Maxing out 403(b) and SEP IRA/Individual 401(k)

[donquixote]

I maxed out my 403(b) as an employee at my regular job to the contribution limit for the year with $18,000.00; I am projected to receive by the end of the year an employer contribution of $10,000 to my 403(b) which is not vested till 2 years. I am projected to make self employed locums work "net" income of greater than $250,000.00 for this year; I have not incorporated as a LLC or S-Corp and did business as sole proprietorship. My employer has no control over my self employment business. I am confused because I have a 403(b) and not 401(k) and rules seam to differ between the two.

a) Which is better for me to open, a SEP IRA or a Individual 401(k).  b) Can I max out the SEP/Individual 401(k) to the full $53,000 as an employer contribution or do I have to subtract my annual personal contribution to the 403(b) from the $53000. (c) do I also have to subtract my non-vested employer match of the 403(b) from the $53000 yearly limit.

[jfoxcpacfp]

donquixote wrote:

a) Which is better for me to open, a SEP IRA or a Individual 401(k).  b) Can I max out the SEP/Individual 401(k) to the full $53,000 as an employer contribution or do I have to subtract my annual personal contribution to the 403(b) from the $53000. (c) do I also have to subtract my non-vested employer match of the 403(b) from the $53000 yearly limit.

Click to expand...

You should open a SOLO 401k. The reason is that you will still be eligible to contribute, tax free, to a back-door Roth IRA and you will not with a SEP.

You can contribute $53k to this but at a percentage only. iow, you do not get to contribute $18k off the top b/c that is available once across all plans. You can contribute 20% of net profits of your business to your SOLO-k, however.

Let's assume you stay at $250k. If you are netting $250k, that gives you another $50k to contribute to your SOLOk ($250k * 20%). However, you will surely have some deductions to lower the $250k so your contribution will be a bit lower. Please work with your CPA or fee-only CFP on this.

[donquixote]

Thank you for your response. I called Vanguard and they discouraged me from opening individual 401k as it involves more paperwork and that I still would not be able to contribute to a backdoor Roth as I will be using up my yearly $53000. That did not make sense to me from the advise I got everywhere.

Anyway my tax plan for this year is as follows and I hope I am not making a mistake.

1) Employer 403(b): My employee contribution : $18,000

2) Employer 457: My deferred compensation: $18,000

3) Sep IRA or SOLO 401(K): Income from my locums: $53,000 - $18000 - Employer match into the 403(b). [20% of my net self employed income after all deductions and expenses will be way above this value. Unfortunately I have 403(b) from my employer. Otherwise I would have maxed out here as well if it was a 401(k) plan].

4) Maximum tax deductible contribution into the state 529 plan

Two points I still have to figure out:

1) Is SOLO 401(k) worth the increased paperwork to do a backdoor Roth IRA at this point.

2) I do not think I will have this much self employed income next year if at all. If I have very little self employed income next year is doing all the work for the SOLO 401(K) worth it?

Any comments are appreciated.

Thank you.

[jfoxcpacfp]

1. Vanguard gave you wrong advice. You will still be able to do backdoor Roth even if you fill up your $53k.


2. Your contribution from your IC profits can go up to $53k without regard to your "day job" contributions. As I said above, it is calculated solely on a % basis, though. So you only get one $18k employee contribution across all plans.


3. Not sure what you mean having a 403b "unfortunately".


4. There is not that much more paperwork for a SOLO-k plan. It is a prototype from your custodian. Unlike many others, I would not use Vanguard.


5. The SOLO-k is worth it, as opposed to SEP. b/c you will remain eligible to contribute, tax free, to a back-door Roth IRA.

[DMFA]

You can contribute employee elective deferrals up to $18,000 to ALL 403b and 401k.

On top of that, EACH employer can add employer contributions up to get each 401k up to $53,000 (noting the 20% of net profit limit).  This, again, is per employer - your 401k "employer" contributions are not limited by either your elective deferrals or other employer contributions.

[EDIT: if you have a 403b, 403b rules max the total compensation to $53,000 from all qualified plans (incl. 401k) as per section 415(c).  This was my mistake from earlier]

Keeping that $5,500 in Roth every year as enabled by the Backdoor Roth (and therefore having no SEP-IRA) is very valuable.  Some investments do far better in Roth holdings (funds with high turnover and dividends, such as bonds) and is the only way to get tax-advantaged IRA contributions in your situation (non-deductible TIRAs are inferior).

