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Individual 401k Rules and FAQs

2014-12-15

What is an Individual 401k?

The Individual 401k plan is sometimes referred to as a "Solo 401k", "Single(k)", “Uni-k”, “Personal 401k” or "Self Employed 401k".

The Individual 401k is a powerful retirement savings plan for the self employed. This plan is available due to the Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA) that went into effect on January 1, 2002. The Individual 401k is only available for owner-only businesses, owner and spouse businesses or if the business is a partnership that employs only the partners and has no W-2 employees. In 2014 the maximum Individual 401k contribution limit is $52,000 or $57,500 if age 50 or older.

Who is eligible for an Individual 401k?

An owner only business, an owner and spouse business and partnerships are eligible for an Individual 401k. Independent contractors, self employed individuals and small business owners frequently setup Individual 401k plans.

The business owner must have the presence of self employed activity which generally would include ownership and operation of the business. It is generally believed that the IRS will consider you eligible for an Individual 401k if the business being conducted is a legitimate business that is run with the intention of generating profits.

What type of business entity can setup an Individual 401k?

Sole proprietors such as independent contractors and self employed individuals. Also eligible business entities include partnerships, LLCs, S corporations and C corporations.

Who is ineligible for an Individual 401k?

If a business owner has salaried W-2 employees age 21 or older who work more than 1,000 hours in a calendar year they are ineligible for an Individual 401k. Business owners and their spouse do not apply to the 1,000 hour threshold.

A business owner is eligible for an Individual 401k if they employ independent contractors who work more than 1,000 hours in a calendar year (the 1,000 hour rule applies to W-2 employees only).

What are the IRS rules about when and how much profit the business must generate before setting up an Individual 401k?

There are no established thresholds for how much profit the business must generate or how soon profits must happen.

What are the IRS rules about how much and when the business owner must make contributions to an Individual 401k?

The intent of the business owner must be to make significant contributions to the Individual 401k plan, however there are no established thresholds regarding how much money is required to be contributed annually. Also there are no IRS rules about how soon contributions must be made after establishing an Individual 401k plan.

How is the Individual 401k contribution calculated?

An Individual 401k contribution consists of two parts, an employee salary deferral contribution and an employer profit sharing contribution. In 2014 the maximum salary deferral contribution is $17,500 and $23,000 if age 50 or older. In addition, a profit sharing contribution is permitted equal to 20% of net self employment income for unincorporated businesses or 25% of W-2 income for incorporated businesses. In 2014 the maximum Individual 401k contribution limit is $52,000 or $57,500 if age 50 or older.

Individual 401k contribution calculation for an S or C corporation or an LLC taxed as a corporation.

  • Employee Salary Deferral Contribution: In 2014, 100% of compensation up to the maximum of $17,500 or $23,000 if age 50 or older can be contributed to an Individual 401k.
  • Employer Profit Sharing Contribution: A profit sharing contribution up to 25% of compensation can be contributed into an Individual 401k.

View examples of Individual 401k Contribution Limits for an S or C corporation or an LLC taxed as a corporation.

Individual 401k contribution calculation for a sole proprietorship, partnership or an LLC taxed as a sole proprietorship.

  • Employee Salary Deferral Contribution: These business organizations do not provide a W-2 salary to the business owner. The employee salary deferral contribution is calculated by taking gross self-employment income and then subtracting business expenses and then subtracting 1/2 of the self-employment tax (this is termed net adjusted business profit). In 2014, 100% of net adjusted business profits income up to the maximum of $17,500 (or $23,000 if age 50 or older) can be contributed as employee salary deferrals into an Individual 401k.
  • Employer Profit Sharing Contribution: An employer profit sharing contribution can be made up to 20% of net adjusted businesses profit. Net adjusted business profit is calculated by taking gross self-employment income and then subtracting business expenses and then subtracting 1/2 of the self-employment tax

View examples of Individual 401k Contribution Limits for a sole proprietorship, partnership or an LLC taxed as a sole proprietorship.

How much can I contribute to an Individual 401k based on my income?

To determine the annual retirement contribution you could make based on your income use the Individual 401k Calculator.

Are Roth 401k contributions permitted in an Individual 401k?

Yes, provided the plan document permits Roth contributions. Participants in an Individual 401k can elect to make after-tax or Roth contributions with the salary deferral portion of the Individual 401k. The 2014 salary deferral contribution limit is $17,500 or $23,000 if age 50 or older. Roth contributions are not permitted with the profit sharing portion of an Individual 401k.

