retirement for an independent contractor

[mdfamily]

Hi, I am sure this has been discussed, but I am trying to narrow down the options.

 

I am an ER doc working as an independent contractor.

I don't know if this makes a difference but I am getting paid through my LLC and will make it an S corp soon.

I haven't saved for retirement yet this year (made other investments instead), but now is the time, and I need to set this up for the first time.

Until now, I had a 403b from one employer where I worked a few years, and a 401k from another where I worked for a few years.

 

My understanding is that there are basically three options:

 

1. solo 401k

2. SEP IRA

3. Simple IRA

4. IRA / Roth IRA

5. HSA

My understanding that solo 401k, SEP IRA and IRA/Roth IRA can be combined with an IRA/Roth IRA and an HSA (I have a backdoor IRA established last year).

 

My questions:

1. did I get all that right so far?

2. Which of the three options do you think is best for me? What is the maximum pre tax contribution I can make in each?

3. My wife helps me with my work (schedules shifts, books hotels, deals with pay stubs) - is there a benefit or a logic in having her employed in my S corporation, should I establish one? If so, can I put money in retirement for her as well?

 

Thank you!

[DMFA]

You cannot make SEP and individual 401(k) contributions for the same year. You can do SEP for 2017, individual 401(k) for 2018, and roll the SEP into the 401(k).

I'd recommend individual 401(k) ($54,000), backdoor Roth IRA ($5,500), and HSA ($6,750), assuming you have a high-deductible health plan and are otherwise eligible. You spouse can also have a backdoor Roth IRA even if she doesn't otherwise work. Many of us do employ our spouses, but it may not be worth it unless you want a higher pretax retirement contribution because it's more payroll taxes (12.5%) to pay since if it were paid to you, you'd already be over the SS tax exemption.

Let me switch gears on you for a moment: why do you feel like you need to file taxes as an S-corp? What benefit do you feel like it will give you over being a sole proprietor? It *may* be a good move for you, but it isn't for many, since you'll spend more in filing fees and would only save 2.9% (Medicare tax) on what you'd take as a distribution.

[mdfamily]

Thank you!
Why would you recommend a 401k and not sep or simple?
And why can't I make 401k in 2017?
How would I open each? Just open an account with one of those companies (t Rowe tiaa Ameritrade) and just transfer the maximum amount?

As for s Corp, I have been going back and forth so much.
It seems that I will save on taxes for anything above my salary, which I believe can be set to 127k if it's reasonable. I believe I would save 1-2% for anything above this salary amount (taking a distribution for any amount above this).
I am not clear if there are additional benefits? Such as deductions for travel and food?

Would love to hear your feedback on this

[mdfamily]

Also, could you elaborate regarding my wife and the higher pretax retirement? So there is no benefit in having her employed?
But I can still put money in retirement for her?


Also, what is the latest I can put money for 2017? I may not be able to catch up until December, would I be able to do that into 2018? Let's say maximize retirement for 2017 by February of 2018?


Thank you!

[spiritrider]

Not wanting to speak for DMFA, but it isn't clear when you started being an IC and whether you might have already maxed the employee deferral limit for this year. I thonk he was just giving you an example of a possibility.

I thought he was clear that a one-participant 401k is the best choice in your situation. It allows you the same exact employer contribution as a SEP IRA, but allows the addition of an employee deferral (2017 = $18K, 2018 = $18.5K). Thus the 401k allows you to reach the annual addition limit (2017 = $54K, 2018 = $55K) on much lower compensation. For an S-Corp shareholder-employee this would be 2017 = $144K and 2018 = $146K vs. a SEP IRA which would be 2017 = $216K and 2018 = $220K.

You can adopt a one-participant 401k for 2017, but you must adopt the plan and make an employee deferral election by 12/31. Just be sure you make the plan effective 1/1/2017 to be able to base the 401k contributions on all of the year's income.

An S-Corp would be problematic for this year. First, the normal deadline for electing to be treated as an S-Corp is 3/15. You can request a waiver for cause, but December is really pushing it. 401k employee deferrals must come from compensation not already received and must be for a pay date on or before 12/31. You will then have until the S-Corp's tax filing deadline (~ 3/15) including extensions (~9/15) to make the employer contributions.

On the other hand as a sole proprietorship, you have until your tax filing deadline (~4/15) including extensions (~10/15) to make both the employee deferrals and the employer contributions. Note you do not actually have to file late to take advantage of the late contributions. As long as you request the extension, you can file claiming the deduction for your full contribution and make the contributions anytime on or before the extended deadline.

