self-employed one-person 401(k0

[Guest 401kproman]

Does anyone know if there are any special rules for starting these plans? I know you can avoid ADP/ACP testing, 5500 preparation until assets are over $100,000. Are there prototypes specific for these?

[Jon Chambers]

Here's a link to one prototype provider that is marketing these plans. Disclaimer--I have no experience with either the provider or the concept of sole proprietor 401(k)s, so do your own due diligence.

http://www.pioneerfunds.com/uni_k/home.jhtml

[Guest FredR]

Why would you want to adopt a 401(k) for a sole proprietor with no employees? It would just complicate both plan accounting and administration without gaining anything. No matter what kind of contribution is made the economic effect is the same. My experience is that the deferral elections, etc. are rarely properly documented by sole proprietors. I would think a plan Profit Sharing Plan would be preferable, particularly with the EGGTRA deductible limit expansion.

If the sole propritor's earned income is not large then a SIMPLE IRA is ususally even better since it uses a different earned income definition (gross rather than net).

[actuarysmith]

FredR -

I respectfully disagree with your conclusion. With the passage of EGTRRA, one person 401(k)s may make sense in at least a couple of instances.

1. Assume that your sole-prop earns $50,000. The 415 limit is lesser of $40,000 or 100% of pay. However, the 404 limit (25% of pay) bites you in the butt and limits this person to $12,500 in a profit sharing only plan. (I am ignoring s/e tax calcs and circular calcs to keep it simple).

By adding 401(k) features, this person could defer another $11,000 to $12,000 into the plan. You have potentially doubled this persons annual additions into the plan!!

I realize that not many people earning $50,000 would want to put half of it into a retirement plan, but it happens. Could have a working spouse or other sources of income.

2. another scenario is in the case of a one-participant DB plan. Assume a 50+ year old with high income. Since 401(k) deferrals don't count against your 404 limits, you could effectively add another $12,000 tax-deduction. (Assumes participant aged 50+).

[Guest FredR]

I see your point. I assume the $50k comp is pre contribution, so if you do the net comp calc (including se credit) the available psp deduction is even less, more like $6,500. With the 401(k) portion off the table in regards to limits it would become the larger portion for lower incomes and just a nice add on for higher incomes.

I have always had some concern for the operation of the deferral elections and the self employed. Since they don't have income until last day of the year and must have deferral election in place by that date I have run into a number of situations where appropriate elections were not done or contributions made when there was no current income. This ocurred in a partnership setting that was more difficult to manage and ran into a problem on an IRS audit. I suppose that the single owner avoids the latter by simply having an election at a large amount to insure the maximum.

[mbozek]

FredR: I thought the 401(k) regs allow declarations of 401(k) contributions by partners to be made as late as 1/31 because of this problem. Many partners solve the problem by submitting a salary reduction election for " the maximum deductible amount" since it may be months before the firm figures out its net income and can calculate the ADP for HCE..

[actuarysmith]

I can see your concerns - I have run into similar issues. I think it just requires some extra diligence to make sure there is a valid election form on file.

Two other thoughts -

I believe that many prototypes allow the employer to elect to treat bonuses paid with the first 2-1/2 months of the close of the plan year to be treated as having been paid in the prior year. (For purposes of salary deferral)

Also, many prototypes allow for a participant to have a seperate election with respect to regular bonuses paid during the plan year.

By using a combination of these you would probably be okay with the sole prop who doesen't take any compensation throughout the year, and then takes it all in December.

[Guest FredR]

The 1/31 idea sounds like the old 30-day deposit rule. I rechecked 1.401(k)-1(a)(6) and it clearly says last day of the year. Pre 1992 they had until the day for filing.

[mbozek]

Then have the partner fill out the election for a fixed amount or the"maximum deductible amount under 402g" by 12/31.

[Guest FredR]

The 402(g) amount seems like a good idea but in most of my active cases testing issues make it unpalatable to the partners.

I find it much better to be conservative on the deferral and tweak other contributions to their advantage.

[mbozek]

ok- but how complicated can testing be?-- if the plan can determine the ADP for the NHCEs then the ADP for the HCEs can be determined by the record keeper. Most partners want to defer the max whatever it is.

[Guest 401kproman]

Thanks to all. Back to my question. It does seem that for one person, the total contribution permitted could be as high as $40,000 with part of it an $11,000 401(k) contribution and part a match or P/S contribution. Since the person is either Highly Compensated or non-highly compensated, there is no ADP testing. In addition, Loans are permitted, which could provide for loan interest to be paid back to the plan.

It would appear that this is a much better tax saving plan now than SIMPLEs, SEPs, etc. for a self-employed person.

