Sep IRA vs. Solo 401k

[ShahMD]

Hey everyone, hoping for a little advice.

 

For 2016, I plan on making 300k for W2 employment and 40k for Independent contractor (unrelated employer).

Now, I'm trying to tax shelter as much of that $40k as possible. At my W2, I already max out my 401k employee contribution.

Questions:

1) So If I use a SEP IRA, would I be able to put all of that $40k into a tax sheltered account??? In the process, I understand I lose the ability to do Roth IRA.

2) If I did the solo 401k instead of a SEP IRA, how much would I be able to contribute? I understand that I have already given my maxed out emploYEE contribution at my W2 job. How much would I be able to give to my Solo401k as an employer??

3) Given this scenario, would SEP IRA > Solo 401k? I also have a Roth Option available at work if that makes the scenario any different.

 

Thank you all so much for your help.

 

[Zaphod]

You cant do a front door roth anyway, but you can back door still, doesnt matter. If you have a sep and it has money you will have pro rata issues with a backdoor, so most people who do this set up an individual 401k. You can have as many 401ks as you have jobs. You can only do one employee contribution, however. Not so for the employer. You wouldnt be able to put that full 40k in, but probably 18 or so. Check out IRS.gov and some other sites and you can find the info Strangely so few people know about this most of the stuff you'll come across will not pertain and will be frankly wrong.

[ShahMD]

Can you explain how you got to the $18k amount stashed out of $40k?
I assume that would be all employer contribution ?

[jfoxcpacfp]

ShahMD wrote:

Hey everyone, hoping for a little advice.

 

For 2016, I plan on making 300k for W2 employment and 40k for Independent contractor (unrelated employer).

Now, I’m trying to tax shelter as much of that $40k as possible. At my W2, I already max out my 401k employee contribution.

Questions:

1) So If I use a SEP IRA, would I be able to put all of that $40k into a tax sheltered account??? In the process, I understand I lose the ability to do Roth IRA.

2) If I did the solo 401k instead of a SEP IRA, how much would I be able to contribute? I understand that I have already given my maxed out emploYEE contribution at my W2 job. How much would I be able to give to my Solo401k as an employer??

3) Given this scenario, would SEP IRA > Solo 401k? I also have a Roth Option available at work if that makes the scenario any different.

 

Thank you all so much for your help.

 

Click to expand...

With either the solo-k or a SEP you will be able to contribute 25% (after Medicare adjustment) to your plan, or a little less than $10k if you have no other business expenses deducted from your income. This would all be employer nonelective contributions. With the solo-k, you would retain the ability to do tax-free back-door Roth IRA contributions.

The only reason I would recommend the SEP is if you also have 1099 income from 2015 that you need to shelter. The deadline for setting up a 401k is 12/31 of the tax year to which it applies. The deadline for setting up and funding a SEP is 10/15 of the year following the year for which it applies, which would give you just under 8 more months.

[Zaphod]

ShahMD wrote:

Can you explain how you got to the $18k amount stashed out of $40k?
I assume that would be all employer contribution ?

Click to expand...

https://www.irs.gov/Retirement-Plans/One-Participant-401%28k%29-Plans

It says you can defer up to 100% of compensation on a i401k up to contribution limits of 18k this year. I'd read more about it on their sites, run the worksheets to make sure, etc...It doesnt have to be all employer but if you've maxed out a 401k contribution through yours already than yes. If you run this set up it would be good to get very familiar with it and get the best mix of contributions. WCI had a post on this so thats a good place to start. If it was the employer contribution it might be a lot less so definitely see the way that works best for you.

[litovskyassetmanagement]

ShahMD wrote:

Hey everyone, hoping for a little advice.

 

For 2016, I plan on making 300k for W2 employment and 40k for Independent contractor (unrelated employer).

Now, I’m trying to tax shelter as much of that $40k as possible. At my W2, I already max out my 401k employee contribution.

