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We own small business (C-Corp without S-election) that currently does not have employees outside the owners (three of us). The business is producing a nice amount of revenue and as of yet none of us have drawn any salary.

We'd like to set up a 401k plan for the business and maximize our contributions. Reading up on the subject, the individual contribution limit for 2016 is $18,000 and the total of individual + employer match is $53,000.

What's the minimum salary we need to pay ourselves and overall structure to enable that maximum $53,000 value per person?

Can we pay ourselves a $18,000 salary with 100% personal contribution to the 401k as well as a $35,000 employer contribution for a total of $53,000? Or do we need to pay ourselves a higher salary to allow for the maximum?

To clarify further, we're trying to figure out the minimum we have to pay out in salary and employer match to maximize the $53,000 total per person limit. We're not sure if the outline in the previous paragraph ($18K salary all going to 401k as individual component and $35K employer contribution) is allowed and, if not, what's the minimum outlay from the company that would be allowed?

  • Do a SEP instead. Much higher limits, around 51K per year and pretty much free to setup. Check with your CPA. – Pete B. May 23 '16 at 16:05
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    A SEP limits contributions to 25% of wages so we'd have to pay out higher wages which would be additional taxable income (that we're looking to avoid). That's why I'm specifically asking about structuring a 401k/payroll to get the max 401k contribution of $53K. – Samuel Rodgers May 23 '16 at 19:03
  • How is your business organized? LLC, partnership, etc.? Did you make an explicit election with the IRS to be taxed in a certain way (like S-Corp) or are you taxed under the default rules for your category? – user32479 May 23 '16 at 19:12
  • It's a C-corp and we don't have (and have no plans to get) an S-election. I added that to the question description. – Samuel Rodgers May 23 '16 at 19:16
  • I'm surprised no one has thrown out the off-topic mention yet, since this question isn't about personal finance. That being said, given that there isn't a good business accounting SE site yet (there probably should be?), I'd personally vote to let this one stay despite it being off topic. – TTT May 24 '16 at 14:19
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My understanding is that to make the $18,000 elective deferral in this case, you need to pay yourself at least $18,000. There will be some tax on that for social security and Medicare, so you'll actually need to pay yourself a bit more to cover that too.

The employer contribution is limited to 25% of your total compensation. The $18,000 above counts, but if you want to max out on the employer side, you'll need to pay yourself $140,000 salary since 25% of $140,000 is the $35,000 that you want to put into the 401k from the employer side.

There are some examples from the IRS here that may help: https://www.irs.gov/retirement-plans/one-participant-401-k-plans I know that you're not a one-participant plan, but some of the examples may help anyway since they are not all specific to one-participant plans.

  • I keep finding conflicting info on the max contribution made by the employer. Your link indicates 25% of salary, but this link indicates up to 100% of salary (lesser of 100% or $53K). And I find blogs that indicate each is correct. Or, is it really just for super-high salaries that this comes into play? Thoughts? irs.gov/retirement-plans/… – BobbyScon May 23 '16 at 20:08
  • Do you have a source for the employer contribution being limited to 25% of the employees total compensation? I can't find that anywhere – Bishop May 23 '16 at 20:23
  • @Bishop - Check the link in Brick's answer, under "Employer nonelective contributions". – BobbyScon May 23 '16 at 20:42
  • The 25% is in the link in the answer, but I have to admit that I'm confused with the apparently different limits shown in the answer by @BobbyScon and link therein. If someone puts up a believable answer that reconciles both, I'll probably delete my answer completely. – user32479 May 23 '16 at 20:45
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    @Brick - I believe it's based on business type. Your link seems to refer to One-Participant plans (covering a business owner with no employees), whereas my link seems to be Multi-Participant plans. I'm not familiar enough with setting up a 401K plan to know if a 3-person C-Corp qualifies for the Multi-Participant plan scenario. – BobbyScon May 23 '16 at 20:49
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According to the 401K information from the IRS' website, it seems that you could seemingly get away with a salary as low as $53,000. It's tough, and I'd suggest speaking with an Accounting professional to get the clear answers, because as Brick's answer suggests, the IRS isn't super clear about it.

An excerpt from a separate page regarding 401K contributions:

The annual additions paid to a participant’s account cannot exceed the lesser of:

  1. 100% of the participant's compensation, or
  2. $53,000 ($59,000 including catch-up contributions) for 2015 and 2016.

There are separate, smaller limits for SIMPLE 401(k) plans.

Example 1: Greg, 46, is employed by an employer with a 401(k) plan and he also works as an independent contractor for an unrelated business. Greg sets up a solo 401(k) plan for his independent contracting business. Greg contributes the maximum amount to his employer’s 401(k) plan for 2015, $18,000. Greg would also like to contribute the maximum amount to his solo 401(k) plan. He is not able to make further elective deferrals to his solo 401(k) plan because he has already contributed his personal maximum, $18,000. He has enough earned income from his business to contribute the overall maximum for the year, $53,000. Greg can make a nonelective contribution of $53,000 to his solo 401(k) plan. This limit is not reduced by the elective deferrals under his employer’s plan because the limit on annual additions applies to each plan separately.

https://www.irs.gov/retirement-plans/plan-participant-employee/retirement-topics-401k-and-profit-sharing-plan-contribution-limits

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I would hire an accountant to help set this up, given the sums of money involved.

$53,000 would be the minimum amount of compensation needed to maximize the 401k. The total limit of contributions is the lesser of:

100% of the participant's compensation, or

$53,000 ($59,000 including catch-up contributions) for 2015 and 2016.

and they don't count contributions as compensation

Your employer's contributions to a qualified retirement plan for you are not included in income at the time contributed. (Your employer can tell you whether your retirement plan is qualified.)

On the bright side, employer contributions aren't subject to FICA withholdings.

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