Learn more about the Individual Roth 401k.

I participate in a 401k through my primary employer and I have a part time business. Can I have an Individual 401k for my part time business?

Yes. You are eligible to establish an Individual 401k for a side business even if you participate in a 401k, 403b, 457 or Thrift Savings Plan through your primary employer. It is important to note that contributions made to the employer’s 401k, 403b or Thrift Savings Plan will impact the contributions for the Individual 401k. Contributions to the employer’s 401k, 403b or TSP count towards the Individual 401k salary deferral limit. The 2013 and 2014 salary deferral limit is $17,500 and $23,000 if age 50 or older. Contributions made into a 457 plan do not count towards the salary deferral limit. In addition to a salary deferral contribution, a business owner can also make contributions to the profit sharing portion of an Individual 401k.

Example: Jennifer is age 40 and works as a W-2 employee for ABC accounting firm and contributes $10,000 to the 401k. In addition to working at the accounting firm, Jennifer is the owner of an S corporation. She is the only employee and pays herself a $100,000 W-2 salary in 2014.

Based on this information Jennifer would be eligible to make a contribution of $7,500 in salary deferrals (the $10,000 contribution to the ABC accounting firm 401k counts toward the $17,500 salary deferral limit) plus make a profit sharing contribution of $25,000 (25% of 100,000 W-2 salary) for a total of $32,500 in Individual 401k contributions in 2014.

Can my spouse contribute to the Individual 401k?

Yes. If a spouse is employed by the business and is on the payroll and receives a W-2 then they are eligible to contribute to an Individual 401k. Owner and spouse businesses are one of the biggest beneficiaries of the Individual 401k because with sufficient income in 2014 they can potentially contribute $104,000 total ($115,000 if both are age 50 or older).

What happens to my Individual 401k if I hire full-time employees?

Then you will need to convert your Individual 401k into a traditional corporate 401k plan. If you anticipate hiring W-2 employees with more than 1000 hours of service in a calendar year in the future, then an Individual 401k may not be the appropriate retirement plan for you. Speak with a BCM financial advisor to learn more about your retirement options.

What is the deadline for establishing an Individual 401k?

The deadline for establishing an Individual 401k is December 31st of the year in which you would like to receive the tax deduction or fiscal year end for corporations.

Can I borrow using the Individual 401k and get a 401k loan?

Yes. IRA rules permit 401k loans with an Individual 401k, however not all Individual 401k providers allow loans.

Provided the 401k plan document has a loan provision you are permitted to have a 401k loan. 401k loans are permitted with an Individual 401k up to 50% of the total 401k value up to a maximum of $50,000. Most 401k loans are paid back monthly over a 5 year term. The loan payments (including the interest) are repaid back to your retirement account. 401k loans are received tax free and provided 401k loan payments are received on time then there are no taxes due. Failure to make the loan payments will cause a 401k loan default causing taxes and IRS penalties on the remain balance of the 401k loan.

Learn more about the Individual 401k Loan.

What is the deadline to make salary deferrals into the Individual 401k?

Sole proprietorship, partnership or a LLC taxed as a sole proprietorship - The deadline for depositing salary deferrals into the Individual 401k is generally the personal tax filing deadline April 15 (or October 15 if an extension was filed).

S or C corporation or a LLC taxed as a corporation – The salary deferral contribution must be made into your Individual 401k within 15 days of the period in which you are paying yourself. For example, 401k salary deferral contributions made at the end of a calendar year on December 31 need to be deposited into the Individual 401k by January 15 at the latest.

What is the deadline to make profit sharing contributions be made into the Individual 401k?

Sole proprietorship, partnership or an LLC taxed as a sole proprietorship - The deadline to fund the profit sharing contribution is the personal tax filing date of April 15 (or October 15 if an extension was filed).

S or C corporation or an LLC taxed as a corporation - The deadline to fund the profit sharing contribution is the corporate tax filing deadline March 15th. If an extension was filed then the deadline is September 15th.

What are my responsibilities to properly maintain my Individual 401k?

You are responsible for submitting the salary deferral and profit sharing contributions by their required deadlines. If you have a loan, you are required to make the loan repayments according to the terms of the loan amortization schedule or risk a loan default. When the total assets in your plan reach $250,000, the IRS requires that IRS Form 5500 is completed and submitted to them annually.

Can I rollover my other retirement plans into an Individual 401k?

