Plan Sponsors and participants contribute a portion of their compensation to their retirement plans. For employees whose earnings are reported on Form W-2, this is fairly straightforward: Vestwell or your payroll provider allocates a portion of the reported earnings based on the plan's definition of compensation. If you are employed by a sole proprietor, partnership, or limited liability company (we'll refer to all of these businesses as "self-employed businesses" or the individual employee as a "self-employed individual,") plan administration can be more complicated. This article explains some of the more common issues and how Plan Sponsors should manage them.
It is usually best to make all contributions at the end of the year
Self-employed businesses may make salary deferrals throughout the year based on guaranteed payments from their company but only find out if their business operated at a loss at the end of the year. If that happens, they will not have any earned income to contribute to the plan and, therefore, cannot make deferrals or receive any employer contributions. For that reason, it's usually best to wait until it is clear that they will have sufficient earned income. Vestwell relies exclusively on your accountant to determine the "earned income" for every "owner-employee," which we use for all plan purposes.
Salary deferral contributions to a 401(k) plan on behalf of a self-employed individual may be made after the end of the plan year as long as the individual's election to defer the compensation is made prior to the end of the entity's tax year. Their deferrals must be deposited as soon as they can reasonably be segregated from partnership or LLC's assets and no later than the self-employed individual's deadline for filing their individual income tax return. Please read our Help Center article about late deposits to understand more about this important compliance area.
Determining the amount of earned income is complicated
For tax purposes, sometimes related LLCs participate in the same retirement plan. Members of the LLC may receive income or losses from more than one business. Those amounts need to be netted against each other to determine the amount of "earned income" that may be eligible for contribution to the plan. As mentioned, we rely exclusively on your accountant to make this determination. Additionally, any guaranteed payments must be netted against the self-employed individual's share of the distributed income or loss from all such related businesses. Plan Sponsors must inform us about those businesses.
Calculating the amount of "earned income" that can be contributed to a plan is tricky. We rely on the Plan Sponsor for all data we use to administer the plan, including the earnings reported on the K-1. Suppose your business has income for some employees, like partners or owners of the business, that vary greatly from year to year. In that case, we may suggest that you work with a Third Party Administrator, or we will work with you to carefully evaluate whether your plan is suitable for our platform.
Investors in a partnership or LLC can't participate in the plan
In order to contribute to a retirement plan or for the Plan Sponsor to contribute on behalf of the partner or member of an LLC, the individual must have earnings from self-employment. The tax code requires that the individual's earnings must be from a trade or business in which the individual's services are a material income-producing factor. If the individual is a partner who only contributed capital but does not provide services to the partnership, they cannot participate in the retirement plan. Those individuals should not be included in your payroll files sent to us.
Additional Plan Sponsor responsibilities for off-cycle payments
Self-employed individuals sometimes receive off-cycle payments for bonuses and distributions from their partnership or LLC. Vestwell has integrations with many payroll providers, but they only process payments that the Plan Sponsor makes through its payroll provider's system. Any payments that the Plan Sponsor makes outside that system must be uploaded to the Vestwell Platform directly. Therefore, you should be sure to alert your Vestwell Team about these off-cycle payments and make sure to follow the submission requirements for your payroll provider, which you can read about here (link to our payroll integrations area).
Controlled Group Issues
The owners of many self-employed businesses may have ownership interests in other entities. If your company is part of a controlled group or affiliated service group, there may be significant impacts on your retirement plan. You can read more about this topic in our Help Center article Control Groups and Affiliated Service Groups here.
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