So now you know that you have to have S-Corp W-2 wages of at least $144K/$146K for 2017/2018 in order to reach the $54K/$55K annual addition limits, you have to ask yourself if it is worth the extra hassle and cost of W-2 payroll, S-Corp Form 1120S tx filing, etc... to save 2.9% on the amount of distributions.

[mdfamily]

Thanks for the response spiritrider

 

If I understand correctly you are saying that with 401k and SEP IRA you can contribute the same amount pre tax, but at a lower compensation. What is that lower compensation?

and what about SIMPLE IRA?

If I am at that compensation level anyway, do 401k and SEP IRA become equivalent?

 

Regarding the S Corp, I understand it might not be possible this year due to deadline and the need for retirement

Would I be able to transfer the retirement I make as an individual into the S corp once it is established?

 

regarding saving on distributions, I am conservatively estimating 500k for next year, so 350k times 2.9% would be over 10k in savings... would you say it's worth it?

How do I open it? just enroll and transfer money from my account?

 

And how should I set it up for my wife?

 

Thank you

 

[spiritrider]

The maximum contribution for both a SEP IRA and a one-participant 401k for 2018 is $55K. Since the employer contribution for an S-Corp is 25% of the shareholder-employee's W-2 wages. With the 401k this requires W-2 wages of $146K. With a SEP IRA this requires W-2 wages of $220K.

Also, at your income you will not be eligible for a Roth IRA. You will want a one-participant 401k so you will have no pre-tax IRA assets. This will allow you to do a Backdoor Roth with little to no tax liability. A SIMPLE IRA is the worst possible choice for someone in your situation.

Yes, you can amend a one-participant 401k plan to add a new affiliated employer (both owned by you).

With $500K in net business profit an S-Corp is almost certainly your best choice, but you will not be saving 2.9%/3.8% on $350K. A 2:1 ratio of distributions to compensation is almost certainly unreasonably low compensation and is an invitation for an IRS audit.

The IRS has specific guidance on "reasonable compensation" for someone in your situation; "If most of the gross receipts and profits are associated with the shareholder's personal services, then most of the profit distribution should be allocated as compensation."

Unless the average W-2 compensation for an ER doc in your area is < $250K, that is probably the lowest salary you should pay yourself and have it be reasonable compensation. That would give you $500K - $250K compensation - $12K employer payroll taxes - $36.5k employer contributions = $201.5K distribution. This is a far more reasonable distribution:compensation ratio.

You should certainly consult with a tax professional in your area. This is just my opinion, but is based on actual IRS guidance and court cases. The two most important considerations for reasonable compensation are the ratio of distributions to compensation and comparable wages for someone in your profession with your knowledge, skills and experience in your area.

As a sole proprietor you have until your tax filing deadline including extensions to make the employee deferrals and employer contributions. The contributions can come from either personal or business accounts, but best practice is to pay the employer contributions out of business accounts.

With an S-Corp, the employee deferrals must come from compensation not already received and deducted from payroll. They must be deducted on or before 12/31, but you have until the S-Corp tax filing deadline including extensions for the employer contribution. Both the employee deferral and employer contribution must come from the S-Corp's accounts.

[mdfamily]

Thanks spiritrider for the excellent answers!

 

I have a roth IRA established last year, which was done as a backdoor, so my understanding is that I can now contribute 5500 per year (or whatever the guidelines say) to it (pre tax money which I can take out at retirement without paying taxes on it).

 

It sounds like if I am an S corp and want to maximize my pre tax retirement with a SEP I will have to earn 220k minimum - is that correct?

Whereas if I take the 401k route then I will have to ear 146k minimum - correct?

"Yes, you can amend a one-participant 401k plan to add a new affiliated employer" - what does "new affiliated employer" mean?

Do you see other advantages to being an S corp?

 

It seems that an individual 401k might be the best option for me.  I called Ameritrade and they told me I can still open a 401k this year.

 

Regarding my wife, what do you think I should do? open a 401k as well?

And what would you do with my old 403b and 401k that I have from previous employers when I was employed (until January 2017)?

 

Thank you!