[Jon Chambers]

The general consensus in the retirement consulting community is that under the new law, 401(k) plans (incorporating other features such as PS or match) offer more potential than other competing DC arrangements for the self employed individual seeking to maximize tax deferred contributions. Other than Pioneer, I'm not aware of bundled providers actively marketing turnkey solutions in this market. As I previously indicated, there may well be others, as I'm not particularly active in the very small 401(k) market.

[Guest rmeigs]

In the last 60 days we have seen a couple of other offerings:

Universal Pensions, Inc. - Individual(k)

AIM Funds - Solo 401(k)

[Guest alilling]

I appreciate the discussion of the Uni-401(k) plans, however I am unclear as to the timing of the contributions of the elective deferral element.

Is the proper time for deposit that provided under the DOL regs (reasonable time or no later than the 15th day of the month following the month that the income relates) or

is it treated like an employer contribution (must be deposited by the due date of the tax return plus extensions)?

Please advise if you have encountered authority addressing this issue or how it is handled in an partnership context.

Thank you and happy new year.

ASL

[Guest 401kproman]

The timing is the same as any other 401(k) plan. There is absolutly no difference in plan procedures simply because there is one person or more. In a partnership, which may include payroll and/or draw, the 15 day after month-end rule still holds after deduction. Since this is a salary reduction, at some stated percentage, the deduction should come out of every type of compensation selected in the plan document, not just taken out at the pleasure of the partner.

[mbozek]

Many partners cannot make elective contribution by 15 days after end of the year because their actual draw/ K-1 income can not be determined at that time. Partners election is defined as "maximum amount permitted under the plan". It is not unusual for partners contributions to be delayed for several months until the accountants have determined the actual amount of the draw for each partner. The same delay would apply to a person who establishes a uni-401k plan if the net earnings from self employment cannot be determined. Also I fail to see how the 15 day rule applies to self employed persons who are not employees covered by the protection of ERISA.

[Guest 401kproman]

You are right about year-end, but that is only total income. That's why I said the 401(k) deduction has to be made during the year as each draw is made. If no draw or income is paid during the year, no 401(k) deduction can be made until the next year.

Self-employed can have 401(k) plans. That is the whole point of single-person 401(k)s. It becomes a question of defining compensation properly.

[KJohnson]

401kproman--I am not sure I agree. I think the election to defer has to be made during the Plan Year but that the actual deduction does not have to be made at that time. In fact, since a partners compensation was not deemed "currently avaialble" until the last day of the Plan Year, there was always some quesiton of whether you could defer out of an ongoing "draw" alhough most people assumed that you could Just recently, the IRS issued a PLR regarding this subject.

http://benefitslink.com/IRS/plr200247052.pdf

[KJohnson]

Also, mbozek's point is a good one regarding ERISA coverage and the DOL plan asset regs. However, once you get past a sole proprietor with no employees, be sure to do careful research in your Circuit with regard to how Courts have interpreted who is an "employee" under ERISA.

Also, once you get beyond 160K of earned income (after adjustments) all the individual 401(k) gets you over a SEP is catch up contribuitons.

Finally, BISYS has posted some vendors for individual k products here:

http://www.individual-k.com/moreInfoBusinessOwner.asp

(this is no endorsement of BISYS).

[KJohnson]

Going back to whether such plans are covered under ERISA and therefore subject to the 15th business day deadline in DOL's plan asset regulations, I recalled a 1999 DOL opionion letter with regard to "working owners". That opinion letter concluced that such owners were both employees and participants. It can be found here.

http://www.dol.gov/pwba/regs/AOs/ao1999-04a.html

Significantly, in a footnote, DOL stated:

In its regulation at 29 C.F.R. 2510.3-3, the Department clarified that the term “employee benefit plan” as defined in section 3(3) of Title I does not include a plan the only participants of which are “[a]n individual and his or her spouse . . . with respect to a trade of business, whether incorporated or unincorporated, which is wholly owned by the individual or by the individual and his or her spouse” or “[a] partner in a partnership and his or her spouse.” The regulation further specifies, however, that a plan that covers as participants “one or more common law employees, in addition to the self-employed individuals” will be included in the definition of “employee benefit plan” under section 3(3). The conclusion of this opinion, that such “self-employed individuals” are themselves “participants” in the covered plan, is fully consistent with that regulation.

I suppose this could lead to the conclusion that if a sole prop has any other employees other than the sole prop, then EVERONE's money (including that of the sole prop) has to meet the 15 business day deadline in the plan asset regulations.