Are you doing an HSA as well?  Deductible on contribution, grow tax-free, and even if not withdrawn tax-free for healthcare are simply taxed as income if you're 65 or older.

[donquixote]

Thank you DMFA for your response.

1) Apparently 401(k) and 403(b) are not the same for the "employer" contributions. 401(k) is considered to be controlled by the employer while 403(b) is considered to be controlled by the employee. So that is why I used "unfortunately" in my message above. My employer gives only 403(b) with match. As 403(b) is considered to be controlled by me I cannot contribute an additional $53000 for my own solo 401(k). I have to contribute $53000 - $18000 - My employer match. Frustrating that there is a difference between the two.  This confusion is what lead me to sign up and post the present thread. I am including my research so far.

A) Look at "Rule #7" in the post below.

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

B) Participation in a qualified plan: https://www.irs.gov/pub/irs-pdf/p571.pdf

Page 18: Maximum Amount Contributable (MAC)

"If you participate in a 403(b) plan and a qualified plan, you must combine contributions made to your 403(b) account with contributions to a qualified plan and simplified employee pension plans of all corporations, partnerships, and sole proprietorships in which you have more than 50% control. You must also combine the contributions made to all 403(b) accounts on your behalf by your employer."

I feel its kind of Catch22. If I contribute the total $53000 to my solo 401(k) then I cannot contribute anything to the 403(b). I had to contribute and max my 403(b) as I had no idea how much my self employment income will be and also I did not want to miss the match of the employer.  But now since I maxed out my 403(b) to keep it within maximum limits, I have to contribute less to my solo 401(k).

2) On jfoxcpacfp advise, I have decided to go ahead and open a solo 401(k). The issue I am faced with now is that due to bad advise from my previous adviser I opened a SEP-IRA earlier in the year. However thankfully I did not put in any contributions into it as I was not sure that was the right strategy. I am now figuring out how I can get rid of the SEP which has zero balance and which was never contributed into and starting a solo 401(k). Vangaurd has not been of much help. Once i figure this out I am planning on going ahead with the backdoor Roth.

3) I do not qualify for a HSA as I have health insurance which is not a high deductible insurance. I however elected to contribute to a FSA in the beginning of the year. I am planning on using all of it in view of the inability to roll over the amount into next year.

I would greatly appreciate if you have any input over the rules for getting rid of the SEP and starting solo 401(K).

[spiritrider]

Actually, donquixote is correct in his most recent post. The other responses are incorrect. He can not contribute $50K to his own SEP IRA or Solo 401k.

While it is true that (401k, 403b, SARSEP, and SIMPLE IRA (with its own lower limit)) plans share the same $18K 402g elective deferral limit.

It is also true that the $53K 415c annual addition limit is per unrelated employer. However, a 403b plan is considered owned by the participant. Therefore, 403b contributions are considered contributions to a related employer and must be included in the same annual addition limit.

457 plans have their own elective deferral limit and annual addition limit.

So, the SEP IRA/Solo 401k employer contribution is limited to $53K - $18K - $10K = $25K.

They are correct that a Solo 401k is probably the better way to go. Alternatively, if the 403b is an excellent plan with very low expense ratio index funds (very few are) and allows incoming rollovers from a SEP IRA, you could make the contributions to the SEP IRA and then rollover the contributions and earnings to the 403b. This would still allow backdoor Roth contributions.

I really don't know why Vanguard is describing the paper work for their i401k as difficult.

1) Yes, you can open a SEP IRA online and it can be opened and funded anytime up to your filing deadline (including extensions). A one-participant 401k (i401k, solo 401k, etc... depending on provider's name) does require a little more paperwork

There is a few page 401k adoption agreement with a small number of choices. Then you have to fill out an account application. The plan adoption, account opening and deferral election must be accomplished by 12/31. Like a SEP IRA, you have until your tax filing deadline (including extensions) to make your contributions.

 

There is one other possible requirement. Once the plan balance >= $250K, you must file an annual Form 5500-EZ. I doesn't sound like this will happen anytime soon.

