Yes, You Can Still Start a 401(k) For 2020

2020 was an odd year for everyone, to say the least. For many business owners the pandemic we’re all still enduring caused much greater stress. Dealing with intermittent shut downs, working from home, and navigating the litany of stimulus legislation was simply a lot to navigate. From a financial perspective it’s also forced many businesses to extend their tax returns.

As you may know, the tax filing deadline for corporations and partnerships is typically March 15th, and April 15th for sole proprietors and LLCs filing through their personal returns. Filing for an extension lets you delay these submissions until September 15th or October 15th, respectively.

New Retirement Plan Deadline

If you’re one of the many business owners that did file for an extension in 2020, there’s a new opportunity you should be aware of related to qualified retirement plans. Historically, newly created retirement plans like 401(k)s, cash balance, and defined benefit plans had to be in place by the end of the calendar year. Which typically meant that you’d meet with a plan administrator, figure out the details, and begin the process by mid-September.

Thanks to the SECURE Act of 2019, you may now establish a qualified retirement plan up until the deadline of your tax returns - including extensions. This means that corporations and partnerships that extended their returns are able to establish new plans for tax year 2020 up until September 15th of 2021. Sole proprietors and LLCs who did so have until October 15th, 2021.

The new deadline will come in handy for thousands of businesses across the country this year. Particularly those with extra cash lying around they’d like to defer from taxation. It’ll help going forward too, as this isn’t just a one year extension.

The prior deadline of 12/31 required some forethought and tax planning to decide when & how to create a plan. You had to begin the process and make design decisions before knowing your year end numbers. With the updated timeline, businesses can now close the books on the prior year and make a more informed decision.

All Qualified Plans Welcome

The opportunity isn’t limited to 401k plans, either. All retirement plans “qualified” by the IRS under section 401(a) do, including:

• Cash balance plans

• Defined benefit pension plans

• 401(a) plans

• 403(b) plans

Businesses out there with preexisting 401k plans should take notice here. Cash balance plans, for example, can be an excellent supplement to a 401k given the right circumstances. If your business has some extra cash & you extended its return for the year, making a deductible 2020 contribution is a unique opportunity.

Beware Contribution Rules

As always, annual contribution limits apply. This is especially relevant with defined contribution plans like 401(k)s and 403(b)s. Whereas employer contributions can be made up until the due date of your business’s tax return (again, plus extensions), employee salary deferrals must be made by the end of the calendar year.

For example, if you decided to establish a 401(k) plan with a 5% match for 2020, you could still do so. (Provided you’ve already filed an extension). Any contributions made by the business to employee accounts - yours or any others - would be deductible. But since salary deferrals can no longer be made for 2020, your contributions as an employee would be $0. And even if the company matches 100% of salary deferrals up to 5% of compensation, 100% of $0 is still $0.

There are workarounds here. The plan could be designed to include a profit sharing component, where the business makes discretionary contributions on an annual basis outside of salary deferrals. The best design will depend on your company’s circumstances. But don’t expect to make salary deferrals for tax year 2020 - they’d all be for 2021 and beyond.

Is A 401(k) Plan Worth It?

Before running out and sneaking a new plan in under the deadline, make sure you understand the ramifications of creating one. There annual compliance requirements, and potentially minimum contributions required each year. Every business is different, and yours may need unique features or set up. Or even a different type of qualified plan entirely. But for many around the country, 401k plans are an excellent means to save money on taxes, attract talented employees, and retain those you already have.