Best 401K options for a small business with one employee (trying to maximize retirement contribution (~35,000-$50,000)

Archived From: Finance
  • Page :
  • 1
  • Text Only
Voting History
rated:
I've seen similar threads to this, but the advice seems conflicted, or the OP didn't give enough information.  Here is everything that I can offer:

Have a small boutique business with my mother.  She is past the age of 60 and isn't focused on maximizing retirement dollars (she's set).  I'll be phasing in more for her in the next 3-5 years.
Have a full time employee that makes about $50,000 a year on payroll.
I pay myself about $70,000 on payroll and my mother about $50,000 on payroll.  We then split about $100,000 in dividend distributions.
My husband has a full time job and maximizes his 401k ($17,500 I think?)
We both currently also maximize Traditional IRAs. 

I am looking for a vehicle to put away as much a year as possible, while also minimizing expenses.  I could put away $40,000-$50,000 a year, or more. 
I've looked at all the IRA options and the most attractive seems to be the simple IRA. 

Simple IRA:
I can put away $12,500
I have to do a 3% match ($2100me/$1500employee) match or 2% ($1000employee) flat on my employee.

If I go for a full blown IRA, I am looking at $3000+ in fees and matches, and not sure that seems worth it. 

Am I better off just forming a second company, having the Prime Company pay me as a subcontractor and then doing a SEP IRA for myself in Company #2?  That way I can put away a lot more than $12,500. 

Thoughts?  Need anymore info?

Member Summary
Most Recent Posts
Much of the advice here could get you in a lot of trouble.

The IRS is wise to the ownership shenanigans employers go to t... (more)

btuttle (Aug. 05, 2016 @ 12:27p) |

FIDELITY

jumroo (Aug. 05, 2016 @ 1:17p) |

Hi.

I just setup a Individual 401k for my S-Corp (with one W2 which is me) through Vanguard. The only cost to me is 20$ p... (more)

Cooz (Aug. 05, 2016 @ 1:43p) |

Staff Summary
Thanks for visiting FatWallet.com. Join for free to remove this ad.

Honestly, find a highly recommended CPA in your area, who knows retirement accounts - then spend the $300 - $500 for (what should be) awesome advice, tailored to your situation.

https://investor.vanguard.com/what-we-offer/small-business/individual-401k
The combined amount of employer plus employee contributions can't exceed $53,000 for the 2016 tax year ($59,000 for employees age 50 or older).

 

If you didn't have the employee, I'd recommend creating an S-Corp and then setting up a individual 401K with Fidelity.

Compare here: https://www.fidelity.com/retirement-ira/small-business/compare-p...

From here: https://www.fidelity.com/retirement-ira/small-business/self-empl... choose the Self-Employed Contribution Calculator

You could put your husband on payroll and pay more in SS/Medicare etc taxes, but then funnel the money to the 401K. Pay him $2000/mo and put it all into 401K (no fed/state taxes).

The kink in this is that you would have to offer your employee the same benefits you offer yourselves (I think). There may be some loopholes that I don't know of. Then again, your employee may decide not to contribute.

jason745 said:   https://investor.vanguard.com/what-we-offer/small-business/individual-401k 

The combined amount of employer plus employee contributions can't exceed $53,000 for the 2016 tax year ($59,000 for employees age 50 or older).


I have an employee.

As for getting a good accountant, I've tried that road and they often refer me to a "retirement account specialist", who pretty much tries to sell me on the full 401K Safe Harbor program, but the benefits of that remain to be seen-

 

samko said:   
The kink in this is that you would have to offer your employee the same benefits you offer yourselves (I think). There may be some loopholes that I don't know of. Then again, your employee may decide not to contribute.


Why is that a kink? The OP is clearly doing well and should fairly offer their employee the same match. Doesn't mean the employee will take it...

Anyone will take free money.

OP
What is the structure of your business (sole prop/s corp)
How much is the salary of the employee?
Is the employee interested in getting the same salary but some of it as 401k contribution?
Can you offer a little more money but have him/her come in as a contractor?

Setting up a separate s-corp for you to come in as a contractor will work but due to the hassles, IMHO leave that as the last option.

