I first wrote about multiple 401(k) accounts back in 2013 in a post entitled Beating the $51K Limit (for which I am still eternally grateful to Mike Piper for the pearl that grew into that post.) Well, the $51K limit has since grown into the $57K limit in 2020 thanks to inflation, but all the same principles still apply.
I get tons of questions on multiple employer 401(k) in our Forum, Podcast, Facebook, and Reddit groups, in the comments sections of the posts on this site and by email. Heck, this post already has over 1,000 comments! Mostly, I wrote this post so I could copy and paste its URL instead of typing the same old stuff over and over again. (Come to think of it, that was the motivation for starting this site in the first place.)
Here's the deal. Many physicians work for multiple employers or work as an employee and either an independent contractor or a consultant. Many others have a side job of another type. Their incomes are far higher than they require for their current spending needs, but they're behind on their savings or otherwise have a desire to maximize the amount of money they can put into retirement accounts, especially tax-deferred retirement accounts.
Obviously, these types of accounts minimize tax, maximize returns, increase asset protection, and facilitate estate planning. Who wouldn't want to get more money into them? However, most of these doctors are surprised to learn that they can have more than one 401(k). That's right,
YOU CAN HAVE MORE THAN ONE 401(K)!
Okay, now that I've got that out of my system, let's make a list of the 7 governing rules for using more than one 401(k):
Multiple 401(k) Rules
Rule # 1 One Employee Contribution Total
In 2020 the IRS only allows you to make a total of $19,500 ($26,000 if 50 or over) worth of “employee contributions” to all of your 401(k)s (or 403(b)s) no matter how many unrelated employers you have. If you have access to two 401(k)s, you can split this up, but the total must be $19.5K ($26K if over 50) or less.
Rule # 2 $57K Per Unrelated Employer
The IRS also only allows you and your employer (which might also be you) to put a total of $57,000 ($63,500 if 50+) per year into a 401(k). This includes the employee contribution, any match from the employer, and any employer contributions. This is the same limit for a SEP-IRA (if <50 anyuway) which is technically all employer contributions. However, unlike rule # 1, this limit applies to each unrelated employer separately.
Unrelated employers means that the businesses doing the employing are not a “controlled group.” There are two types of controlled groups:
“Parent-Subsidiary” Group
This is when a parent business (corporation, sole proprietor, LLC, partnership etc) owns 80%+ of another business.
“Brother-Sister” Group
This is where 5 or fewer individuals, estates, or trusts own a controlling interest (again, 80%+) of two different businesses.
So if the two businesses you are involved in aren't a controlled group, and they each have a 401(k), (or a 401(k) and a SEP-IRA) you get two $57K limits. Pretty cool huh? There are several common examples where this could apply to a physician:
Example One
A 40-year-old single physician is an employee of two completely unrelated hospitals. The first pays her $200K per year and matches 100% of her first $5K put into the 401(k). It also offers her a 457. The second pays her $100K per year and matches 50% of the first $7K she puts into her 401(k). What retirement accounts should this physician use in order to maximize her contributions in 2020?
- Hospital 1 401(k): At least $5K (plus the $5K match)= $10K
- Hospital 1 457: $19.5K
- Hospital 2 401(k): At least $7K (plus the $3,500 match) = $10,500
- Plus another $6K into either hospital's 401(k) (pick the one with the better investments)
- Plus $6,000 into a Backdoor Roth IRA
- Total: $52,000
Example Two
A 40-year-old married physician whose spouse doesn't work is a partner in a 100 doctor partnership which offers a 401(k)/Profit-sharing plan in which he can “self-match” up to the $57K limit. The partnership also offers a defined benefit/cash balance plan with a $30K limit. He makes $300K practicing medicine. He is also the sole owner of a website on the side that makes $300K per year and has its own individual 401(k). Both 401(k)s offer a Roth option. What is the maximum amount he can put into Roth accounts in any given year without doing a conversion of tax-deferred dollars?
