SEP IRA and solo 401K

[DaveinTexas]

Page 13-4 of the Tax Book under deduction section of SEP IRA states that "If a self-employed taxpayer contributes to a defined contribution plan, annual additions to an account are limited to the lesser of $44,000 or 100% of the participant's compensation."

A solo 401k is not a defined contribution plan so does that mean that a single shareholder of a C or S or even a sole proprietor can setup both a SEP and a solo 401k if he has adequate compensation to do so?

So the max contribution for a person over 50 could be $44,000 for the SEP and another $20,500 for the solo 401k?

TIA.

[solomon]

In 2007

the maximum is 45k - 50k if old enough. It is not 45k for a Sep and another 15500 (or 20500) for a Solo but rather the two combined. Can have one or the other alone as well with the same amounts - at least for a sole proprietor.

[Bees Knees]

correction...

According to IRS Pub 560, page 12, (2005 version) there are two basic types of qualified plans: a defined contribution plan and a defined benefit plan. Under defined contribution plans, it lists two types: a profit sharing plan, and a money purchase plan.

Later on page 15, it describes a 401(k) plan. It says that a 401(k) plan is a qualified plan that includes a cash or deferred arrangement, which basically means the employee can choose to either receive the cash, or defer it as a voluntary contribution to the qualified plan. It then says that in order to have a cash or deferred arrangement in a qualified plan, the plan must either be a profit sharing plan, or a money purchase plan.

Thus, your statement that a solo 401(k) plan is not a defined contribution plan is incorrect. All 401(k) plans and SIMPLE IRAs that allow employees to defer wages are defined contribution plans.

Under SEP IRAs, covered on page 6 of Pub 560, it says:

More than one plan. If you contribute to a
defined contribution plan (defined in chapter 4),
annual additions to an account are limited to the
lesser of $42,000 (2005 tax year) or 100% of the participant’s
compensation. When you figure this limit, you
must add your contributions to all defined contribution
plans. Because a SEP is considered a
defined contribution plan for this limit, your
contributions to a SEP must be added to your
contributions to other defined contribution plans.

So in other words, if you are self employed and set up both a SEP and a solo 401(k) plan, the employer contributions to both plans are combined and limited to the lesser of $45,000 (for tax year 2007) or the taxpayers total compensation. The elective deferrals, on the other hand, are not included in the $45,000 limit. So theoretically, given enough compensation, the self-employed taxpayer could contribute the full $45,000 plus the $20,500 max elective deferrals for a taxpayer age 50 or older. You cannot, however, double the $45,000 limit if both employers are related (such as in the case of a self-employed individual).

[John of PA]

401k better unless high income

The SEP has a limit of 20% of net income, the 401k does not. So if the net income is only, say 30,000; then you can put much more into the 4r01k. The SEP you can only put (6000 or 20% of 30,000; or maby 25% ?); where the 401k you can put the maximim elective derreral of 15,500, as long as your net income is at least 15,500. Sor your maximum contribution on 30,000 of income is 15,500 with the 401k and only 6000 with the SEP. I understand the solo 401k's do not have all the administrative work a standard 401k has.

[New York Enrolled Agent]

So in other words, if you are self employed and set up both a SEP and a solo 401(k) plan, the employer contributions to both plans are combined and limited to the lesser of $45,000 (for tax year 2007) or the taxpayers total compensation. The elective deferrals, on the other hand, are not included in the $45,000 limit. So theoretically, given enough compensation, the self-employed taxpayer could contribute the full $45,000 plus the $20,500 max elective deferrals for a taxpayer age 50 or older.

I'm having some trouble with the notion that the elective deferrals are not included in the $45K limit.

The overall limit (currently $45K) on "annual additions" found in §415(c) is composed of the sum of three components - one of which is (A) employer contributions. But Reg. §1.401(k)-1(a)(5)(ii) says elective deferrals are treated as employer contibutions. Perhaps, I'm mis-reading the Reg but that suggests to me that the elective deferrals are included in the overall limit of $45K.

BTW, the special "catch up elective deferral" of 5K is specifically excluded from the overall limit in §415(c) by §414(v)(3) so I have no trouble with the extra 5K. But, I would request that you help me understand this in the event I'm mis-reading the reg.

[Bees Knees]

I'm having some trouble with the notion that the elective deferrals are not included in the $45K limit.

Sorry, my mistake. You are correct that the elective deferrals do in fact fall within the $45,000 limit. TTB, page 13-2 under 401(k) says the employer’s deduction is limited to 25% of combined wages for all participants before reducing wages for elective deferrals…Total of employer and employee contributions cannot exceed…$45,000 (for 2007).

The elective deferrals, however, do not reduce compensation for purposes of the 25% of employee wage contribution limit (see example in TTB, page 13-9).