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All Things Tax

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Valued Pioneer
Posts: 6
Registered: ‎04-26-2018
Accepted Solution

Ineligible 401k contributions in 2017

[ Edited ]

Hi Community,

 

I was self-employed last year and had a 401k that was set up by an employment broker.  It allowed individual, roth, and safe harbor match contributions.

 

Not fully understanding the safe harbor match, I mistakenly funded the 401k from my bank account rather than from payroll deductions.

 

Is there a process I can follow to fix this?  It is not an excess employee contribution, as the bank account funding was after-tax dollars.  How do I get the bank account portion out and avoid getting taxed twice?

 

Thank you for any help,

MM

 

 

Council Member
Posts: 548
Registered: ‎04-06-2016

Re: Ineligible 401k contributions in 2017

I'm not clear what your situation is. You said you were self-employed; what do you mean the 401k was set up by an employment broker?  Did your self-employed business pay you via payroll? What type of self-employed person are you-- i.e. what business type (sole proprietor, LLC, partnership, S-corp), do you have employees, etc.? 

 

The safe harbor match, I believe means that it allows employer contributions under certain conditions. If there is more than one participant and/or employee of the business, there can be restrictions on how much can be contributed to employees considered highly compensated. If you're the only employee, the restrictions wouldn't be applicable.

 

Self-employed individuals filing their income on Schedule C as a sole proprietor can set up an individual 401k that can be funded with money from a checking account rather than payroll deductions (since there isn't usually a payroll). You'd only be able to contribute the maximum of your income from the business or $18,000 employee contribution + 20% of your self employment income as an employer contribution, whichever is less.  

 

If you can provide more details, I might be able to give more helpful, specific information.


Karen

Valued Pioneer
Posts: 6
Registered: ‎04-26-2018

Re: Ineligible 401k contributions in 2017

Hi Karen, thank you for replying.

I had a third party company set everything up and administer the 401k.  I was paid via payroll, and my company was a pass-through C Corporation with me as the only employee.  My 401k was funded via payroll deductions.

This is the issue I am trying to resolve: I called the brokerage firm that held my account and asked if I could make after-tax contributions from my bank account to my Individual 401k and they said I could.  I then made a transfer from my bank to my Individual 401k but now realize I will be double-taxed on this amount as my bank account is after-tax dollars going to a pre-tax 401k, and when I take this amount out of the 401k it will be taxed a second time.

Note that I am an employee at a new company now, and this company allows after-tax contributions to the 401k as well as a Roth 401k.  My last 401k limited after-tax contributions to a Roth 401k which I did not realize at the time I made the bank transfer.

Thanks,
Mike.

 

Council Member
Posts: 548
Registered: ‎04-06-2016

Re: Ineligible 401k contributions in 2017

[ Edited ]
Mike, 
I've answered in blue text below...

Good luck!
Karen

 


@mmallory wrote:

Hi Karen, thank you for replying.

I had a third party company set everything up and administer the 401k.  I was paid via payroll, and my company was a pass-through C Corporation with me as the only employee.  My 401k was funded via payroll deductions.

This is the issue I am trying to resolve: I called the brokerage firm that held my account and asked if I could make after-tax contributions from my bank account to my Individual 401k and they said I could.  I then made a transfer from my bank to my Individual 401k but now realize I will be double-taxed on this amount as my bank account is after-tax dollars going to a pre-tax 401k, and when I take this amount out of the 401k it will be taxed a second time. I don't think this is the case.   You'll have a basis in your 401k that you shouldn't have to pay taxes on. You'll need to make sure to keep track of the amount you contributed after-tax. See the articles I included below about how to handle this to avoid being double taxed on this money.

Note that I am an employee at a new company now, and this company allows after-tax contributions to the 401k as well as a Roth 401k.  My last 401k limited after-tax contributions to a Roth 401k which I did not realize at the time I made the bank transfer. So, is the new company the one you're having trouble with, or the old one?