- Partnership 401(k)/PSP: $57K, of which $19.5K can be Roth
- Partnership DB/CBP: $30K, of which $0K can be Roth
- Website Individual 401(k): $57K, of which $19.5K could be Roth if none of the Partnership 401(k) money represents an “employee contribution.” Otherwise, $0K Roth.
- Personal Backdoor Roth IRA: $6,000
- Spousal Backdoor Roth IRA: $6,000
- HSA: $7,100
- Total: $163,100 of which $39K can be Roth
Example Three
This 52-year-old married physician (spouse doesn't work) is an employee of a hospital where she is paid $200K. She has a 401(k) with a set $20K employer profit-sharing contribution (not a match) and the hospital pays most of the premiums on a non-high-deductible health plan. She moonlights across town as an independent contractor and is paid on a 1099, where she earns $100K and has opened up an individual 401(k). The hospital 401(k) has terrible investments and high fees. How should she allocate her retirement savings in order to best use these options?
- Hospital 401(k): $20K employer contribution
- Individual 401(k): $26K employee contribution (50+) + 20% * $100K = $20K employer contribution = $46K (technically slightly less due to Rule # 5 below)
- Personal Backdoor Roth IRA: $7,000 (50+)
- Spousal Backdoor Roth IRA: $7,000 (50+)
- Total: $60K
Example Four
A 40-year-old single physician is in a business partnership with one other physician and they have several employees. Due to hassles and the costs of their employees, they have opted to use a SIMPLE 401(k) for their practice. He makes $200K. He also does some consulting work on his own as a sole proprietorship where he is paid on a 1099, about $50K per year. He and his physician business partner recently opened up another business where they sell a medical device. They are the only owners of both the practice and of the corporation that sells the device (which has no employees.) He makes another $50K from this company of which $25K is salary and $25K is a “distribution” from the S Corp. What kind of retirement set-up should this physician do?
- Practice SIMPLE IRA: $13,500 employee contribution plus $6K (3% of salary) employer contribution: $19,500
- Unfortunately, these three entities are part of a “controlled group”, so he cannot have a separate retirement plan for either of the other two entities that ignore the employees in the practice. The presence of a SIMPLE IRA also makes it tough to use a Backdoor Roth IRA due to the pro-rata rule.
- Total: $19,500
Rule # 3 Employer Contributions Are 20% of “Net Earnings From Self-Employment”
When calculating the employer contribution for a SEP-IRA or an Individual 401(k), you use your “net earnings from self-employment” This includes any amount used for an employee contribution, but excludes the amount used for S Corp distributions (those aren't “earned income” and so can't be used for retirement account contributions) and used for the employer half of the payroll taxes (same as the self-employment tax deduction.)
The employer contribution in an individual 401(k) and a SEP-IRA is exactly the same (for those under 50), but since you can also make an employee contribution into an individual 401(k) (and 401(k) money isn't included in the backdoor Roth pro-rata calculation,) a 401(k) is generally the better option for the self-employed, even if it is slightly more complicated to open (and must be opened in the calendar year rather than before tax day of the next year.)
Rule # 4 You Only Get One SEP, SIMPLE, or 401(k) Per Unrelated Employer Per Year
Each unrelated employer should only have one of these three types of accounts for each tax year. However, you could open a SEP-IRA for your self-employment income in March 2021 for tax year 2020, and then open an individual 401(k) in June 2021 for tax year 2021 if you like. Remember that just because you are the sole owner of two separate businesses doesn't mean you get two different retirement accounts. Those businesses are a controlled group.
Rule # 5 These Rules Have Nothing to do With 457s, IRAs, HSAs, or DBPs
457(b)s, Backdoor Roth IRAs, HSAs, and defined benefit/cash balance plans all have their own separate limits that have nothing to do with the limits for 401(k)s, 403(b)s, SEP-IRAs, and SIMPLE IRAs. Putting more into a Roth IRA doesn't mean you can't still max out your 401(k).