And OP - maybe I have a bad luck but in my experience, the CPAs have been useless.
They are paper pushers.

I even tried a CPA who was recommended by a fellow FWFer.
I sent him my last year's return with all the details. I asked him to identify if I am leaving anything on the table. And to tell me valid ways to save taxes.
He just redid the return in his system and ate my $1100.
On top of that, when I sent a follow up email asking him "If / How can I use the AMT Sweet spot strategy"
He simply replied "So you want to reduce your AMT to $0"
And then sent me a bill for $65.

I gave up.

You should be able to find someone to setup a 401k and manage it and keep in compliance for about $500 a year. We use a small company in San Jose and they even manage our self directed 401k with 4 employees.

ssgcinty said:   Anyone will take free money.

OP
What is the structure of your business (sole prop/s corp)
How much is the salary of the employee?
Is the employee interested in getting the same salary but some of it as 401k contribution?
Can you offer a little more money but have him/her come in as a contractor?

Setting up a separate s-corp for you to come in as a contractor will work but due to the hassles, IMHO leave that as the last option.

Company is an S-Corp
Salary of employee is $50,000, they may or may not participate, if they don't, obviously Simple IRA is best, but I'm also trying to find ways to put away more than $15,000, without giving my employee Tens of Thousands of Dollars.
It's illegal I think to use 401k contributions as salary substitute, but I doubt it.  Employee is a money in hands kind of person.  
Employee cannot function as a subcontractor (legally), and my industry is watched pretty closely on this. 
I can easily function as sub contractor, my employee cannot.
 

The only way to sock away 40-50k is via SEP (20% of sole-prop profits ) or 401k (25% of salary).
If you want more 40-50k retirement contributions, profits/salary have to go way up and dividends have to come down.
But that means your FICA eligible income will go up correspondingly.
And that may negate some of the advantages of retirement contributions.

Consider this:

I assume your current numbers are
  Salary Dividends IRA contribution Net taxable
You 70 50 -3 117
Mom 50 50 -3 97

Say, you set up a 401k plan for all employees
Company contributes 25% to employees (but that means you have to pay the employee an extra 12.5k)
Then you defer 18k from your salary. Mom can defer another 18k if she wants too.
Now your business profit is
270k - 170k salaries - 42.5 company contributions = 57.5
You and your mom splits the profit 50/50%.
So your net taxable income is 57.5/2 (dividend) + 70k (salary) - 18k (deferral) -3k (IRA) = 77.75

Note that your mom loses out because the business profit has gone down to pay for your 401k match (which is more than her match)
You both lose out because you are paying for the employee's 401k match.

If you decide not to do the 25% company match, then company profit remains same (100k)
Your net taxable income is 100/2 (dividend) + 70k salary - 18k deferral - 3k ira = 99k

I am assuming you can do regular IRA. If not, you can always do backdoor Roth.

On a different note, even if your mom's retirement is set, I think she should still consider the 18k deferral, age catch-up contributions (5k) and the IRA (3k).  She can easily sock away 26k (unless she needs the money - which I doubt)
And if she is going to leave the money to her kids/grandkids, it will be great to have her setup Roth 401k. That way you can inherit and let it grow tax free.

NOTE: I know a solo-401k can be managed by yourself without any fees. Since you have an non-spouse employees, verify that you can still self-manage and save on the fees. If not, you can expect to pay upto $500 (not $3000 as you mentioned).

401kquestions said:   .....
Am I better off just forming a second company, having the Prime Company pay me as a subcontractor and then doing a SEP IRA for myself in Company #2?  That way I can put away a lot more than $12,500. 

Thoughts?  Need anymore info?

I would not form new company but would get paid as contractor on 1099 and file schedule C as sole proprietor, you also need to get EIN for that activity to open Self-Employed 401k - look up form SS-4, very easy process.
Plan will be free for you, no need to worry about employee or mom and with 70k income you can contribute around $31k ( according to calculator on Fidelity.com - link was given above)
Keep in mind that business will not pay second half of your FICA taxes and you will need to pay it yourself, you may need to increase your salary to make you "whole".