In the 401k you contributed to, did you contribute the maximum allowed as an employee to your 401k (for 2017, $18,000 under 50 yrs old, $26,000 for 50+) via payroll deduction before you made the after-tax contribution from your bank account? If so, just track your basis.  If you didn't and the amount you made from your bank account would have still been below the limit of what you were allowed to contribute, you might want to contact your 401k brokerage account where your after tax money is sitting in the regular 401k account and see if they can make those Roth 401k contributions instead of regular 401k contributions.  

 

You might find these articles useful: 

https://www.nytimes.com/2015/09/23/your-money/401ks-and-similar-plans/irs-ruling-makes-after-tax-con...

http://www.morningstar.com/articles/682209/should-you-make-aftertax-contributions-to-your-401.html


Thanks,
Mike.

 


 

Valued Pioneer
Posts: 6
Registered: ‎04-26-2018

Re: Ineligible 401k contributions in 2017

Thank you for your continued help, Karen.

 

It is the old plan I am having the issue with.

 

I learned of the problem as I am now trying to do a rollover to my new 401k.  It turns out that my old plan does not accept after-tax dollars to the 401k even though they took my bank transfer.  So in my rollover paperwork, they will not designate the bank transfer amount as an after-tax amount.  They say they have no way of doing that as the entire amount is pre-tax.

 

As per the nytimes link, am I to track the after-tax amount on my own?  I didn't know that was allowed, in that when I do eventually retire and get the money, the fed is going to expect their piece.  Do I just save the proof of after-tax payment from my bank and include that with my return as to why some of the distribution is not taxed?  I hope I am not over-confusing things.

 

Thanks,

Mike.

Council Member
Posts: 548
Registered: ‎04-06-2016

Re: Ineligible 401k contributions in 2017

Mike,

I'm not sure if you can do what you're suggesting (track your basis yourself) if your old 401k-custodian is saying that it's all pre-tax. 

 

Let me make sure I'm understanding the situation correctly. 

 

Your old 401k (from your self-employed C-corp-- let's call this Plan A) was the one that you asked about making after-tax contributions from your bank account. Plan-A representative said yes, and you made what you thought was going to be classified as an after-tax contribution to your Plan-A account from your bank account. I have some questions: 1) When did this contribution take place--when and for what year was the contribution made?  Was it a one time thing, or recurring? 2) Is there a reason you didn't just make the contribution as a a Roth-401k contribution to start?  3) Had you already maxed-out your employee contribution amount for the year? 4) You said you weren't clear about what the safe harbor contribution was. (This would have been an employer pre-tax contribution typically limited to 25% of the employee compensation-- it should have come out of the business's bank account and would have been deducted as a business expense on the C-corp return-- making it pre-tax because it would have offset any business income. It wouldn't have been a payroll deduction since it wasn't taken from your employee pay.) Is it possible that this is what the Plan-A representative was thinking you were asking-- did you ask about making a safe-harbor contributions from a bank account, or were you clear that what you wanted to make was an after-tax employee contribution?

 

Now that you've gotten a new job with an employer that has a 401k plan (Plan B, for simplification), you're trying to rollover the money from Plan-A to Plan-B.  The Plan-A brokerage house is now telling you that what they told you earlier about being able to make after-tax contributions is not true, even though they took your money as an after-tax contribution? Are you sure there wasn't a miscommunication between what you thought you were asking and what they thought you were asking (re: my question 4 above)?  If you were clear that you wanted to make a employee after-tax contribution, Plan-A has made this problem for you because they shouldn't have taken the after-tax contribution from you to start. I'd ask them what they can do to fix it.  If you're not sure if there was a miscommunication, it might be useful to ask Plan-A how they coded the contribution you made from your bank account-- was it as an employer contribution, or employee contribution?  This would likely help you to figure out how to move forward.  I'd also ask them if there are forms you can fill out, or something else you can do to correct this problem contribution.