Rule # 6 Catch-up Contributions Also Allow You to Beat the $57K Limit
Many accounts have catch up contributions if you're old enough (usually 50 or older, but 55 or older for HSAs.) Roth IRAs have a $1,000 catch-up, HSAs have a $1,000 catch-up, and 401(k)/403(b)s have a $6,500 catch up. That $6,500 catch-up is in addition to the $57K limit, so if you're over 50, you're self-employed with lots of income, and you make your full $26,000 employee contribution to your individual 401(k), the $57K limit becomes a $63,500K limit.
If 401(k)s are so great, why just stop at one?
Rule # 7 403(b)s Are Not 401(k)s
Many physicians have access to a 403(b) by working for a hospital or public entity. There is a unique rule for 403(b)s, however, which will prevent many doctors who use a 403(b) at their main job from maxing out an individual 401(k) on the side, at least if they own 50% or more of the company for which they have an individual 401(k) (and they probably do.) It doesn't make much sense, but neither do many tax and retirement plan rules out there. Basically, your 403(b) at work, unlike a 401(k), is considered to be controlled by you. So you are stuck with the same 415c limit of $57K (see Chapter 3 at the link.) So if you put $19.5K into your 403(b) at work, you are only allowed to put $57K-$19.5K=$37.5K into an individual 401(k).
My Accountant Doesn't Believe You
Obviously, having access to multiple 401(k)s is an unusual situation among Americans in general, even if it is quite common among doctors. As such, an unbelievable number of accountants (and especially their clients) have a misunderstanding of the rules noted above, particularly the one about having a separate $57K limit for each unrelated employer. However, taking a look at this article on IRS.Gov written in layman's language, you can see this is true:
Overall limit on contributions
Total annual contributions (annual additions) to all of your accounts in plans maintained by one employer (and any related employer) are limited. The limit applies to the total of:
- elective deferrals
- employer matching contributions
- employer nonelective contributions
- allocations of forfeitures
The annual additions paid to a participant’s account cannot exceed the lesser of
- 100% of the participant's compensation, or
There are separate, smaller limits for SIMPLE 401(k) plans.
If that's not enough for your accountant, you can simply go straight to the actual code sections in question, in this case, 415(c) (where the $57K limit comes from, originally $40K.) Be sure to scroll through subsections (f) through (h) where the relevant examples are used:
(f) Combining of plans
(1) In general
For purposes of applying the limitations of subsections (b) and (c)—(A) all defined benefit plans (whether or not terminated) of an employer are to be treated as one defined benefit plan, and(B) all defined contribution plans (whether or not terminated) of an employer are to be treated as one defined contribution plan.
Note how it says all defined contribution plans OF AN EMPLOYER are to be treated as one plan. Section (g) reads similarly:
(g) Aggregation of plans
… the Secretary, in applying the provisions of this section to benefits or contributions under more than one plan maintained by the same employer, ….with respect to which the participant has the control required under section 414 (b) or (c)…shall…disqualify one or more…plans…until such benefits or contributions do not exceed the limitations contained in this section.
This site is incredible!
Here is my situation:
1. Full time employee that contributes $18,000 to 401k.
2. Own an S-Corp that is separate from full time employer. The S-Corp earns $300,000 net income.
What is the maximum amount that I can deduct? Does the Solo 401k give me the maximum deduction? What wage do I need to pay myself to achieve the maximum deduction? And does my employer match (from my full time employer) factor into this?
Thanks for this fabulous blog!
A- $53K (assuming you’re under 50) into your individual 401(k) + $18K into your employer’s 401(k) + the employer’s match.
B- Since it is all “employer contribution” you’ll need $53K/0.20= $265K of NET (of self-employment tax) wages from the S corp. Unfortunately, that is going to negate most of the tax benefit of the S corp and in fact you may no longer wish to have it given the additional costs and hassle.
C- It doesn’t factor into how much can go into the individual 401(k).
Would it be more beneficial to just report that income on Schedule C then instead of filing as an S-Corp?
For S corp, if you get a $200k salary and $100k distribution, the 25% of salary is $50k, so just above that salary is enough to max out the profit sharing part of the solo 401k.
