throughout the year as finances allow, and at the end of the year if I contributed say, $14,500, I can just draft my Elective Deferral Agreement to read something like "I elect to contribute an amount up to and not exceeding 15k"? Is it really that simple? I guess it just seems bizarre to me that I have to declare any amount beforehand rather than simply adding money when I have it.
Yes, it's that simple.
baffledinvestor wrote:
Wed May 27, 2020 11:11 pm
Along those lines - is it best to notate my contributions as employee contributions? Not sure where the benefits fall between contributing as employee or employer - but if it matters I expect to take in about $46k before taxes/expenses and I usually only have about $2-3k of expenses to claim.
Your employee deferral is limited to $19,500 (plus $6,000 if over 50). Your employer contribution is limited to 20% of net income if you file on schedule C. So what you don't want to do is start making employer contributions and then find that your income is unexpectedly lower at year end leaving you with an excess contribution that may be difficult to remove. Best to make employee deferrals throughout the year, and then the employer contribution at year end, or even the next year prior to your tax deadline. But keep in mind the maximum allowable amount for each type.
baffledinvestor wrote:
Wed May 27, 2020 11:11 pm
Also, out of curiosity if the above is correct, then what is the purpose of this form for self-employed people? I guess I'm not understanding what the form actually achieves since it sounds like we can simply fill in the amount at the end of the year and then just file it in our paperwork? It sounds like it's not sent off anywhere for verification, unless I'm mistaken, so I'm not seeing what purpose it actually serves. I feel like I'm missing the reasoning for this form.
You might possibly be asked to show it at some future point, but not likely. For the regular employees it serves as an understanding between the employee and employer, since you're both it's a bit superfluous but still important to keep.
MP123, Thank you for the concise explanations.

gasdoc

HomeStretch
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Re: Solo 401k - elective deferral agreement question

Post by HomeStretch » Thu May 28, 2020 2:18 pm

gasdoc wrote:
Thu May 28, 2020 2:09 pm
HomeStretch wrote:
Thu May 28, 2020 11:33 am
Choose a Solo 401k provider that allows IRA rollovers in (Vanguard does not).
Fidelity would be the next best thing- that's where my new solo 401K is going.

gasdoc
I use and like Fidelity’s Solo 401k plan. But I am tempted to amend my plan to e*Trade’s plan which has two features that Fidelity does not - Roth deferrals and in-plan Roth rollovers.

Topic Author
baffledinvestor
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Re: Solo 401k - elective deferral agreement question

Post by baffledinvestor » Thu May 28, 2020 4:01 pm

Thank you again for the additional information. And thanks for the warning about verifying which companies will do an IRA to Solo 401k rollover - I just realized that issue today and have been trying to confirm which companies allow that. Honestly, I thought switching to a new retirement account would be simpler but I keep fearing that I'll make a big mistake along the way. :)

One more question if you'd be so kind - some of the provider applications ask for not only for an EIN (which I have), but also for another EIN designated for the 401k plan itself. So, I have to apply for another EIN for the 401k too? Does this sound correct, and if so, do you run into any tax issues by having a SSN, EIN and 401k EIN to consider?

aristotelian
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Re: Solo 401k - elective deferral agreement question

Post by aristotelian » Thu May 28, 2020 4:09 pm

I have never been asked for the form, not by the custodian, not by the IRS. IMO the form is basically a vestige of the traditional 401k, which requires an agreement between employer and employee to contribute to the plan. The form makes no sense in a self employment context except to fulfill the legal requirements of all 401ks. My form sits in my file cabinet. Nobody has ever asked me for it and nobody ever will, for any purpose. And yet it is legally required so there it sits.

nolesrule
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Re: Solo 401k - elective deferral agreement question

Post by nolesrule » Thu May 28, 2020 4:27 pm

baffledinvestor wrote:
Wed May 27, 2020 11:11 pm
Also, out of curiosity if the above is correct, then what is the purpose of this form for self-employed people? I guess I'm not understanding what the form actually achieves since it sounds like we can simply fill in the amount at the end of the year and then just file it in our paperwork? It sounds like it's not sent off anywhere for verification, unless I'm mistaken, so I'm not seeing what purpose it actually serves. I feel like I'm missing the reasoning for this form. :confused
A Solo 401k is still a 401k and subject to the 401k rules and regulations. The employer is obligated to follow the written instructions of the employee in regard to salary deferrals.