ETA: we use Fidelity SE 401k ourselves and highly recommend it.


 

401kquestions said:   ssgcinty said:   Anyone will take free money.

OP
What is the structure of your business (sole prop/s corp)
How much is the salary of the employee?
Is the employee interested in getting the same salary but some of it as 401k contribution?
Can you offer a little more money but have him/her come in as a contractor?

Setting up a separate s-corp for you to come in as a contractor will work but due to the hassles, IMHO leave that as the last option.

Company is an S-Corp
Salary of employee is $50,000, they may or may not participate, if they don't, obviously Simple IRA is best, but I'm also trying to find ways to put away more than $15,000, without giving my employee Tens of Thousands of Dollars.
It's illegal I think to use 401k contributions as salary substitute, but I doubt it.  Employee is a money in hands kind of person.  
Employee cannot function as a subcontractor (legally), and my industry is watched pretty closely on this. 
I can easily function as sub contractor, my employee cannot.
 


Nothing like putting the squeeze on the people who help you pay your bills.

401kquestions said:   Am I better off just forming a second company, having the Prime Company pay me as a subcontractor and then doing a SEP IRA for myself in Company #2?  That way I can put away a lot more than $12,500. 
No matter how you structure this and however many companies you have, you can only have one retirement plan for ALL companies under your control. They would all be considered what is known as part of a controlled group. The rules are specifically designed to prevent you from playing games to discriminate against your employees.

You may not like it, but you just are not going to be able to contribute as much as you would like. Most small businesses in your circumstances (2 employees), would just use a SIMPLE IRA. Yes, you could contribute more with a small business 401k, but there will be additional administrative expenses and whatever employer match or profit sharing you do will have to be the same for you and your employees. If you do a match and the employees choose to limit their contributions, you could still be limited by top heavy rules.

The tax benefits are designed first and for most to benefit employees not employers. You as the higher income earning employer are perfectly capable of saving more money in taxable accounts.
 

OP Here:

@Chargum85- Our employee is wonderful, but not prepared to give them a $15,000 raise.
@btuttle- What if my Mother takes sole ownership of the business and then I set up an Scorp and pay myself as a Sub? Having to pay the FICA again, isn't really any different, as I would have to pay it in Company #1 too.
@ssgcinty- Thanks for doing the workup. Probably not worth setting up 401k, as I am not prepared to giveaway $15,000 a year to employee. Am I missing something?

Thanks for all the help people. Any other thoughts? Is there a professional that would be good to consult in setting all this up optimally? Haven't been too impressed with accountants or financial advisors.

Slightly off-topic question for the OP...

How are you able to max out 2x Traditional IRAs given your income (and the fact that your spouse has a company retirement plan).

https://www.irs.gov/retirement-plans/plan-participant-employee/2...

I'm guessing you both combined make more than $118k...

401kquestions said:   @btuttle- What if my Mother takes sole ownership of the business and then I set up an Scorp and pay myself as a Sub? Having to pay the FICA again, isn't really any different, as I would have to pay it in Company #1 too.
@ssgcinty- Thanks for doing the workup. Probably not worth setting up 401k, as I am not prepared to giveaway $15,000 a year to employee. Am I missing something?

Thanks for all the help people. Any other thoughts? Is there a professional that would be good to consult in setting all this up optimally? Haven't been too impressed with accountants or financial advisors.

1)   Yes - you can give up ownership and get paid $120k to your s corp. The s corp can give you a 70k salary and you can contribute 18k(deferral) + 17.5k(company contribution) = 35.5.  Your FICA will remain the same.  And you will be able to deduct some additional expenses (such as home-office etc)  You can still contribute 3k to IRA or backdoor roth.
2) No - you are not missing anything. A 401k plan is obligated to pay the same % of salary to all employees.
3) I described my experience with two accountants who charged $1000+.  I assume one has to go higher to get good advice but I am not ready for that.  For now, I rely on self-study.
 

justignoredem said:   Slightly off-topic question for the OP...