2) As has been already pointed out, the 401k allows you to make backdoor Roth contributions. As counter-intuitive as it is, the 401k is actually, more advantageous if you aren't going to reach the $250k limit.

One additional consideration for Vanguard. For some bizarre reason, they do not allow you to purchase Admiral shares in their i401k, but you can in a SEP IRA. Fidelity does allow you to purchase their Premium shares in their solo 401k which have expense ratios <= Vanguard Admiral shares.

 

[spiritrider]

It would be much more involved if you had employees. Luckily, a SEP IRA plan is only considered an active plan for the year when you make employer contributions to it. The IRS suggests you notify the provider that you want to terminate the plan. However, there is no reporting requirement by either you or the provider. Some providers do nothing with this information other than the CSR saying "gee thanks". Don't be surprised if the account doesn't disappear util years of non-use.

SEP Plan FAQs - Terminating a SEP plan

[donquixote]

Thank you spiritrider for your valuable input.

1) I think from your input and my own research, I will stick with around $25,000 as my contribution to my solo 401(k). I do not want to over-contribute and run into headaches later.

2) I will go ahead and try to open a solo 401(k) with someone other than Vangaurd. I will keep the SEP IRA I opened before for now without making any contributions. If I am able to set up my solo 401(k) by 12/31, I will terminate the SEP and contribute to my solo 401(k).

3) If for some reason I fail to setup the 401(k) by the deadline time, I will contribute to the SEP this year. I will forego the backdoor Roth for this year. I will rollover the funds into the solo 401(k) next year, so that I am free to accomplish the backdoor Roth next year.

If there is a mistake in the above strategy please let me know.

[DMFA]

Stupid 415(c) $53k limit.  I forget that every ************************ time about 403(b).  That always screws me.

[jfoxcpacfp]

spiritrider wrote:

Actually, donquixote is correct in his most recent post. The other responses are incorrect. He can not contribute $50K to his own SEP IRA or Solo 401k.

Click to expand...

I totally bombed on that answer - thank you for pointing it out, spiritrider.

[spiritrider]

It sounds like you have a good flexible strategy. I would make a final point that is very important in your case. It is very, Very, VERY important that you do not make an excess solo 401k employer contribution for 2016 before the end of the year.

Most people are aware that while it causes tax return complications, it is relatively easy to remove an excessive contribution to either a traditional or Roth IRA. This is also true of an employer contributions to a SEP IRA. Also, people with two employers in one year may have had to remove an excess deferral and some HCE employees might have been blindsided with excess contribution distributions due to their employer's testing failures. The key point of all of these is, that you can do it.

However, under most circumstances it is not possible to remove an excess employer contribution to a 401k. I does not matter that it is a solo 401k, it is still a 401k. I won't get into the remedy, because it is never going to happen, right!

I usually recommend that people never contribute more than 80% of their calculated employer contributions as they go along as a safety margin. If you noticed above I said not before the end of the year. That is because contributions you make in 2017 for 2016 can be reallocated to 2017 before you file your return. Presto, no excess contribution.

For many people this is not a problem because they tend not to make any of their employer contribution until they have competed their tax return. I just wanted you to be aware of this, because I have never seen this mentioned in any of the information that solo 401k custodians provide to their customers and because of the 403b issues, you can see how this might be easy to miss.

The advantage of waiting is that you have the correct numbers to calculate the proper contribution. Also, if you are off by a small amount you can reallocate contributions to the current year.

 

[childay]

Great post spiritrider thanks

[donquixote]

Thank you spiritrider for suggesting what is a good business practice! I will wait till February/March to make my contribution.

Also the thing that baffles me with the different set of rules for 403(b) is that I am forced to include the employer contributions which are not vested yet into the maximum limit that I can contribute to the solo 401(k).

In the hypothetical scenario of me leaving the job before this amount is vested. Would it mean I lost the ability to contribute $10k to my solo 401(K) forever or can I retroactively amend my return and contribute an additional $10K?

[spiritrider]

Yes, there really are way too many complex rules when it comes to employer retirement plans.

I really don't know how unvested 403b employer contributions are treated. I  am inclined to think that they still count, because they are still contributions. Unvested contributions do not immediately go away after separation. You have certain rehire rights to resume vesting. Maybe someone else has a definitive answer.