 

I'd try to get this straightened out with Plan A before I did anything else about rolling the money over to Plan B. Otherwise, I'm not sure what happens since Plan A is saying the whole transfer amount is pre-tax. 


I've got some more ideas, but it would useful to have the answers to the questions I've asked above so I can figure out if any might be applicable.

 

Karen

@mmallory wrote:

Thank you for your continued help, Karen.

 

It is the old plan I am having the issue with.

 

I learned of the problem as I am now trying to do a rollover to my new 401k.  It turns out that my old plan does not accept after-tax dollars to the 401k even though they took my bank transfer.  So in my rollover paperwork, they will not designate the bank transfer amount as an after-tax amount.  They say they have no way of doing that as the entire amount is pre-tax.

 

As per the nytimes link, am I to track the after-tax amount on my own?  I didn't know that was allowed, in that when I do eventually retire and get the money, the fed is going to expect their piece.  Do I just save the proof of after-tax payment from my bank and include that with my return as to why some of the distribution is not taxed?  I hope I am not over-confusing things.

 

Thanks,

Mike.


 

Valued Pioneer
Posts: 6
Registered: ‎04-26-2018

Re: Ineligible 401k contributions in 2017

Hi Karen,

 

1) I made a one time contribution in October 2017 to max out the safe harbor portion of Plan A.

2) I had already maxed out my Roth for 2017.

3) Yes, including catch-up contributions.

4) My intention was to max out the safe harbor match with an employee contribution. I understand now that this is not possible

 

There was definitely a miscommunication (on both sides, in my opinion). Since the contribution from my personal bank is clearly not allowed to a 401k, it is surprising that Plan A allowed me to make such a contribution. Lesson learned for me.

 

Plan A told be they do not track the source of funds. They only see this bank transfer as an employer contribution. I will ask them again if there is a form I can fill out to 'undo' the bank transfer.

 

Thank you so much for helping me sort this out.

 

Sincerely,
Mike.

 

Council Member
Posts: 548
Registered: ‎04-06-2016

Re: Ineligible 401k contributions in 2017

I've commented below in blue text...

Karen 


@mmallory wrote:

Hi Karen,

 

1) I made a one time contribution in October 2017 to max out the safe harbor portion of Plan A.

2) I had already maxed out my Roth for 2017.

3) Yes, including catch-up contributions.

4) My intention was to max out the safe harbor match with an employee contribution. I understand now that this is not possible

 

There was definitely a miscommunication (on both sides, in my opinion). Since the contribution from my personal bank is clearly not allowed to a 401k, it is surprising that Plan A allowed me to make such a contribution. (They may not have realized that it wasn't coming from the company's account. It is possible to make "employer" contributions from a personal bank account. In fact, it's not uncommon for sole proprietors who may not have a separate bank account for their business.) Lesson learned for me.

 

Plan A told be they do not track the source of funds. They only see this bank transfer as an employer contribution. I will ask them again if there is a form I can fill out to 'undo' the bank transfer. Yes, so this will be considered a pre-tax contribution because employers can not make after-tax contributions.  If there's nothing your 401k plan representative can do for you, I wonder if it's possible for the business to reimburse you the amount you contributed to in effect "shift" the contribution to the business which would likely make it a deductible expense for the C-corp-- I'm not familiar with C-Corp accounting so am not sure if this would be possible at this point.  Might be worth asking an accountant.  

Back to your previous question about tracking the after-tax basis yourself, given your situation, with the funds in question being designated as employer contributions, I don't think tracking the after-tax basis is really going to work.  Hopefully, you'll be able to straighten things out.  

 

Thank you so much for helping me sort this out.

 

Sincerely,
Mike.

 


 

Valued Pioneer
Posts: 6
Registered: ‎04-26-2018

Re: Ineligible 401k contributions in 2017

Hi Karen,

 

Thank you, I will check with an accountant if I can have this treated as a business expense.

 

Regards,

Mike.