Timing issues to start solo 401k for 2004...Please help

[robbie]

I am attempting to start a solo K plan using a third party prototype plan with effective date 1/1/2004. We are in the last throes of making changes to the adoption agreement and then I will create a custodial account at a brokerage house. The sponsor, and my ERISA lawyer tell me that the plan is in effect as soon as the Adoption agreement is signed on or before 12/31/04. However, given the late date I am concerned about the consequences if the actual account at the broker is not established and funded by 12/31/04. The brokerage house has to review my plan before accepting it so I am not sure it will be in place by year-end. I want to be able to make contributions for 2004. I've been advised that the contributions do not have to be made till tax filing date with extensions, and I need not be concerned. But does the custodial account itself have to be opened in 2004, or is the signed adoption plan enough.

If not, should I quickly open a standard solo k program with one of the online-vendors, partially fund that before 12/31, and then subsequently transfer the assets to my original custodian with my original plan in 2005? Or can I keep two plans if I stay within the maximum combined limits?

Thank you for any advice regarding these questions. Obviously, I am not a professional in this field.

[Archimage]

The plan document is the only thing that has to be executed before year end.

[Tom Poje]

usually you also have to fill out a deferral election form as well - especially since you can't defer on $ already earned.

[austin3515]

Your deferral election can be to defer the maximum allowable (i.e., 13,000, or $16,000 if >50). If you use a percentage of earnings (as typical for a regular employee) you will never know what your deferral is until you figure out your income. That makes trying to max out harder (i.e., if you don't max out on deferrals, your limited to 25% of earned income on the profit sharing side, which may or may not give you enough room to max out).

All of this is assuming your a schedule C by the way. IF you're incorporated, or an LLC taxed as a corp. (and therefore are paid as a W-2 employee), you would neeed to have deferrals withheld in December, and deposited shortly after year-end.

[Guest forohonek]

The question is when is the plan document executed...

Assuming you are a sole-proprietorship (Schedule C)

It sounds like rather than taking a boiler-plate brokerage plan, that you are making your own plan document?? If so good luck getting a "regular" brokerage firm to open an account to be funded at all, let alone doing so after 12/31/2004.

Since you want a 2004 deduction consider: contact a brokerage now and open a boiler-plate solo-401K/profit sharing plan AND fund the plan with $500 or some other amount before 1/1/2005. Now you will have until your timely filed tax return is due in 2005 to fund the remainer.

You can then have your custom plan filed for your 2005 and future year dedcutions.

[robbie]

Thanks everyone for your help. My ERISA attorney still assures me that the plan is in effect for 2004 as soon as I sign the Adoption Agreement, even if the custodial account is not yet opened, especially since as a sch. C sole proprietor I don't have to contribute either the elective deferrals or the employer contributions till my extended tax filing date in Oct. 2005. The posts by Archimage, Tom and Austin seem to agree with that.

Forohek, I was in fact considering doing just what you suggested. However, the fund company I intend to use as custodian actually has an arrangement for people bringing their own plans and acting solely as custodian. They do have to review the plan first, but it is a plan which has already received an opinion letter from the IRS. The only question is the timing at this late date. Do you have good reason for thinking that I couldn't take 2004 deductions just on the basis of the plan being signed in 2004?

[robbie]

Austin,

Thanks for the advice. My adoption agreement does allow that choice and I have selected it. Now, I also have the discretionary ability to make matching contributions equal to a discretionary percentage of a participant's compensation.

So, suppose my wife and I (both over 50) each electively defer $16,000. Does this mean as an employer I can then make two matching contributions of $16,000 also? And then top it off with a $12,000 profit sharing contribution to get 2X$44,000 ($41K + $3K catch-up) in total contributions. And is it all deductible?

OR AM I JUST DREAMING???

[Bird]

OR AM I JUST DREAMING???

Maybe/maybe not.

First, you have to pay your wife a salary from which she defers $16,000. You'll have to pay her about $17,500 or so because she still has to pay SS taxes on those wages.

...unless you're organized as a partnership with her, which doesn't sound like the case.

Second, you can forgot about matching contributions. They just complicate things in this situation where there are no other employees (is that correct?).