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MP123
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Re: Solo 401k - elective deferral agreement question

Post by MP123 » Thu May 28, 2020 4:32 pm

baffledinvestor wrote:
Thu May 28, 2020 4:01 pm
One more question if you'd be so kind - some of the provider applications ask for not only for an EIN (which I have), but also for another EIN designated for the 401k plan itself. So, I have to apply for another EIN for the 401k too? Does this sound correct, and if so, do you run into any tax issues by having a SSN, EIN and 401k EIN to consider?
Opinions about that vary. If you have an EIN for your business you can likely just use that. But if the custodian insists (or you prefer) it's quick and easy to get another EIN online from the IRS. You won't have any issues with having another EIN, and I've never heard of anyone having problems with using the same EIN as the business either. If you do get a new one there's special type for 401k plans.

lstone19
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Re: Solo 401k - elective deferral agreement question

Post by lstone19 » Thu May 28, 2020 4:59 pm

aristotelian wrote:
Thu May 28, 2020 4:09 pm
I have never been asked for the form, not by the custodian, not by the IRS. IMO the form is basically a vestige of the traditional 401k, which requires an agreement between employer and employee to contribute to the plan. The form makes no sense in a self employment context except to fulfill the legal requirements of all 401ks. My form sits in my file cabinet. Nobody has ever asked me for it and nobody ever will, for any purpose. And yet it is legally required so there it sits.
I agree that it's a vestige of the a traditional 401k. And it's because (I assume) it's a defined contribution plan and that form is what defines the employee contribution. Like others, I filled on out and put it in my "SE 401k" folder in my desk with copies of other forms about the plan (all also saved as PDFs). And there it will sit, most likely unseen by anybody else ever.

Spirit Rider
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Re: Solo 401k - elective deferral agreement question

Post by Spirit Rider » Thu May 28, 2020 10:25 pm

baffledinvestor wrote:
Wed May 27, 2020 11:11 pm
Also, out of curiosity if the above is correct, then what is the purpose of this form for self-employed people? I guess I'm not understanding what the form actually achieves since it sounds like we can simply fill in the amount at the end of the year and then just file it in our paperwork? It sounds like it's not sent off anywhere for verification, unless I'm mistaken, so I'm not seeing what purpose it actually serves. I feel like I'm missing the reasoning for this form. :confused
As has been pointed out, a one-participant 401k is still fundamentally a full fledged 401k plan. What gets people in trouble is thinking it is just an IRA, but with larger contribution limits. There can be severe consequences in failing to be compliant with the Internal Revenue Code, IRS regulations and/or guidance.

As has also been pointed out the elective deferral agreement (AKA salary reduction agreement) is used in the vast majority of cases for W-2 employees (including an S-Corp 2% shareholder-employee). In that case, the salary reduction agreement must be completed before any elective deferral.

It is the uniqueness of being self-employed and having your compensation deemed "currently available" on the last day of the year. That gives you until 12/31 to make the elective deferral agreement.

While this gives you leeway to make deferrals during the tax year. It is critical when you make employee deferrals after 12/31 and before your tax filing deadline including extensions.

This is when the elective deferral agreement must be both prospective and deterministic. That is, it applies before you have calculated your self-employed earned income (business profit - 1/2 SE tax), but must be based on an amount or calculation from that income without discretion.

Many self-employed individuals make their final employee deferrals after they have completed their taxes. The results of that and the elective deferral agreement must be explicitly followed or they are in non-compliance with a 401k plan error.

knightrider
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Re: Solo 401k - elective deferral agreement question

Post by knightrider » Mon Jun 29, 2020 7:04 pm

Spirit Rider wrote:
Thu May 28, 2020 10:25 pm
As has also been pointed out the elective deferral agreement (AKA salary reduction agreement) is used in the vast majority of cases for W-2 employees (including an S-Corp 2% shareholder-employee). In that case, the salary reduction agreement must be completed before any elective deferral.
So for a sole proprietor the only purpose of the Salary reduction agreement is to document the Employee contribution? This form has nothing to do with the Employer contributions, correct? And there is no special form for employer contributions?

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MP123
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Re: Solo 401k - elective deferral agreement question

Post by MP123 » Mon Jun 29, 2020 8:45 pm

knightrider wrote:
Mon Jun 29, 2020 7:04 pm
Spirit Rider wrote:
Thu May 28, 2020 10:25 pm
As has also been pointed out the elective deferral agreement (AKA salary reduction agreement) is used in the vast majority of cases for W-2 employees (including an S-Corp 2% shareholder-employee). In that case, the salary reduction agreement must be completed before any elective deferral.
So for a sole proprietor the only purpose of the Salary reduction agreement is to document the Employee contribution? This form has nothing to do with the Employer contributions, correct? And there is no special form for employer contributions?
That's all correct for an S-Corp, and I believe for a sole proprietor too.

The above form is kept for your records. There's no similar form for employER contributions, but there is a form that you send in that says which type you are making when you send the check (at least at Schwab).

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