[DMFA]

As it pertains to employing your spouse, everything you pay her up to the SS exemption ($127,000ish) you'd owe 15.3% in payroll taxes (6.2% SS, 1.45% Medicare, then doubled for both employer and employee portions). On the other hand, you could do a 401(k) for her as well based on that earning, of $18,500 (2018) for an employee salary deferral and 25% of her W-2 income for employer contribution.

So if your goal is putting more away in tax-deferred investments beyond your individual maxima, then employing your wife and doing a 401(k) for her would enable that; just keep in mind you still owe the 15.3% payroll taxes even if you don't owe income tax on the 401(k) contribution. If you're in the 39.6% bracket, you'll still save 24.3% on the tax bill; whether that's worth it for you to tax-defer and pay prob 25% in retirement, or whether you'd rather put it on taxable, is up to you.

[mdfamily]

Rex, were you referring to employing my spouse that it's not worth it?

[spiritrider]

mdfamily wrote:

I have a roth IRA established last year, which was done as a backdoor, so my understanding is that I can now contribute 5500 per year (or whatever the guidelines say) to it (pre tax money which I can take out at retirement without paying taxes on it). Roth IRA contributions are after-tax. You can take out contributions at anytime without tax liability. Earnings can only be distributed tax-free after age 59 1/2 or under one of the exceptions.

It sounds like if I am an S corp and want to maximize my pre tax retirement with a SEP I will have to earn 220k minimum – is that correct? Yes.

Whereas if I take the 401k route then I will have to ear 146k minimum – correct? Yes.

“Yes, you can amend a one-participant 401k plan to add a new affiliated employer” – what does “new affiliated employer” mean? Any business you have >= 80% ownership are considered the same for retirement plan purposes. You can add all businesses owned >= 80% by you to the same 401k plan. They are all subject to the same annual limit.

Do you see other advantages to being an S corp? An S-Corp has some degree of added creditor and liability protection. As I said, you should really consult with a small business lawyer in your specific state, so he can give you advice for your specific circumstances. IANAL and am only giving general advice. When you have $0.5M in income, you should not be cheaping out on professional services.

It seems that an individual 401k might be the best option for me.  I called Ameritrade and they told me I can still open a 401k this year. As I said, you have until 12/31 to adopt a one-participant 401k and make the employee deferral election. You will want to make it effective 1/1/2017.

Regarding my wife, what do you think I should do? open a 401k as well? DMFA gave you all the parameters to consider. It is entirely up to you whether you think it is worth it or not. Personally, I would do it, but I would try to get the biggest bang for the buck. If you are going to pay the 15.3% FICA and FUTA, it makes the most sense only when the annual additions are 100% of salary. This really only makes sense if she will not use her employee deferral limit elsewhere. If not, for 2018 this would be $23.125K, $18.5K employee deferral + $4.625K. Remember her employee deferrals must be deducted from her payroll, so it is not really practical for this year.

And what would you do with my old 403b and 401k that I have from previous employers when I was employed (until January 2017)? It depends what the investment options are. If they are excellent, then you should leave them where they are. Also, the 401k will have greater asset protection than a one-participant 401k.

Click to expand...

 

[litovskyassetmanagement]

mdfamily wrote:

Hi, I am sure this has been discussed, but I am trying to narrow down the options.

 

I am an ER doc working as an independent contractor.

I don’t know if this makes a difference but I am getting paid through my LLC and will make it an S corp soon.

I haven’t saved for retirement yet this year (made other investments instead), but now is the time, and I need to set this up for the first time.

Until now, I had a 403b from one employer where I worked a few years, and a 401k from another where I worked for a few years.

 

My understanding is that there are basically three options:

 

1. solo 401k

2. SEP IRA

3. Simple IRA

4. IRA / Roth IRA

5. HSA

My understanding that solo 401k, SEP IRA and IRA/Roth IRA can be combined with an IRA/Roth IRA and an HSA (I have a backdoor IRA established last year).

 

My questions:

1. did I get all that right so far?

2. Which of the three options do you think is best for me? What is the maximum pre tax contribution I can make in each?

3. My wife helps me with my work (schedules shifts, books hotels, deals with pay stubs) – is there a benefit or a logic in having her employed in my S corporation, should I establish one? If so, can I put money in retirement for her as well?

 

Thank you!

Click to expand...