You can make profit sharing contributions up to 25% of total covered payroll, but no individual participant can get more than 100% of covered pay. Your own "pay" is determined by subtracting plan contributions from your gross profit, and there's an adjustment that has to be made for paying self-employment taxes.

Third, when you fill out the adoption agreement, you need to make sure your wife is eligible.

It's probably more complicated than you thought, and you can screw things up pretty badly quite innocently. I hope you're working closely with that ERISA lawyer or some other professional to make sure everything is set up and done properly.

[austin3515]

I agree that there s no point in a match with no employees.

In order to max you both out at $44,000 (41K + 3K, as it sounds your both >50), you need at least $112,000 in compensation for each of you, calculated as:

$44,000 minus $16,000 = $28,000 in profit sharing contributions.

$28,000 divided by 25% = $112,000.

BTW, just open a money market account at any bank if you have trouble getting the account open before your due date. As long as the account is in the name of the Plan you're fine. The money doesn't HAVE to be in a brokerage account right away.

[robbie]

Thanks guys for straightening me out re: the matches. But just out of curiosity what is the reason that it makes no sense with no employees except me and my wife?

[austin3515]

The main reason to use a match to max out is because if you have employees that don't defer, you don't have to make a contribution for them.

Absent that motivating factor, there is no difference to you how you get to the $41,000.

[robbie]

So, Austin,

If our total compensation isn't enough to generate the max through the profit sharing contribution, why not use a matching contribution of $16K each and then the smaller sized profit sharing would get us up there?

[austin3515]

The match is till subject to the 25% of comp deduction limit. If you don't have the $112k of comp calculated above, there is no way to max out, whether you use match or PS.

[mbozek]

If you are SE why do you need to establish a 401k plan instead of a PS plan in which you would make a discretionary contribution by the date for filing your tax return if the plan is adopted by 12/31. Otherwise you can adopt a SEP plan up to the date for filing your tax return and take the same deduction that can be taken for a PS plan.

[WDIK]

If you are SE why do you need to establish a 401k plan instead of a PS plan in which you would make a discretionary contribution by the date for filing your tax return if the plan is adopted by 12/31.

If I haven't started my Christmas celebration too early, adopting the 401(k) deferrals as part of the profit sharing plan will allow the maximum contribution to be made on a lower salary.

Without adjustments for self-employment factors:

PS only - $164,000 needed to contribute and deduct $41,000

PS/(k) - $112,000 needed to contribute and deduct $28,000 PS + $13,000 deferrals.

[robbie]

Right. Its exactly because of the elective deferrals. I already have a Keogh plan which allows the ps contributions. With the 401k I can still make the same total ps contributions plus $16k for my wife and I.

AND...I see I was dreaming. If it seems to good to be true it probably is, and all that.

I thought I could do the matching contributions AND still do the full ps in order to max out. If the total of the ps and match have to fall within the 25%, there's no point to doing the match.

Another question. Since I'm a sole proprietor I understand that I can only do a 20% ps contribution for myself, but 25% for employees. Now, this is a "solo 401k" because my wife and I are both considered owner employees. Nevertheless I have to pay her a salary of at least $17.5k (as per Bird) to allow her to defer the $16K. I presume that is done on a W2 basis. So do I then make a 20% or a 25% ps contribution for her?

[austin3515]

What's the 20% limit? Not something I've heard of before...

[austin3515]

415 limits annual additions (including deferrals this time) to 100% of comp or $44K, whichever is less. In this case 100% of comp is less, so the total allowable annual additions is 17,500 (minus $16,000 equals PS of $1,500 or 8.571%).

Or is the limit $20,500? (100% of comp plus $3,000)?

[Bird]

Austin, I think he's saying that 25% of net = 20% of gross. Of course it's not quite that simple with the self-employment tax adjustment.

And yes, I think it is $20,500 if over age 50.

Just to expand a bit on the comp needed to max out, you don't have to pay $112,000 each since the individual limit is 100% as you noted. (In a corporate setting) you could pay the wife $41,000 (well, a little more for SS taxes) and $183,000 to husband (or vice versa!). Still a total of $224,000 (2 X $112,000). PS contribution is $56,000 or 25%; allocate pro-rata until husband is maxed at $28,000 ($41,000 total); wife gets the rest ($28,000 total PS; $41,000 overall). You save on some SS taxes this way.