Can I contribute more than my business has in revenue?
Can I contribute more than my business has in revenue?
Answer:
No. All your contributions (whether pre-tax or Roth) must come from your business earnings.
Contributions
Do Roth contributions need to come from business revenue?
Answer:
Yes. All your contributions must come from your business profits. You should create a separate designated Roth account for ease of tracking your Roth balance and use the appropriate form to document your contributions. Forms can be accessed here:
Forms to Administer Solo 401k Plan
Excess Solo 401k contributions
The Solo 401k participant typically makes annual Solo 401k plan contribution when completing business tax return for the year. As a result, the Solo 401k participant can usually determine her IRC Sec. 404 deduction limits before making her Solo 401k contribution, thus preventing any excess Solo 401k contribution headaches.
10 Percent Penalty and Form 5330: When the Solo 401k participant contributes more than the allowable deduction for a given tax year, he is typically required to pay a 10 percent penalty on the over contribution amount also known as the excess nondeductible contribution amount pursuant to (IRC Sec. 4972). As such, this penalty amount must be reported to the IRS by the plan participant since he is the owner of the business by filing IRS Form 5330, Return of Excise Taxes Related to Employee Benefit Plans, and remit the penalty to the IRS. Please refer to IRC Sec. 404(a)(1)(E) as it details that the amount of the otherwise deductible contribution that exceeds the limitation for any given year shall be carried forward indefinitely and applied to subsequent years.
IMPORTANT: Even though excess nondeductible Solo 401k contributions may be returned to the Solo 401k employer under limited circumstances, the Solo 401k employer runs the risk of incurring substantially greater penalties by taking a reversion of plan contributions. The reversion penalty is typically as high as 50 percent depending on the circumstances pursuant to (IRC Sec. 4980).
First Determine Contribution Type
When removing excess contributions from a solo 401k plan, you first need to determine the type of contribution being removed. There are 2 (two) types of contributions that apply to a solo 401k plan.
- Type 1 (one): Employee Elective Deferrals Contributions that exceed the annual limit
- Type 2 (two): Employer Profit Sharing Contributions
The Rules Are Different for Each Contribution Type
The rules for removing the employee contributions vs the employer profit sharing contributions are different and are discussed below.
Here is what the IRS code says regarding removing Employee Contributions
If the excess salary deferral is not returned on or before April 15 of the following year, the contributing participant must pay income tax on the deferral both in the year of deferral and in the year of distribution. The deferrals are not included as after-tax assets even though they have previously been included in income in the year of deferral (IRC Sec. 402(g)(1) and (Treas. Reg. 1.402(g)-1(e)(8)). The earnings on the excess will be taxed in the year of distribution. Any corrective distribution of less than the entire amount of the excess deferral plus income is treated as a pro rata distribution of excess deferrals and income (IRC Sec. 402(g)(2)(D), Treas. Reg.1.402(g)-1(e)(10)).
For the employer contributions (profit sharing), here is what the rules state:
- They will need to remain in the solo 40k plan and treated as contributions in future years. However, a 10% penalty will need to be paid on the over contribution amount also known as the excess nondeductible contribution amount pursuant to (IRC Sec. 4972).
- This penalty amount of 10% will need to be reported by the solo 401k owner by filing IRS Form 5330, Return of Excess Taxes Related to Employee Benefit Plans, and remit the penalty to the IRS.
- Please refer to IRC Sec. 404(a)(1)(E) as it details that the amount of the otherwise deductible contribution that exceeds the limitation for any given year shall be carried forward indefinitely and applied to subsequent years.
Contribution basics
As the year comes to a close, we'd like to remind you to plan for your contributions to your Solo 401k. In this article, we'll discuss the following questions:
- How do I calculate my contributions for this year?
- How do I actually make contributions to my Solo 401k?
- When is the deadline to make contributions?
How do I calculate my contributions for this year?
- Solo 401k contributions are comprised of two components:
- On the employee side – employee salary elective deferral
- On the employer or business-owner side – employer profit sharing
- Contributions can only be made from the business earnings of the adopting business
- The Contributions Calculator explains the maximum employee and employer contributions that can be made to the Solo 401k
- Always check the totals with your CPA
- Starting in 2025, the SECURE Act 2.0 provides for "super catch-up contributions" for those turning 60-63:
For more information:
- Contributions calculator
- Article: “Contribution Limits”
How do I actually make contributions to my Solo 401k?
- The way to make contributions to your Solo 401k depends on the type of adopting business.
