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Solo 401k vs. Sep IRA

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  • Avatar coug16 
    Participant
    Status: Resident
    Posts: 37
    Joined: 01/17/2016

    I’m in my 4th year of residency and fortunate to have many moonlighting opportunities available that have allowed me to max our 403b, 457, and Roth IRA x2. We have been aggressive savers and trying to put everything possible into retirement while we’re so early in our career and in a lower tax bracket. My wife does some freelancing and receives 20-40k annually1099 money from 3-5 companies. We’ve met a lot of our savings goals this year and ready for the next one. We have two kids and will have another baby in the near future. She has told me she wants to scale back with each baby that we’ve had but she can’t help herself and just keeps grinding. I’d like to take advantage of this while we can and haven’t really been in a position to previously. My tentative plan is to create a sep IRA for her and max it out with however much we can and then at the end of residency concert all our pretax account (457, 401a, and now sep IRA) to Roth while we’re in the low tax bracket.

    Solo 401k would probably be better but seems like more hassle to setup if we’re only going to use it for a year or two. I think once I’m an attending my wife will finally quit working but I don’t know for sure. If she’s was to keep working solo 401k would be the way to go so I don’t run into pro Rata rule with sep IRa each year. So I have to figure that out.

    Any problems with this general plan? Any recommendations or advice?

    #236361 Reply
    Avatar Steven Podnos MD CFP 
    Participant
    Status: Physician, Financial Advisor
    Posts: 168
    Joined: 09/21/2017

    Assuming your wife does not do salary deferral in another plan, she could put much more of her freelancing income in a solo 401k.  For example, if she makes 25K in net income, she could contribute 19K in salary deferral plus 20% of the remaining 6K (less 1/2 SE taxes on the income).  In contrast, the SEP would allow only 20% of 25K net income (less 1/2 SE taxes).

    #236367 Reply
    Liked by spiritrider
    Faithful Steward Faithful Steward 
    Participant
    Status: Financial Advisor, Small Business Owner
    Posts: 511
    Joined: 06/12/2017

    In addition, the Solo 401(k) would not cause pro-rata rule issues with any potential Backdoor Roth strategy.

    Michael Peterson, CFP® | Faithful Steward Wealth Advisors
    https://ProsperousPhysician.com | (717) 496-0900

    #236419 Reply
    Liked by spiritrider
    Avatar spiritrider 
    Participant
    Status: Small Business Owner
    Posts: 1903
    Joined: 02/01/2016

    Solo 401k would probably be better but seems like more hassle to setup if we’re only going to use it for a year or two.

    Click to expand…

    I don’t know where this idea comes from or my understanding of hassle is way different than most people.

    Yes, you have to complete a paper adoption agreement and maybe mail in contributions, but a “hassle” it is not.

    #236505 Reply
    Avatar coug16 
    Participant
    Status: Resident
    Posts: 37
    Joined: 01/17/2016

    I guess hassle isn’t the right word but it seems more complicated to set up and I’m worried that I’ll mess something up. The sep IRA seems pretty straight forward. I guess I should just research it better and go with the solo 401k. Seems like the consensus for my situation. Thanks for the advice.

    #236737 Reply
    The White Coat Investor The White Coat Investor 
    Keymaster
    Status: Physician
    Posts: 4529
    Joined: 05/13/2011

    Check out this article: https://www.whitecoatinvestor.com/sep-ira-vs-solo-401k/

    Site/Forum Owner, Emergency Physician, Blogger, and author of The White Coat Investor: A Doctor's Guide to Personal Finance and Investing
    Helping Those Who Wear The White Coat Get A "Fair Shake" on Wall Street since 2011

    #236912 Reply
    Liked by coug16
    DMFA DMFA 
    Moderator
    Status: Physician
    Posts: 2136
    Joined: 06/24/2016

    Honestly, if you’re going to convert it all to Roth IRA before the end of the year, then SEP-IRA is easier.

    You’d just contribute to it, then convert it to Roth IRA after the contribution.  You’d deduct the SEP-IRA contribution but add the amount converted to taxable income, so it’s a wash – as though it had been contributed to Roth IRA anyway.  Kind of like “backdoor SEP Roth IRA.”

    This isn’t commonly the best thing to do – usually just for those who moonlight but are still in a low bracket, like residents/fellows, who max their §402(g) limit of elective deferrals ($19,000) in their employer plan.  You’d probably be better off with a one-participant Roth 401(k), or by doing a custom non-prototype plan with non-Roth after-tax contributions and in-plan Roth rollover (mega-Backdoor Roth), but again, it is much easier.

    "I like money." - Frito Pendejo (Idiocracy)

    [Not a financial professional (yet), lawyer, or employee of The White Coat Investor]

    #236924 Reply
    Liked by coug16
    Avatar coug16 
    Participant
    Status: Resident
    Posts: 37
    Joined: 01/17/2016

    I moonlight a lot, I’m in my final year of residency. I’ll likely make 60-70k moonlighting on top of by ~60k salary. This is all reported on my W2 as additional duties separate from my normal salary. As I mentioned previously my wife will make 20k-30k in 1099 from freelance work. Would my moonlighting income be eligible for contribution to solo 401k or does it have to be 1099 income only? We’ve already maxed 403b, 457, Roth IRAx2, and not eligible for HSA so looking for the next step.

    What you stated as the back door sep IRA was a perfect explanation of what I originally intended to do since I don’t think my wife will continue to have 1099 income much longer but don’t know for sure.

    Thanks again to everyone for all of the help.

    #237188 Reply
    Avatar spiritrider 
    Participant
    Status: Small Business Owner
    Posts: 1903
    Joined: 02/01/2016

    Only an employer can adopt an employer retirement plan. Your W-2 moonlighting income can not used to adopt a SEP IRA or one-participant 401k and make contributions. It can only be used as compensation under your employer’s plan.

    You haven’t indicated which of the plans you identified in your OP are yours and which are your spouse’s. The employee elective contribution limit (2019 = $19K) is across all 401k, 403b, SARSEP and SIMPLE IRA plans.

    If your spouse has not maximized her employee elective contribution limit across those plans, then she would be better off with a one-participant 401k plan. This would allow her to make a far greater contribution ($19K + $3K = $22K) vs. a $5K SEP IRA contribution.

    #237221 Reply
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    Avatar spiritrider 
    Participant
    Status: Small Business Owner
    Posts: 1903
    Joined: 02/01/2016

    Assuming your wife does not do salary deferral in another plan, she could put much more of her freelancing income in a solo 401k.  For example, if she makes 25K in net income, she could contribute 19K in salary deferral plus 20% of the remaining 6K (less 1/2 SE taxes on the income).  In contrast, the SEP would allow only 20% of 25K net income (less 1/2 SE taxes).

    Click to expand…

    I just re-read this post and there are some clarifications:

    • Self-employed SEP IRA or one-participant 401k contributions are based on self-employed earned income (business profit – 1/2 SE tax).
    • SEP IRA or one-participant 401k maximum employer contributions are first calculated as 20% of self-employed earned income, not 20% * (self-employed earned income – employee elective contributions).
    • However, at lower self-employed earned income. Maximum employer contributions are further limited to (self-employed earned income – employee elective contributions) / 2.
    • With $25K in self-employed earned income, the maximum employer contribution would be $25K * 20% = $5K. With $19K in employee elective contributions, the maximum employer contribution would be limited to ($25K – $19K = $6K) / 2 = $3K.
    #237223 Reply

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