[mbozek]

Without going into the precendential value of a footnote to a DOL opinion letter on a matter falling under the IRC, there is still the question of whether an elective maximum contribution to a 401(k) plan can be made by a self employed person prior to the time the sep's income from the sponsor can be definitely determined by the partnership. There is substantial authority for delaying the contributions to a plan because contributions must be definitely determinable under applicable IRS rulings. Also making an incorrect contribution can subject a participant to a penalty for over contribution.

[KJohnson]

Mbozek--I believe your quote in the prior post was

"Also I fail to see how the 15 day rule applies to self employed persons who are not employees covered by the protection of ERISA."

As you yourself seem to acknowledge, the 15 day rule is clearly an ERISA issue and not a Code issue.

I was in agreement with you on your prior post that if you have a sole proprietor with no other employees you are probably exempt from ERISA and the 15 day rule in the plan asset reg. I just wanted people to be aware that the fact that an individual is a sole proprietor or a partner does not exempt that individual from the 15 day rule if they have additional employees. Moreover, if you take the DOL at its word, the 15 day rule would arguably be applicable to the contributions by the sole proprietor and partners themselves in addition to their common law employees since they would be "participants". The Courts as well have been all over the lot on the issue of whether an "owner" is an employee/participant. Although I haven't researched it lately I recall both the Kwatcher decision out of the 1st Circuit in the late 1980's and the Madonia decision out of the Fourth Circuit in the early 1990's

Harmonizing Code and ERISA provisions in this area is difficult. They obvioulsy have different concerns and agendas--beginning with the very nature of an elective deferral (an employee/participant contribution in DOL's eyes and an employer contribution in the IRS' eyes). If ERISA is applicable, for a partner or sole proprietor you are left to determine when their contributions were "received by the employer" or would have been "otherwise payable in cash." I agree that there is no easy answer to this on earned income for a self-employed person.

[mbozek]

KJ- The legislative history of ERISA indicates that Congress understood that certain provisons of ERISA would conflict with the IRC. I see no basis for the application of the 15 day rule to Self employed persons who are not employees under ERISA to the IRC provisions for deductions. Also the 15 day rule would apply only to timing of the contributions by the partners. In the pship situations I have been discussing the partners have earned income by 12/31 which is held by the P ship until the final allocation of profits for each partner is determined by the accountants. After the profit determination is made then the k contribution (ADP % x profit/draw) for each partner is transferred by the pship to the plan and the pship takes a deduction. The partner thus has made a contribution to the plan by year end.

[KJohnson]

"I see no basis for the application of the 15 day rule to Self employed persons who are not employees under ERISA"

I think the confusion here is that self-employed individuals may, iin fact, be emloyees and participants under ERISA. There are two steps in the analysis.

First, is there an employee benefit plan? If you have only a self-employed person in the plan and that individual has no common law employees then I would agree with your analysis--because you don't have an employee benefit plan regulated by ERISA. However, if you do have common law employees covered by the plan, then you have an employee benefit plan regulated by ERISA and the quesiton becomes whether the self-employed individual is a participant in the plan. I think that the DOL would say that they are and therefore governed by the plan asset regulations. Also, here is some language from the Madonia decision I mentioned above in this regard:

Second, Madonia points to a DOL regulation dealing with the existence of an "employee benefit plan," which provides:

For purposes of this section: (1) An individual and his or her spouse shall not be deemed to be employees with respect to a trade or business, whether incorporated or unincorporated, which is wholly owned by the individual or by the individual and his or her spouse....

> 29 C.F.R. § 2510.3-3© (emphasis added). Madonia contends that this regulation governs the definition of "employee" throughout ERISA and thereby precludes Dr. Madonia from being deemed an "employee" or a plan "participant."

Madonia, however, overlooks the introductory clause of the regulation: "[f]or purposes of this section." "[T]his section" refers to > 29 C.F.R. § 2510.3-3, which deals exclusively with the determination of the existence of an "employee benefit plan." Therefore, by its very terms, the regulation's exclusion of sole business owners from the definition of "employee" is "limited to its self-proclaimed purpose of clarifying when a plan is covered by ERISA and does not modify the statutory definition of employee for all purposes." > Dodd v. John Hancock Mutual Life Ins. Co., 688 F.Supp. 564, 571 (E.D.Cal.1988). The cases on which Madonia relies simply fail to address the import of the introductory language to this regulation. See > Kwatcher, 879 F.2d at 960-62; > Peckham v. Board of Trustees of the Int'l Bhd. of Painters and Allied Trades Union, 653 F.2d 424, 427 (10th Cir.1981). Specifically, the regulation does not

govern the issue of whether someone is a "participant" in an ERISA plan, once the existence of that plan has been established. This makes perfect sense: once a plan has been established, it would be anomalous to have those persons benefitting from it governed by two disparate sets of legal obligations.