My understanding is the 25% includes the contribution and the 20% does not. So either way, it’s the same number. Am I missing something? I vaguely recall a discussion we had in the past on this subject, but don’t recall the bottom line.
Just wanted to make sure we are on the same page. So if you are an S corp, you give yourself a salary, in which case you can contribute up to 25% of the salary into the profit sharing. If you are a solo proprietor it is 20% of the net profit that can be contributed (up to $53k). You’ll need a higher net profit to contribute the $53k as a sole proprietor, though with $300k it is a moot point as you can still max the profit sharing out. Just pointing out that S-corp would probably save the OP more on taxes.
As I understand it from Pub 560, there are special rules when making contributions for yourself. I quote from Chapter 4 under “deduction limit for self employed individuals”, which is what you are if you and your spouse are the only owners of the S corp:
If you make contributions for yourself, you need to make a special computation to figure your maximum deduction for these contributions. Compensation is your net earnings from self-employment, defined in chapter 1. This definition takes into account both the following items.
The deduction for the deductible part of your self-employment tax.
The deduction for contributions on your behalf to the plan.
The deduction for your own contributions and your net earnings depend on each other. For this reason, you determine the deduction for your own contributions indirectly by reducing the contribution rate called for in your plan. To do this, use either the Rate Table for Self-Employed or the Rate Worksheet for Self-Employed in chapter 5. Then figure your maximum deduction by using the Deduction Worksheet for Self-Employed in chapter 5.
When you use that deduction worksheet, it becomes quite clear that the number is 20%, not 25%, because it includes the contribution.
This makes a big difference. Because if you use 25% and wish to max out a $53K contribution you would only need a net income of $212K, which would allow this $300K earner to declare $88K as distribution, saving him 2.9%*$88K= $2552 in Medicare taxes. If you use 20%, then you need a net income of $265K, leaving only $35K for a distribution, which only saves 2.9%*$35K = $1015. I’m not sure $1015 is worth the hassle and expense of setting up an S corp.
It is actually 2.9% + another 0.9% that he’d save by electing to be taxed as S-corp. He should probably have an LLC established anyway. So the savings are between $3k and $4k, though I think that electing to be taxed as S-corp might have other advantages in addition to some tax savings. Also, if the income grows beyond $300k, the benefit of using an S corp increases.
Would it be more beneficial to just report that income on Schedule C then instead of filing as an S-Corp?
Probably not. Even though you will only be saving the 3.8% in FICA taxes with S-corp (I actually prefer LLC taxed as S-corp vs. being a full blown S corp),I think that giving yourself $200k salary with $100k in distributions to put in $50k into your solo 401k plan will be better than taking the entire $300k as SE income. You’ll save about $4k in taxes with S-corp (though filing might cost you an extra $1k). It is also much cleaner to give yourself a salary so that you can make periodic contributions into the plan. This is something that I’d discuss with your CPA.
Great article. Thanks for the info, it’s easy to understand. BTW, if anyone needs to fill out a Form W2, I found a blank form here: http://goo.gl/EM55Wg
My situation( which I find complicated):
-Mandatory contribution to 401(a) of 13.5% and equal match by the univ( we don’t contribute to Social security). This amount to 22+22=44K
-Contribute to 403(b): 17.5K
-Also work at VA and contributed to TSP, 17.5K.
My accountant tells me I can’t make any contribution to the VA bec of I have already reached my limits at the univ.Is that true?
Are the limits any different if in your job you don’t contribute to social security( My individual contribution to 401 is 22k much above the 18K limit)
Yes, that’s almost surely true. The 401(a), however, is separate.
Hi Kon and WCI. Please help me figure out if this is a controlled group situation. Though it is probably obvious to you both, I am still learning the rules and could use some clarity. I receive:
-140K on 1099 from independent contractor work as a physician at a hospital (this amount will increase in the future)
– 50K W2 from my husbands oral surgery practice that I help him manage that also has several employees
These two businesses have nothing to do with each other. We have two young children. Ideally I would like to contribute maximum nonelective contribution based on schedule c to my Individual 401k each year, as well an 18K elective contribution and profit sharing to my account with my husband’s business 401k/profit sharing account? In other words, if the total to both is over 53,000, can I still contribute or is this a controlled group and my combined limit to both is 53,000?
