Non-Deductible Solo 401k Tax Strategy
August 10th, 2017
The Secret Way to Boost Your Annual 401(k) Plan Contributions
In the case of an IRA, most people know that IRA contributions can be made in pre-tax, after-tax, or Roth. However, it is not widely known that a Solo 401(k) plan can allow you to make non-deductible plan contributions based off your income on a dollar for dollar basis.
Types of Plan Contributions
A contribution to a pre-tax 401(k) plan is a tax-deductible contribution; however, it is subject to tax when distributed. Unlike pre-tax elective contributions, a Roth 401(k) plan contribution is an after-tax contribution that is currently includible in gross income but generally tax-free when distributed. Whereas, when after-tax plan contributions are made from an employee’s compensation (other than Roth contributions), then an employee must include it as income on his or her tax return.
Non-Deductible 401(k) Plan Contribution Tax Strategy
Generally, when an individual is over the age of 50, he or she is able to make employee deferrals in a pre-tax fund or Roth of up to $18,000 or $24,000. A profit sharing contribution can be made in pre-tax funds in the amount equal to 25% of compensation (20% in case of self-employment or a single member LLC), and both contributions cannot exceed $54,000 or $60,000 in the aggregate for 2017. An after-tax deferral, (neither Roth or pre-tax), is also an option that can go up to $54,000 or $60,000 and include other plan contributions such as employee deferrals and profit sharing. For example, if a 40-year-old self-employed individual earns $100,000 in 2017, he or she would be able to make a maximum employee deferral contribution of $18,000 in pre-tax funds or Roth and make an after-tax contribution dollar-for dollar equal to $36,000. This is the difference between $54,000 (the maximum annual 401(k) contribution for 2017) and $18,000, the maximum employee deferral contributions limit. Those contributions can then be converted to a Roth. The advantage of making after-tax contributions versus a profit sharing contribution is that you can make a dollar for dollar contribution as opposed to a profit sharing contribution, which is based off a percentage of your compensation (20% or 25%). If a profit sharing contribution were made instead of an after-tax contribution, the individual would only be able to make a $20,000 contribution, giving him or her an annual contribution of just $38,000 versus $54,000 if employee deferrals were combined with after-tax contributions.
Is the Nondeductible 401(k) Contribution Option New?
No, non-deductible 401(k) plan contributions are not new, but new IRS regulations (Notice 2014-54) make after-tax contributions more appealing and allows the retiree to effectively segregate the after-tax assets from the pre-tax funds. The pre-tax funds can be rolled into a Traditional IRA, whereas the after-tax dollars can be converted into a Roth IRA.
Do All Solo 401(k) Plans Allow for Non-Deductible contributions?
No. You must check the 401(k) plan documents to confirm that the plan allows for non-deductible contributions. IRA Financial Group’s Solo 401(k) Plan allows for non-deductible contributions, in addition to pre-tax and Roth contributions.
For additional information on making non-deductible contributions to a Solo 401(k) plan, please contact one of our Solo 401(k) plan experts at 800-472-0646.