As others have said, the timing and contribution coordination matters for 2017, and individual 401k plan (ideally with a custom plan document) can be set up this year (even if not fully funded this year).  Several other things to add:

1) You can set up an LLC and have it taxed as S corp (vs. just an S corp), but it is not required.  This can be advantageous in some states (depending on your net income of course), but in places like NY (where you are accessed an extra tax on S corps) it might not be.  You should be working with a good CPA at this point given the complexity of your situation - having an entity and a spouse employee is reason enough to hire a CPA to file your taxes as well as to provide tax planning advice, because your situation may change year to year, so getting good advice can be valuable.

2) Another plan that can be added to a 401k down the line (when you are at least 35, but ideally closer to 40) is a Cash Balance plan. You can significantly increase your contributions by using this type of plan, however, you need to make sure that your source of income is stable  (for at least 3-4 years) and that you have the cash flow to make higher contributions. Ideally this type of plan is opened 10 years or so prior to retirement, but you can also do this earlier, especially if your goal is to potentially join a group practice down the line (in which case you can have another CB plan with that group), or if you simply are not sure how long your high earning years will last.  For this type of plan you definitely will need to have a custom plan document, and you'll need to hire a TPA, but it is more than worth it given that you can contribute $136k or so at age 40 into both plans).

[mdfamily]

Kon, thank you very much.

Today was actually the first time I ever heard about a cash balance plan from a colleague I am working with, and this will require even further researching.

BTW, my tax situation is further complicated by the fact that I work in about 6 different states (although hopefully there will be much more consistent work in Texas next year).

I don't think I will join a group practice.

I do operate under an LLC, and recently I transferred it from New York to Wyoming

 

We are definitely in need of a good CPA. I have not had much luck over the past few years, literally changing them every year. Some were not communicative or accessible, some were just late filing the documents (although all paperwork was given to them by the deadline they requested), some not familiar with doctors although having lots of good will, and some taking a very "sterile" approach to handling my finances without taking any reasonable risk.

[litovskyassetmanagement]

mdfamily wrote:

Kon, thank you very much.

Today was actually the first time I ever heard about a cash balance plan from a colleague I am working with, and this will require even further researching.

BTW, my tax situation is further complicated by the fact that I work in about 6 different states (although hopefully there will be much more consistent work in Texas next year).

I don’t think I will join a group practice.

I do operate under an LLC, and recently I transferred it from New York to Wyoming

 

We are definitely in need of a good CPA. I have not had much luck over the past few years, literally changing them every year. Some were not communicative or accessible, some were just late filing the documents (although all paperwork was given to them by the deadline they requested), some not familiar with doctors although having lots of good will, and some taking a very “sterile” approach to handling my finances without taking any reasonable risk.

Click to expand...

What you describe is very familiar to me in terms of CPAs.  I work with many CPAs, including several high end dental CPAs, and they definitely provide very good service, but they also charge more for it.  So at the end of the day you get what you pay for with professional services.  It is difficult to find a transaction-based CPA who will do everything for you cheaply and who will also provide you with pro-active advice.  I find that medical/dental CPAs are usually a notch above everyone else with respect to providing ongoing services as well as being more proactive about tax planning.  Also, not too many CPAs have good familiarity with retirement plans, unfortunately, so you will need to do your research as well.

I've written several presentations on CB plans for QuantiaMD, which might be a good starting point:

http://quantiamd.com/player/ygvmhdmbm?cid=1467

http://quantiamd.com/player/yewvnfqav?cid=1467

 

 

[litovskyassetmanagement]

Rex wrote:

Yes the hiring of spouse just for tax deferral isn’t necessarily a no brained.

It is unlikely that you should pursue a defined benefit plan at this time. They are expensive to open, operate, and close. As you get older they become “more worth it”.

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Yes, definitely.  That's what I think too, but many younger docs (~40) don't want to wait until they are 50 to start one, for some reason.  They all want to do it now because they are not sure how long their high earning years would last.  Also, some docs might end up doing things in reverse.  This is also doctors vs. dentists thing.  Dentists start up with huge debts when they are young, and then kids grow up and need college money, so they don't get to do these plans until they are in their 50s.  Doctors on the other hand (esp. the ones who read WCI) might end up with no debt by the time they are 40 (yet the kids will still need college money later), so they might simply reverse the order  of things and get their CB plan filled up, and then spend on kids in their 50s.  Also, it appears that even though you can fill up a plan from 40-50, when you are in your 60s, it might be possible to 'top it off' over several years, and especially if you are maxing it out the costs are worth it given the tax deduction for someone in the highest brackets.