Thanks again for any insight.
What do you do for your husband’s business? Sure sounds controlled to me based on the spouse rules recently discussed on the site here in this comments section:
https://www.whitecoatinvestor.com/small-practice-retirement-plans-part-1/
Thanks for your reply. I mainly take care of office managerial tasks and marketing, and have occasionally filled in here and there if a staff member is out.
I think you’re out of luck for two 401(k)s.
I agree with Jim. You can have a solo 401k plan for yourself, but you can’t participate in your husband’s practice 401k plan AND have a solo 401k plan for yourself. Both plans would have to be tested together and your contribution will not be nearly as high as it can be with just the solo 401k.
Your husband can have a 401k plan for himself though, and can contribute $53k into it.
If you really want to max out your contribution, so the following:
1) Get an entity established once your income is higher than maybe $200k or so. It can be LLC taxed as S-corp. You will need to talk to an accountant who understands retirement plans. If your income will increase, you can set your salary high enough to max out your plan and have the rest ‘distributed’ to avoid the 3.9% FICA taxes (not much, but probably worth it if your income is closer to $300k).
2) You can open a solo DB plan and if you are at least 38 years old, you can potentially contribute a lot more than $53k into it together with your solo 401k. This way you can contribute even more than your husband can!
While the filing cost for an LLC/S-corp will be a bit higher, giving yourself a W2 is a lot cleaner, allowing you to make periodic salary withholdings to contribute to your retirement plan, and can save you some taxes if your income is high enough.
Thank you both for your comments. This is such a wonderful site. I do have a couple more questions:
1. At this point if I had a solo DB plan for myself, would it also have to be offered to and tested with my husband’s employees due to the controlled group?
2. Based on previous posts, it looks like if I weren’t also employed by my husband’s business, would we still be considered a controlled group even though we have two completely separate businesses due to the fact that we have children (until they turn 21)?
3. If I were not employed by my husband’s business, would my solo 401k have to be tested with his company’s retirement plan?
1. I don’t think so, but would like to hear Kon’s thoughts.
2. Did you read the comments about that after the other post I linked to above? I don’t think the kids have anything to do with it, but marriage does.
3. Same as above. I think so. Not very fair, but that’s the way the rules are written.
1. This can get complicated. Please see 3.
2. Yes, children under 21 cause the businesses to become a controlled group. Very counter-intuitive. Marriage does too, but there are very specific rules about this, and sometimes marriage does not cause common control, but children under 21 always do.
3. I just re-read the rules again, and EVEN IF you don’t work for your husband, and have your own separate practice, it just MIGHT be the case that ANY plan you have for yourself (solo 401k/DB, etc) will have to be tested with your husband’s plan. It will definitely be necessary to hire an ERISA attorney so that they can write a letter of opinion to make sure that you can actually have your own separate plans. Even if the answer is no, then at least you’ll know the reason and will try to find other ways to contribute.
Sorry about that – my brain says YES, but when I read the rules again, I scream NO! This can’t be. I don’t want to encourage you to do anything that you will later regret, so I highly recommend that you speak with an ERISA attorney.
I work with a great attorney who agreed to write these letters in the past for a very reasonable price, so please feel free to get in touch if you have any questions, my email is [email protected].
Psychiatrist w/3 part-time jobs that are not related:
1.County-20hours w/full benefits, nice pension, non matching 457–put in max ie 18grand–long term job
2.tele-psych w-2 includes only malpractice paid and payroll taxes (that the above job pays anyway-long term job
3.Locums 1099 but they are on/off, sometimes whole year, sometimes no work during the whole year and sometimes couple of months here and there.
Can I get a personal 401K for job 2 as a w-2 or do I have to ask the hospital to join theirs and can I get a 401K for locums 1099 work when the job is not stable–for example they may be years where my income would be zero.
thanks and I enjoyed your book and posts.
