Defined benefit or 401k Profit share for self employed ?

[Startupmaster]

Client is self employed with $204,000 in self employment income. Client claims no need for a pension as a 401k profit sharing will allow $62,000 in contributions because he is over age 50. Client's advisor states the 25% of pay rule does not apply and the client also is allowed $6,000 as the phase -out due to income does not apply. Client files jointly. Is the client and advisor correct. The advisor states also 415 does not apply.. .Hence no need for a pension. No employees except the owner.

[Mike Preston]

Does the client's business have any employees or partners?

[Larry Starr]

On 5/8/2020 at 6:50 PM, Startupmaster said:

Client is self employed with $204,000 in self employment income. Client claims no need for a pension as a 401k profit sharing will allow $62,000 in contributions because he is over age 50. Client's advisor states the 25% of pay rule does not apply and the client also is allowed $6,000 as the phase -out due to income does not apply. Client files jointly. Is the client and advisor correct. The advisor states also 415 does not apply.. .Hence no need for a pension.

Client's advisor sounds like he doesn't know what he's talking about if you have accurately reported what was said by the advisor.  The 25% of pay rule does apply (it just might not matter here; but it still applies). There is no "phase out" of the $6,000 catch up amount (which I have to assume is what you are referring to). Also, 415 definitely DOES apply to ALL plans, but that has nothing to do with why he would not need a pension plan (and by that, I assume you actually mean a defined benefit plan).  

What is your relationship to the client as it appears you are NOT his "advisor"?

Answer Mike's question and we might be able to give you some more guidance.

[Startupmaster]

No employees except the owner.

[spiritrider]

As alluded to by Larry, this is likely a misunderstanding and/or miscommunication by/between the advisor and you. As he also pointed out this is likely a distinction without a difference. Important considerations:

• While some might think it is semantics, there is no monolithic $62K limit for 2019. There is a a $19K employee deferral limit, a $56K annual addition limit and a $6K catch-up contribution limit if and only if the applicable employee deferral limit is reached.
• Employer contributions are limited to 25% of the plan's compensation, but is calculated as 20% of a self-employed individual's net earnings from self-employment (business profit - 1/2 SE tax).
• The annual addition limit does not apply to any catch-up contributions
• Therefore, only ($56K - $19K = $37K) / 20% = $185K in net earnings from self-employment is required to make the maximum employee deferral, maximum employer contribution and maximum catch-up contribution for a total of $62K in total contributions. This is why Larry said that it might not matter. Of course providing the correct contributions are made.

Notwithstanding the above, since the client is >= age 50. They could make greater retirement plan contributions in the future with a paired 401k/defined benefit plan. They would need to have reasonably stable net earnings from self-employment for a minimum of five years. So maybe this isn't the year to start thinking about doing it. However, it might be an option for the future.

[FPGuy]

Recommend client consider that whatever he is contributing pre-tax to any plan will be taxed later, but that at the same time he may be reducing his net income for which he gets a permanent 20% QBI deduction. On the other hand, if joint return taxable income is over the phase-out threshold, deduction may get him a QBI deduction he might otherwise not get, particularly if his is an SSTB.