When would a sole proprietor (with no employee) want a § 401(k) arrangement?

[Peter Gulia]

Combining SECURE 2019 and SECURE 2022 changes, a sole proprietor may establish, retroactively, a plan (up to her tax-return date with extensions) and may make, retroactively, an elective-deferral election (up to her tax-return date without extensions).

(Let’s leave aside the BenefitsLink discussion about whether that’s practically useful for 2022. Imagine a sole proprietor with calendar tax years, and a plan and § 401(k) arrangement that, when retroactively adopted, are effective January 1, 2023.)

Am I right in thinking the situations in which a proprietor might want a § 401(k) arrangement are:

the proprietor is 50 or older and classifying a portion of a contribution as a § 414(v) catch-up elective deferral enables a contribution up to $73,500 instead of $66,000; or

the proprietor’s deemed compensation is less than $264,000?

Is there another situation in which an elective deferral allows a proprietor to do something she could not do with her nonelective contribution alone?

(Please ignore Pennsylvania income tax.)

 

[truphao]

mega back door roth, if there is a db plan

[Lou S.]

Has a DB plan and wants to contribute more than 6% to the DC. With 401(k) they can contribute 401(k) limit plus 6% employer contribution.

[Peter Gulia]

tuphao and Lou S., thank you.

[Paul I]

Depending upon the individual's perspectives and priorities on taxes, generational wealth, Social Security and current income level:

Elective deferrals are not included in the calculation of the deductible limit on contributions to the plan, so an individual with relatively low net income can get a disproportionately larger tax deduction.

On the other side, mega Roth deferrals/Roth conversions/Roth NECs start laying the foundation for no RMDs.

If the entire amount in the plan is Roth, then there is no taxable income on payments.  When the individual begins taking Social Security benefits, the payments will not count as income that could trigger income taxes on those Social Security benefits.

Payroll taxes apply to elective deferrals which, if the individual's net income is below the SSTWB, adds to the individual's Social Security retirement benefit (and possibly to a spousal benefit.

These things can work against each other, so the individual needs to decide what is more important.