- If your Solo 401k is sponsored by a corporation:
- Employee salary elective deferrals must be processed through payroll. Speak with your payroll provider to request this.
- If payroll has already been processed for the year, the only option is to amend the Q4 reports to reflect the contributions to the 401k. Keep in mind that contributions will affect the taxes paid as well as other numbers. Speak with your payroll provider about making this correction.
- If your Solo 401k is sponsored by another type of business (e.g. sole proprietorship, LLC), all contributions must come from your adopting business's bank account.
- All contributions must be elected and documented via the appropriate form.
- There are two forms, depending on the type of contribution made.
- All elections to contribute must be made before December 31st of the year. This means the date on your contributions form must be before December 31st.
- As Plan Administrator, keep the completed contribution forms as part of your record-keeping for the plan.
- Issue a check payable to your 401k trust (refer to the IRS letter for the exact spelling)
For more information:
When is the deadline to make contributions?
- The Solo 401k contribution deadline can vary depending on two factors:
- Type of adopting business (e.g. sole proprietorship, single-member or multiple-member LLC, C or S Corporation)
- How the contribution is made, e.g. as an employee salary elective deferral or employer profit-sharing
- Review our “Contribution Deadline” article for the specific deadlines
For more information:
- Article: “Contribution Deadline”
Accounting within your Solo 401k
As Plan Administrator of your 401k, you are responsible for tracking all of the funds and assets of your 401k. The monies in your 401k should be kept accounted for separately.
Types of monies include:
- Rollover(s)
- Employee salary deferral contribution(s)
- Employer profit sharing contribution(s)
- Roth contributions
- etc.
You will need to establish a clear accounting method to keep track of each type. Accounting will include the incoming amount(s) as well as the transactions and investments for each. The format for tracking and accounting is up to you. You can use any type of accounting software, such as:
- Excel spreadsheet
- QuickBooks
- Quicken
Am I required to contribute every year to my Solo 401k plan?
Am I required to make annual contributions to my Solo 401k Plan?
Answer:
Contributions are not required every year. However, the plan will not be considered qualified if it appears from surrounding facts and circumstances that the plan was established as a temporary program.
A plan will be considered temporary if:
- The plan is abandoned within a few years after being established for reasons other than business necessity
- Substantial and recurring contributions are not made to the plan
A plan will be considered permanent as long as substantial contributions are being made occasionally, even if contributions are not made every year. The employer reserves the right to discontinue the profit sharing contributions without jeopardizing its status as a permanent program.
Matching contributions for a Solo 401k?
Are there any matching contributions for a Solo 401k?
Answer:
No. Matching contributions are listed in the Solo 401k Plan as not applicable.
There are no matching contributions because the plan is designed to be as flexible as any retirement plan can be allowed by law in the U.S. This might mean that some years you will make employer contributions and in other years you won’t. This allows the greatest flexibility within the plan. Employer contributions are known as "Profit Sharing". Please review the following link to learn more:
Separate accounts
I read in the banking instructions that I need to have separate account for different type monies in my plan. I understand the difference between pre-tax contributions vs. post-tax (Roth), but why do I need separate account for profit sharing contributions?
Answer:
Separate accounts are set for each type of contribution because of the different plan and IRS rules for each type of contribution. The regulations require this for qualified plans.
For example, elective deferrals cannot be distributed as an in-service distribution prior to the participant attaining age 59 ½; whereas, profit sharing contributions can be distributed as an in-service distribution with no age restriction.
Another example: if the plan allows for hardship distributions for elective deferrals, you can only distribute the contributions, not the earnings.
Can profit sharing contributions be made to my Solo 401k throughout the year?
Can profit sharing contributions to my Solo 401k be made throughout the year, or do I have to wait until the end of the year to make them?
Answer:
Profit sharing contributions can be made throughout the year. However, note that the profit sharing contributions are limited to a percentage of your compensation (25% for corporations, 20% for single member LLCs or sole proprietors) at the time you are making them.
For example, if your compensation (i.e. the wages you take from the company) up to date are $16,000, your corporation can put up to $4,000 in profit sharing contributions.
What happens when my spouse stops working for my business?
Answer:
If you and your spouse work in your business together and your spouse stops working in the business, (s)he can still participate in the plan in terms of directing their existing assets in the plan. Your spouse has all the rights of the participant except the ability to make contributions into the plan.
Your spouse does not need to transfer their funds out of the plan and stop being a participant. However, (s)he can not make contributions.