How are you able to max out 2x Traditional IRAs given your income (and the fact that your spouse has a company retirement plan).

https://www.irs.gov/retirement-plans/plan-participant-employee/2016-ira-contribution-and-deduction-limits-effect-of-modified-agi-on-deductible-contributions-if-you-are-covered-by-a-retirement-plan-at-work

I'm guessing you both combined make more than $118k...

 ​Ahh, I think you're right.  Maybe it was just me.  Or maybe we both did Roths, cant remember.

ssgcinty said:   
401kquestions said:   @btuttle- What if my Mother takes sole ownership of the business and then I set up an Scorp and pay myself as a Sub? Having to pay the FICA again, isn't really any different, as I would have to pay it in Company #1 too.
@ssgcinty- Thanks for doing the workup. Probably not worth setting up 401k, as I am not prepared to giveaway $15,000 a year to employee. Am I missing something?

Thanks for all the help people. Any other thoughts? Is there a professional that would be good to consult in setting all this up optimally? Haven't been too impressed with accountants or financial advisors.

1)   Yes - you can give up ownership and get paid $120k to your s corp. The s corp can give you a 70k salary and you can contribute 18k(deferral) + 17.5k(company contribution) = 35.5.  Your FICA will remain the same.  And you will be able to deduct some additional expenses (such as home-office etc)  You can still contribute 3k to IRA or backdoor roth.
2) No - you are not missing anything. A 401k plan is obligated to pay the same % of salary to all employees.
3) I described my experience with two accountants who charged $1000+.  I assume one has to go higher to get good advice but I am not ready for that.  For now, I rely on self-study.

 ​Thanks ssgcinty!!! So essentially my two best options are:

1.) Open up a sub-company solo- and put away (25% of salary) + ($18k deferral) + fees (accountancy fees approx. $500 for sub business)

2.) Do a Simple IRA and offer company match to 3%  - ($12,500max) + (3% match ~$2100 for me) and then give my employee a potential match (approx. $1500), nominal management fees. 

So in essence:

1.) Put away $35,000 at a cost of $500-$1000

2.) Put away ~$15,000 at a cost of 0-$1,500  (plus benefit of helping employee) Is that right? 

option 3) Keep existing structure - create a 401k plan without any company match. All 3 of you can put away upto 18k each (via deferral). $0 costs

Depending on where you are, option 1 will involve more expenses. For example, in some states S-corp has to pay income tax as well. I believe CA is 1.5%
And estimate of $500 per year for accountant seems on the lower side.

ssgcinty said:   option 3) Keep existing structure - create a 401k plan without any company match. All 3 of you can put away upto 18k each (via deferral). $0 costs
Also, if in future the employee leaves, you start a 25% match and put a 1 year service requirement BEFORE hiring a new employee.
That way, even if you hire a new employee, you don't have to pay him the 25% for at least a year.
After 1 year, you can revert the plan to 0% match.
 

ssgcinty said:   option 3) Keep existing structure - create a 401k plan without any company match. All 3 of you can put away upto 18k each (via deferral). $0 costs
That might be the best idea. And then can we do employee matches if its a good year or something, or is that not allowed?
How would I go about setting something like this up? Employee Fidicuiary?  Vanguard?

Profit sharing can be weighted from my understanding but I am sure there are rules to be fair.

401kquestions said:   
ssgcinty said:   option 3) Keep existing structure - create a 401k plan without any company match. All 3 of you can put away upto 18k each (via deferral). $0 costs
That might be the best idea. And then can we do employee matches if its a good year or something, or is that not allowed?
How would I go about setting something like this up? Employee Fidicuiary?  Vanguard?

  Yes - you can adjust the profit percentages year to year.
  You can setup a plan with ETrade  , ameritrade, fidelity.  They all are the same - and they should not cost you a dime.  The form will be a bit long but easy.
  The plan must be established before Dec 31.  Even if the plan existed for partial year, you can defer the entire 18k.  Make sure your accountant adjusts the w2 appropriately.
  Make sure that the 18k is deducted from your paycheck by the company.  And then company makes the deposit into the 401k account.  Do not send a personal check.
  The company should not hold on to the 18k for long. 
  The deferral must be less that the salary you were paid.  
  Add a reminder to your calendar to file 5500-ez every July.
 

ssgcinty said:   
401kquestions said:   
ssgcinty said:   option 3) Keep existing structure - create a 401k plan without any company match. All 3 of you can put away upto 18k each (via deferral). $0 costs
That might be the best idea. And then can we do employee matches if its a good year or something, or is that not allowed?
How would I go about setting something like this up? Employee Fidicuiary?  Vanguard?

