Combining a Workplace Retirement Plan and a Solo 401(k)

Q: I have a full-time job with a 401(k) benefit.  Additionally, I receive side business income (unincorporated).  Can I combine my workplace 401(k) with a self-employed 401(k) plan?
John

A: Yes, you can.  However, you have to be careful to juggle the separate limits that apply.  These include the limit on elective deferrals, the limit on self-employed contributions, and the overall limit on defined contribution pension savings...

Those not familiar with this topic should first read my post on 401(k) plans, as well as my post on self-employed retirement plans.

What you're really talking about is contributing to two separate 401(k) plans in the same year.  There are three limits that must be coordinated to do this.

1. The Elective Deferral Limit

No matter how many 401(k), 403(b), or 457 plans you participate in during the year, there is an overall cap on how much you can elect to defer from your salary.  The overall limit for 2007 is $15,500 (plus $5000 if you are over age 50), or 100% of eligible compensation, whichever is less.  It matters not whether you elect pre-tax deferrals or after-tax "Roth" deferrals.

2. The Self-Employed Limit

Self-employed (or "Solo") 401(k) plans allow small business owners to make two types of contributions--the elective deferral (see above), plus the profit-sharing contribution.  In employee-type 401(k) plans, this often comes in the form of an employer match.  If you're self-employed, you are your own boss, and can set your own contribution level.

There's a limit to this, though.  The self-employed can only make a profit-sharing contribution of up to 20% of their net income from self-employment.  This is defined as business income minus expenses and minus the adjustment for one-half of the self employment tax.

As an example, suppose someone has $50,000 in side income and $10,000 in expenses.  This $40,000 in business profit would probably generate a self-employment tax of $5652.  So, his net income from self-employment would be $50,000 - $10,000 - $5652/2, or $37,174.  20% of this is $7435.  That's what his maximum contribution can be.

The Defined Contribution Limit

Overall, there is a limit on how much can be socked away for a given individual in all defined contribution accounts.  For 2007, this limit is $45,000 ($50,000 if over age 50), or 100% of eligible compensation, whichever is less.

What counts toward this limit?

• Elective and non-elective contributions to your day job's 401(k) by your employer
• All elective deferrals made
• The self-employed profit share

So long as you are able to juggle all these limits, you should be able to max out your retirement savings.

Comments

[GregHfrom LI]

I always thought there was no coordination of elctive deferral limits between 403(b) accounts and 457 accounts?? I thought you could sock away $15,500 in both similtaneously. I recall seeing a CCH analysis stating this.