Questions:

1) So If I use a SEP IRA, would I be able to put all of that $40k into a tax sheltered account??? In the process, I understand I lose the ability to do Roth IRA.

2) If I did the solo 401k instead of a SEP IRA, how much would I be able to contribute? I understand that I have already given my maxed out emploYEE contribution at my W2 job. How much would I be able to give to my Solo401k as an employer??

3) Given this scenario, would SEP IRA > Solo 401k? I also have a Roth Option available at work if that makes the scenario any different.

 

Thank you all so much for your help.

 

Click to expand...

There are other considerations as well.  For example, if your retirement plan at work has bad/low quality investment choices, you might want to contribute just enough to get the match (if any), and instead put the rest of the $18k salary deferral into your own solo 401k plan (so that's one reason I like the solo 401k over SEP).

You can do the SEP for 2015 (since you are too late in doing the solo 401k), and start with a solo 401k for 2016.  The SEP can be rolled over into your solo 401k, and this will allow you to also do 'backdoor' Roth IRA contributions.  That's another reason why I don't like using the SEP for more than one year.

[eyeballboy]

I don't want to hijack the discussion, but I have a similar question.  I am looking to break off a component of the business side of my practice that generates about $20,000/year.  I would like to put my wife in charge of it since I have already maxed out my 401k, profit share, and DBP. I would like to defer as much of the taxes as possible through tax deferred savings (i-401k, SEP IRA, profit share, etc). Can I set it up in a way that she can contribute the maximum to her 401k and other tax deferred savings plans that will bring the taxes down to 0, if not, how low can we go?  Would we still need to pay the employer-side of payroll taxes on 401k, profit share contributions?

Thanks!

[childay]

eyeballboy,

Sounds like a "controlled group" since it is your spouse but I am not sure

https://www.whitecoatinvestor.com/multiple-401k-rules/

https://www.irs.gov/pub/irs-tege/2013cpe_related_employers.pdf

 

 

[litovskyassetmanagement]

eyeballboy wrote:

I don’t want to hijack the discussion, but I have a similar question.  I am looking to break off a component of the business side of my practice that generates about $20,000/year.  I would like to put my wife in charge of it since I have already maxed out my 401k, profit share, and DBP. I would like to defer as much of the taxes as possible through tax deferred savings (i-401k, SEP IRA, profit share, etc). Can I set it up in a way that she can contribute the maximum to her 401k and other tax deferred savings plans that will bring the taxes down to 0, if not, how low can we go?  Would we still need to pay the employer-side of payroll taxes on 401k, profit share contributions?

Thanks!

Click to expand...

Does your business have any non-spouse employees in it?  Or would you simply be adding her to the practice payroll?  If no other employees, then certainly you can add your spouse to the payroll and contribute on their behalf into your solo 401k and/or a DB plan (making sure that their salary is reasonable).  If there are other non-spouse employees, then no, you can not do this.  However, you can still add her to the payroll and make contributions on her behalf, just not into a separate plan.

[eyeballboy]

Thanks Childay.  That's good to know, didn't know about that.  I'll have to look into it more.  Would it make any difference that the main corporation already gives full benefits for all employees including 401k, safe harbor, profit share, and a cash balance plan?  I can't really make her an employee of the established corporation since I am 1 of a handfulll of physician owners, however, the profits that I want to split off are related soley to what I do so I could split them off without it affecting the other partners financially.  It has to do with providing medications for my clinic.  Any additional thoughts with this additional information?

[litovskyassetmanagement]

eyeballboy wrote:

Thanks Childay.  That’s good to know, didn’t know about that.  I’ll have to look into it more.  Would it make any difference that the main corporation already gives full benefits for all employees including 401k, safe harbor, profit share, and a cash balance plan?  I can’t really make her an employee of the established corporation since I am 1 of a handfulll of physician owners, however, the profits that I want to split off are related soley to what I do so I could split them off without it affecting the other partners financially.  It has to do with providing medications for my clinic.  Any additional thoughts with this additional information?

Click to expand...