  Yes - you can adjust the profit percentages year to year.
  You can setup a plan with ETrade  , ameritrade, fidelity.  They all are the same - and they should not cost you a dime.  The form will be a bit long but easy.
  The plan must be established before Dec 31.  Even if the plan existed for partial year, you can defer the entire 18k.  Make sure your accountant adjusts the w2 appropriately.
  Make sure that the 18k is deducted from your paycheck by the company.  And then company makes the deposit into the 401k account.  Do not send a personal check.
  The company should not hold on to the 18k for long. 
  The deferral must be less that the salary you were paid.  
  Add a reminder to your calendar to file 5500-ez every July.

 So I just setup a company 401k plan, no match.  And if I want to do a match on a particular year, I can, right?  If I am paying myself $70,000 a year, does that mean I essentially don't pay myself the last four months?  Is that the best way to do it?Whats the 5500-EZ for? 

1) Yes - 401k plan with no match
2) Yes - you can introduce a match for a year and remove it later
3) Yes - essentially you don't get any take home pay because almost all is going into 401k deferral.
4) 5500-EZ is IRS form to report on your 401k plan.

So I talked to Employee Fiduciary (Vanguards Minimums were $3000 annually). They said we have to do a Safe Harbour plan, as our "highly compensated employees," would unbalance any such plan. He said if we don't do an employee match, HCE's cannot own more than 60% of the plan.

He recommended:
401k plan
either a 3% gift to employee or a up to 4% match.
$1500 a year for plan maintenance.

He said I can't do what we've been discussing.

If this is accurate, not sure it's worth ~$2700-$3500 a year for me to put away $18,000. Especially if my mother doesn't use the plan.

A Simple IRA allows:
$12,500 to be socked away
2% employee gift
$25 yr fee

That is a bummer. I guess IRA it is.

ssgcinty said:   That is a bummer. I guess IRA it is.
  Or transfer ownership to my mom, and set up my subisidary.
 

401kquestions said:   
Or transfer ownership to my mom, and set up my subisidary.

Much of the advice here could get you in a lot of trouble.

The IRS is wise to the ownership shenanigans employers go to to avoid their anti-discrimination responsibilities. There are the controlled/affiliated service group rules and attribution rules.

The controlled group and affiliated service group rules requires companies with common ownership and/or common affiliation to be treated as one company. If this is true, then all companies are aggregated for retirement plan and other benefit rules. Paying yourself as a contractor is just another company and will not fly.

Attribution rules apply to spouses and grandparent/parent/child relationships. Business owned by these immediate family members are likely to be considered owned by all these family members. The controlled/affiliated service group rules then apply.

These rules are exceedingly complex and the penalties for violating them can be severe. So my advice, don't even think about going there without sound legal support

I advise you to find the retirement plan that gives you and your employee the plan with the best cost benefit analysis. While the non-elective employer contribution (3% SH 401k, 2% SIMPLE IRA) are 1% lower than the employee match, you have already stated that the employee is not likely to contribute. Also, there is one additional benefit of a SIMPLE IRA. You can reduce the 3% employer match to as low as 1% in two out of five years.  

FIDELITY

Hi.

I just setup a Individual 401k for my S-Corp (with one W2 which is me) through Vanguard. The only cost to me is 20$ per fund that I invest in. I'll read this thread again in detail after work today, but is the challenge you're facing due to the additional employee you have?



Disclaimer: By providing links to other sites, FatWallet.com does not guarantee, approve or endorse the information or products available at these sites, nor does a link indicate any association with or endorsement by the linked site to FatWallet.com.

Thanks for visiting FatWallet.com. Join for free to remove this ad.

While FatWallet makes every effort to post correct information, offers are subject to change without notice.
Some exclusions may apply based upon merchant policies.
© 1999-2017