Self-Employed Individuals Wrap Up Their Year With Plan Contributions
By Lisa Haberman, MBA, MAM, ChFC, CLU
The holiday season is often called the most wonderful time of the year, but many self-employed individuals also call it the most stressful time of the year. They’re hustling to meet annual revenue goals in the midst of enjoying the holidays with friends and family. With all the seasonal activity, it’s easy to forget the importance of finalizing a deferral election by the time the mirror ball falls on New Year’s Eve—the symbolic end of not only a calendar year, but also a tax year and plan year for many businesses.
Many self-employed individuals who operate their retirement plans on a calendar-year basis let this milestone go by without declaring their intent to make a deferral election. The timing can be confusing for many business owners, as end-of-year business accounting is not completed until after the conclusion of the current tax year. But, keep in mind that an individual who is self-employed (e.g., a sole proprietor or a partner) is deemed to have compensation that is currently available as of the last day of the taxable year. As a result, self-employed individuals may not make a deferral election for that specific year’s compensation after the last day of that tax year (Treasury Regulation (Treas. Reg.) 1.401(k)-1(a)(6)(iii)).
This may confuse many self-employed individuals for a couple of reasons. First, they may have already made deferrals throughout the year. In other words, deferrals were made before the last day of the tax year and before their compensation would be deemed currently available on the last day of that tax year. Generally, this is permissible under Treas. Reg. 1.401(k)-1(a)(6)(iv) as long as 1) the payments (e.g., draws or guaranteed payments) made during the plan year are made based on the value of the self-employed individual’s services before the date of the payment, and 2) the payment does not exceed a reasonable estimate of the self-employed individual’s earned income for the year.
When making deferrals during the year, self-employed individuals should try to ensure that their deferrals do not exceed a reasonable estimate of their earned income, or exceed a compensation-based limitation on deferrals. This may be challenging because the final compensation calculation for plan contribution purposes is not made until after year end. It is possible for a self-employed individual to make excess deferral contributions if the amount deferred during the plan year exceeds the final compensation calculation for plan contribution purposes.
Keeping these rules in mind may help self-employed individuals to maximize their retirement savings and alleviate some of the stress that comes along this time of year.