Yes. You can rollover a 401k, 403b, 457 or Thrift Saving Plan from a previous employer. You can also rollover a SEP IRA, Keogh plan (money purchase/profit sharing plan), Defined Benefit Plan, Traditional IRA and Rollover IRA. 

By consolidating multiple retirement plans retirement assets can be easily monitored and a greater selection of investment choices may be gained. Another advantage of rolling over retirement accounts into an Individual 401k is these assets become eligible for a 401k loan.

Learn more about an Individual 401k Rollover.

Can a Roth IRA be rolled over into an Individual 401k?

No. IRS rules do not allow a Roth IRA to be rolled over into an Individual Roth 401k.

Can a Roth 401k from a previous employer be rolled into an Individual Roth 401k?

Yes. A Roth 401k from a previous employer may be eligible to be rolled over into an Individual Roth 401k provided the Individual 401k plan document permits Roth 401k contributions and rollovers.

Can a SIMPLE IRA be rolled over into an Individual 401k?

Yes. A SIMPLE IRA can be rolled over into an Individual 401k provided the 2 year rule is satisfied. The 2-year period begins the first day contributions are deposited in the individual's SIMPLE IRA.

Are contributions to an Individual 401k mandatory each year?

No contributions are not mandatory. Each year the funding of the Individual 401k plan is completely discretionary and flexible. Funding can be increased, decreased, or skipped entirely if necessary. The contribution flexibility of an Individual 401k eliminates potential funding worries if there is a bad business year.

Are Individual 401k contributions 100% tax deductible?

Yes, salary deferral and profit sharing contributions are generally 100% tax deductible. Roth 401k contributions made with the salary deferral portion of an Individual 401k are not tax deductible.

Subchapter S and C corporations or LLCs electing to be taxed as a corporation can generally deduct the salary deferral contribution from personal W-2 earnings and the profit sharing contribution as a business expense.

A sole proprietorship, partnership or a LLC taxed as a sole proprietorship can generally deduct salary deferral and profit sharing contributions from personal income.

What investments can be selected in an Individual 401k?

The investments that can be selected within an Individual 401k plan depend on the Individual 401k provider and can be divided into 3 general categories:

  1. Individual 401k with one mutual fund family.
  2. Individual 401k with multiple mutual fund families and stock trading.
  3. Individual 401k investing in real estate, tax liens, gold and other alternative investments.

Learn more about Individual 401k Providers.

What is the deadline for establishing an Individual 401k?

The deadline for establishing an Individual 401k is December 31st of the year in which you would like to receive the tax deduction or fiscal year end for corporations.

What are the responsibilities of the plan administrator?

The plan administrator (usually the business owner) must make contributions prior to the deadlines, make timely payments according to the loan amortization schedule if a loan has been taken, and file Form 5500 if plan assets exceed $250,000.

What type of Individual 401k does BCM setup for clients?

If you search online you will find that several types of Individual 401k plans that are available. Some of these self directed 401k plans allow investors to invest in alternative investments like gold, tax liens and real estate. Some Individual 401k plans allow you to do complex transactions in which you can buy shares of stock in your business. These 401k plans are complex, very expensive (sometimes thousands of dollars to setup and have high annual maintenance fees) and may have potential complications with the IRS.

A simple alternative to these complex plans would be to set up an Individual 401k that uses mutual funds as the investment choice within the 401k. US corporations traditionally have had mutual funds as the investment vehicle within their 401k plan and 401k participants are usually familiar with this type of investment option. An Individual 401k that uses mutual funds as the investment option can be inexpensive administratively. BCM works with several Individual 401k providers, however the Individual 401k we recommend most frequently to our clients costs $0 to setup, a $15 annual fee and a $75 fee if you request a 401k loan. Through this 401k there are 40 mutual funds to choose from ranging from conservative bond mutual funds to aggressive stock mutual funds to accommodate investors based on their age, time horizon and personal risk tolerance. Complete the form below and we would be happy to provide you with information about this Individual 401k.

 

How Can BCM Help You?

Beacon Capital Management Advisors (BCM) is experienced in setting up retirement plans for our clients. BCM provides retirement plans to the self employed, freelancers, entrepreneurs, independent contractors and small business owners and is registered in 50 States. Complete the form below and a BCM Advisor will promptly respond to your inquiry.

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Disclosures:

*The information on this page is for informational purposes only and does not constitute, and should not be construed as, professional, legal or tax advice. To determine your individual tax situation and specific needs, please consult a professional tax advisor.

*Information contained in these sections merely highlight some benefits. There are risks involved with all investments that could include tax penalties and risk/loss of principal.