Maximum Contributions to Your 401(k) with Less Income!

After-Tax Contributions…an oldie but a goodie!

How do you have maximum contributions to your 401(k) with less income?  Enjoy Part 2 of a blog series on after-tax contributions you can make to your Solo-K plan (also marketed as Uni-K, self-directed 401(k), self-administered 401(k) and Individual 401(k) plans).  From the previous post on this topic, an initial introduction was provided to give a brief explanation as to the benefits of after-tax contributions made into one’s 401(k) plan, and some of the specific benefits associated with this type of contribution.  Today, we will examine how you can make maximum contributions to your 401(k) with less income (and, probably, at a faster pace!).

I’ve Never Heard of After-Tax Contributions?

Well, for the most part, join the group.  There are a couple of reasons for this.

If, for example, you have worked as a W-2 employee and participant in an employer’s 401(k) plan, rarely will one be provided the option of making after-tax contributions.  This can be a result of an employer trying to make the 401(k) plan less expensive and easier to operate/manage…at many levels.  Quite bluntly, due to compliance requirements for multi-participant plans, an employer would probably not even want to offer participants the ability to make after-tax contributions…one reason you probably have never heard of after-tax contributions.  But, not only have after-tax contributions been permitted for a long time, after-tax contributions have the potential to be extremely beneficial to the self-employed individual.  For those who understand its benefits, you may be keenly interested.

Maximum Contributions to Your 401(k) with Less Income!

Let’s examine how this statement can be true.  Is it always true…no.  As with anything, one’s ability to maximize contributions to your 401(k) with less income will significantly be impacted by your income level and your interest in actually paying taxes on these contributions.  It’s what you are potentially able to do after you make these contributions (and pay your tax…just like Roth) that should really intrigue you.

For the example below, I am making it brief and simple for illustration purposes and will make some basic assumptions. However, this planning and investment strategy can be applied to any business….whether it be a sole proprietorship, LLC (tax filing as a sole prop or corp), S or C-Corps.  The following assumptions are made:

  1.  Participant is under the age of 50;
  2.  Participant has an S-Corp sponsoring their self-employed business;
  3.  Participant fits within a specific income range (e.g., we will use $30,000 – $130,000 approximate) from their self-employed business;
  4. The companies listed below do not trigger any Controlled Group or Affiliated Service Group conflicts; and,
  5. This strategy can be extremely beneficial to those self-employed individuals who also are W-2 employees and participating in that employer’s 401(k) plan.

Example — Maximum Contributions to Your 401(k) with Less Income!

  1.  John is self-employed with his own business (Widgets, LLC) and is paid $100,000;
  2.  John also works for Acme, Co. as a W-2 employee and receives W-2 income of $100,000;
  3.  John is interested in making maximum contributions to both plans.

Between the two plans, what is the maximum amount of contributions that can be made:

John’s 401(k) Contributions into the Acme, Co 401(k) Plan:

$18,000 — Elective Deferral made by John from payroll deductions;

$25,000 – Acme, Co. makes a $25,000 profit sharing contribution (25% of John’s W-2 income) on John’s behalf; which equals….

$43,000 — Total contributions made to the plan by John or on John’s behalf when combining elective deferrals and business profit sharing contributions.

John’s 401(k) Contributions into the Widgets, LLC 401(k) Plan:

$0 — Elective Deferral.  Remember, an elective deferral is tied to the individual.  This means that regardless of how many plans John participates in, he cannot make contributions in excess of $18,000 (under the age of 50 elective deferral limit).  Since he made the $18,000 elective deferral in the Acme, Co. 401(k) plan, he is not permitted to make any additional 401(k) elective deferrals into the Widgets, LLC 401(k) plan.

$25,000 — Widgets, LLC makes a $25,000 profit sharing contribution (25% of John’s income of $100,000 from Widgets, LLC) on John’s behalf.  Since there are no controlled group of affiliated service group issues, both companies in this example are permitted to make separate (and up to the maximum permitted) business profit sharing contributions.

$25,000 — Total contributions made to the Widget’s plan on John’s behalf.  Since elective deferrals would not be permitted, Widgets, LLC can make only make the profit sharing contribution of $25,000.

In the above example, having a total of $68,000 (between the two plans) being contributed for John’s benefit is not a bad deal, right?!  But, can it be better?  Yes, because John has the ability to make after-tax contributions into the Widgets, LLC 401(k) plan.  So, let’s look at what potential contributions could be made.

Total Combined Contributions made from Both Plans with After-Tax Contributions$97,000 (see below)

$43,000 — Elective deferral and profit sharing contributions from John (elective deferrals) and Acme, Co. (profit sharing) for John’s benefit (same as above example);

$25,000 — Business profit sharing contribution from Widget, LLC for John’s benefit (same as above);

$29,000 — Additional “after-tax” contribution made by John into the Widget’s LLC 401(k) Plan based on his qualifying income of $100,000 earned from Widgets, LLC.

(You will see that for Widget’s LLC 401(k) plan the total amount of contributions does not exceed $54,000 or 100% of John’s income.  And, based on his income, he would certainly be able to max out the contributions to $54,000. Since Widget’s LLC had made a $25,000 employer profit sharing contribution (25% of $100,000) and  John had qualifying income ($100,000), John would be permitted to make an additional $29,000 after-tax contribution. Remember, in this hypothetical example, the ability to do this was 1) his plan permitted after-tax contributions, and 2) there were no controlled group of affiliated service issues existing between the two companies (e.g., Acme, Widgets).

And, you probably thought $68,000 was awesome, so I can only imagine you might think that $97,000 is even better!! 

“But, What if John Doesn’t Work for Acme, Co. — He just has Widgets, LLC”

Okay, let’s forget Acme, Co. altogether and just concentrate on John operating Widget, LLC with all the same assumptions as above.  Let’s also spice it up and say that John does not even make an elective deferral and Widget, LLC makes no profit sharing contributions.  In short, $0 contributions have been made into the plan for John’s benefit.

What is the maximum after-tax contribution that John could make to his 401(k) plan (provided the plan permitted after-tax contributions)?

Did you say $18,000?  (Nope, that is an elective deferral, and he did not even make any elective deferrals).

Did you say $25,000?  (Nope, that could have been the profit sharing contribution the company could have made, but didn’t)

Did you say…

$54,000?  (ding, ding, ding…you would be correct)

Since John had income of $100,000, he is permitted to put into the plan up to 100% of his income OR $54,000, whichever, of course, is less.  But, in this example, John made no elective deferrals and Widgets, LLC made not profit sharing contributions.  This would then allow John to make an after-tax contribution of $54,000….and, it would be the only way he could make that contribution in this example.

Now, for those of you who ask:  what if John had made elective deferral contributions and Widgets, LLC had made profit sharing contributions… how would it affect John’s ability to make after-tax contributions?  Great question…in this example, it would simply reduce, dollar for dollar, the amount possible to put in as an after-tax contribution. That raises even more tax strategy questions!!

As always, the information provided is intended to be educational in nature.  It is not intended, nor should it be interpreted as, any form of tax, legal, financial or investment advice.  One must always consult with their respective professional in all such matters.