There is no reason why you can't employ your spouse if you are a part-owner of the company, unless other physicians object.  Sometimes each physician is paid out through their own S-corp internally, so in that case you can add a spouse to that entity, or just add her to the payroll.

Correction: I wasn't careful and said that paying your spouse for doing work for the practice constituted a controlled group.  In fact, this is more likely an affiliated group situation.

[eyeballboy]

Good to know, I like to spend my vacation in other parts of the world other than jail!  :-)

[jfoxcpacfp]

eyeballboy wrote:

I don’t want to hijack the discussion, but I have a similar question.  I am looking to break off a component of the business side of my practice that generates about $20,000/year.  I would like to put my wife in charge of it since I have already maxed out my 401k, profit share, and DBP. I would like to defer as much of the taxes as possible through tax deferred savings (i-401k, SEP IRA, profit share, etc). Can I set it up in a way that she can contribute the maximum to her 401k and other tax deferred savings plans that will bring the taxes down to 0, if not, how low can we go?  Would we still need to pay the employer-side of payroll taxes on 401k, profit share contributions?

Thanks!

Click to expand...

eyeballboy - Controlled group rules are not applicable. Each spouse can max out 401k accounts. The $20k would be swallowed by her 401k contribution and other minor business expenses, such as HO. Yes, you would have to pay her a salary and withhold/match FICA if she has no other earned income, which is kind of a tough pill to swallow. Basis would come into play here and your choice of entity might make a difference. This might be a situation you'd want to consult with a professional. Lot of "might's", I realize :-)

[eyeballboy]

Thanks Johanna, great to get your input.  It sounds like I'll have to get more in depth with it.

[litovskyassetmanagement]

jfoxcpacfp wrote:

eyeballboy wrote:

I don’t want to hijack the discussion, but I have a similar question.  I am looking to break off a component of the business side of my practice that generates about $20,000/year.  I would like to put my wife in charge of it since I have already maxed out my 401k, profit share, and DBP. I would like to defer as much of the taxes as possible through tax deferred savings (i-401k, SEP IRA, profit share, etc). Can I set it up in a way that she can contribute the maximum to her 401k and other tax deferred savings plans that will bring the taxes down to 0, if not, how low can we go?  Would we still need to pay the employer-side of payroll taxes on 401k, profit share contributions?

Thanks!

Click to expand…

eyeballboy – Controlled group rules are not applicable. Each spouse can max out 401k accounts. The $20k would be swallowed by her 401k contribution and other minor business expenses, such as HO. Yes, you would have to pay her a salary and withhold/match FICA if she has no other earned income, which is kind of a tough pill to swallow. Basis would come into play here and your choice of entity might make a difference. This might be a situation you’d want to consult with a professional. Lot of “might’s”, I realize

Click to expand...

Correction: this is an affiliated group, not a controlled group, but the rules are the same (both plans - your wife's and the practice one would have to be tested together).  I would need to consult an ERISA attorney just to make sure because details matter (and I'm not sure whether it would be possible to set up the arrangement to avoid the ASG rules).  The problem is the following.  Your wife can't be a 1099 contractor - she has to be an employee.  To be an employee, you'd have to create some sort of entity that employs her.  That entity then would provide service to the practice. So this is most likely an affiliated service group. If the wife has a plan, it has to be tested together with the practice plan (or else that would violate the IRS rules). It would be much easier, and less expensive to add her to the practice payroll instead.

So the set-up would be like this:

1) You set up an entity (LLC or sole proprietorship), and add your wife to the payroll.  The question is, how should this be structured?  Your wife can be the owner of the entity or you can be - in both cases she is the employee of this entity.

2) The money comes from the practice - so the practice pays the entity, which then pays your wife a W2.

The employer is still the practice, but the question is whether this arrangement creates an affiliated service group, and this is where getting an ERISA attorney's opinion is key.  I will see if I can get an answer for this, as it turns out I had exactly the same question in my notes that did not have an answer yet.