One of the benefits of a Self-Directed 401(k) is that the business owner can make both employee elective deferral contributions and employer profit share contributions. To state it more simply, contributions can be made by both the participant and the business. Employer profit share contributions can be made even if the self-employed individual is a sole proprietor.
Employee Elective Deferrals (your contributions)
For 2014, the participant in a plan (whether sole proprietorship or incorporated entity) can contribute up to $17,500 per year. These contributions can be made in either a pre-tax or Roth (after-tax) basis….and, even a combination of the two. If the participant is over the age of 50, an additional $5,500 can be contributed (up to $23,000) as part of what the IRS calls a “catch-up” provision. This level of contribution can be up to 100% of the individual’s self-employment income.
Important note: While you can participate (e.g., you are a participant in your self-employed side business and a 401((k) participant in a W-2 employer’s plan) in more than one 401(k) plan as a participant, you must coordinate your employee elective deferral contributions….in simple terms you must still abide to the $17,500/$23,000 employee elective deferral.
Profit Sharing (Employer Contributions)
Through the role of employer, an additional contribution can be made to the plan in an amount up to 25% of the participant’s self employment compensation IF the business is an incorporated entity or 20% of the individual’s compensation if they are a sole proprietorship.
What is Your Total Potential Limit
If you qualified for the maximum contributions to your plan, the potential maximum contributions to your plan can reach $52,000 per year (for 2014) or $57,500 for persons over age 50.
You Say Your Spouse if Also Employed in Your Business?
If your spouse is a legitimate participant in the business, not only can the spouse rollover their funds into the plan, but the spouse can also make contributions to the plan based on the compensation they receive. Now, if the participants qualify for the maximum contributions, the couples’ annual total contribution can be $104,000 for 2014 or $115,000 if both spouses over age 50.
Let’s use an easy illustration which demonstrates one’s ability to maximize contributions. John Doe , age 40, is self-employed and operates his business as an S-Corp. The business pays John $100,000 per year in compensation.
For 2014, the maximum deductible contribution John can make to his self-directed 401(k) account would be $42,500. This is broken down into employee elective deferrals of $17,500 and a business profit share contribution of $25,000 (25% of $100,000).
Let’s use the same numbers for the sole proprietor. For 2014, the maximum deductible contribution John can make to his self-directed 401(k) account would be $37,500. This is broken down into employee elective deferrals of $17,500 and a business profit share contribution of $20,000 (20% of $100,000).
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