“How do you know when you have enough money?” –This is the title of a program I am presenting this Thursday, September 23, at noon for the Take a ...
A “major” concern he expressed was that he did not want to continue his solo 401k because of the accounting fees. I told him that this is a foolish reason. It’s similar to not going to a physician when you are sick because you haven’t used your deductible and have to pay her bill. The accounting fees are not relevant compared to the total benefits of continuing the 401k. The fees relate to the need to file an annual Form 5500-EZ once the plan balance exceeds $250,000. Under $250,000 no tax filing is due (and no extra accounting fees). To have accumulated $250,000 you would have needed to have been making contributions for at least 7 or 8 years.
The annual deductions provide good current tax benefits, but the tax-deferred growth within the plan can provide even greater benefits. At some point, assuming the normal progression of activities, the accumulated fund would provide a lifetime of cash flow once age 72 is attained.
This client also has a problem designating his beneficiary. His custodian does not have a standard designation of beneficiary forms for 401k accounts and the plan provides for his estate to be the default beneficiary, which is not what he wants. This client can have his attorney prepare this form for him to give to the custodian, or he could do it himself (which I do not recommend). Comment: The custodian manages the investments and the client told me he would not be terminating that relationship.
This client seems, misguidedly to want to get out of the solo 401k, so here are two alternatives for him. Regardless of which alternative, he would need to terminate the plan and roll it over completely before the end of 2020 to an existing IRA or a newly opened Rollover IRA account. This should be done from custodian or trustee to custodian or trustee. He should then use the IRA custodian’s designation of beneficiary forms (which his custodian has). Alternative 1 would be for the client to then make annual IRA contributions to the IRA account starting for 2021 providing that his total income is under the annual limitations. The second alternative after terminating the 401k as mentioned is to open a separate SEP/IRA and make future contributions of approximately 20% of his annual business income starting for 2021. Either alternative would provide a lower contribution than the 401k, but it will still give him a deduction for the contribution. In both cases, he can still make his 2020 solo 401k contribution (see next two sections).
In order to avoid having to file a Form 5500 beyond the 2020 year, the 401k should be closed and rolled over by December 31, 2020. He will need a Form 5500 for 2020 since the account was open during this year. Further, if he wants he could also make a tax-deductible 401k contribution for 2020 but it must be contributed by December 31 and before the account is terminated. After the 401k is terminated in 2020, for 2021 he could decide until April 15, 2022, whether to contribute to an IRA for 2021; or his extended due date (which could be October 15, 2022) to decide if he wants to open and contribute to a SEP for 2021.
As mentioned above, even if it is decided to terminate the plan, a contribution could still be made for 2020, just that it must be made before terminating the 401k. At this point in the year it should be pretty evident how much would be made from his business and how much the contribution would be based on that. He should not use the termination as an “excuse” to skip the 2020 contribution. He might not want to make it because of his overall financial and tax situation this year but that is unrelated to the termination. If in doubt then he should have a projection prepared by his tax advisor.
For those with a solo 401k, make sure you are not required to file Form 5500. Also, save this blog and refer to it each year and also discuss it with your tax advisor. There are substantial penalties for failure to file the Form 5500.
Ain’t taxes fun!