No. Individual 401(k)s require self-employment. But you can do one for your independent contractor job. Contribute less when you work less, no biggie.
Hello WCI,
What I’d like to do is a variation of the multiple 401Ks you’ve been discussing. I am a sole proprietor physician only, so I can have only one 401K – a solo 401K. (My overall limit for 2015 will be the maximum of $53,000.) However, I’d like to have a solo 401K account each at Vanguard and at Fidelity. The reason for this is to have broader investment options when one firm doesn’t have everything I want. As long as I don’t go over an aggregate maximum limit of $53,000 for 2015, couldn’t I effectively hold 2 separate solo 401Ks, but under the same EIN? I need to have the Fidelity because it will allow me to rollover my current SEP, which a Vanguard solo 401K will not permit, but I’d like to have Vanguard mutual funds at Vanguard rather than at Fidelity. Plus, I’d like to to be able to transfer assets between these two solo 401Ks. When I talked with Fidelity, a rep said this was possible, because to them, it would just a transfer of assets between the same vehicle that have the same registration (meaning, they’re both solo 401Ks rather than one being, say, a SEP). Basically, I’d have 2 custodians of my one solo 401K.
I can’t seem to find anything from the IRS where this is explicitly permitted. Fidelity suggested that I get a letter of opinion from the IRS regarding this to cover my bases in case the IRS decides look into this for auditing. Would you have any information regarding this scenario of holding two solo 401K accounts for one business arrangement? Again, there is no intention to make two separate $53,000 contributions into each account. The plan is to aggregate the two accounts to come up with $53,000 for myself. I do intend to call the IRS about this, but I wanted to find out what you knew about this first.
Thanks for all the help you’ve been providing with this site.
What a hassle this will be for you. Just get a custom plan document for your Vanguard solo 401k and call it a day. If you are maxing out your plan anyway, this will be the best solution in your case.
https://www.whitecoatinvestor.com/improving-the-vanguard-individual-401k-with-a-customized-plan/
Thanks, Kon, for the link. I read your posting and got excited about the possibility of a custom Solo 401K at Vanguard, until I read how complex it would be to set up. It doesn’t seem all that simple. The initial startup cost is high, and as Jim, noted, it would take about 4 years to break even on the cost of the startup fee (vs. costs of ER in investor shares rather than Admiral shares.) I would prefer to manage the solo 401K myself and do my own 5055 form filing once the Solo 401K reached $250K. I’ll call the person you recommended though to see that I can take on management of my Solo 401K after the TPA sets up the plan document. I need to digest all this some more to see if I want to take on the task of going down this route.
You can still manage the solo 401k yourself. We do custom plan documents for our wealth management clients who already work with us, but only if the numbers make sense. In some cases we do it for associates who plan on purchasing their own practice, but who happen to have some 1099 income, so in fact having a custom plan document saves them the cost of getting a full document down the line (which is about $1500), so when they buy their own practice and hire employees, this plan can easily turn into a pooled 401k plan for the practice (with a simple plan document amendment).
I wouldn’t do this. The benefits aren’t worth the hassle in my view. If you want to be able to buy both Vanguard and Fidelity funds, why not do an etrade one?
They do rollovers and you can buy the Vanguard Funds via ETFs through the brokerage option. What is it at Fidelity that you want other than the rollover option?
https://www.whitecoatinvestor.com/where-to-open-your-solo-401k/
And I don’t think the IRS would allow it either, but I don’t have a definitive source. I do know you can’t have a SEP and a 401(k) for the same business in the same year, and I think this would be similar. At any rate, I don’t see much benefit and plenty of downside.
ETFs are a good idea but unfortunately none of the brokerages allow periodic investment with ETFs (which can be a hassle if you make smaller periodic contributions throughout the year). Other than that, the best of Vanguard’s funds can be purchased as ETFs.
I don’t think that Fidelity has any more or better investments than Vanguard has. In fact, I believe that Vanguard has more asset classes than Fidelity does, so it makes sense to either go to a brokerage that has ETFs or to consolidate at Vanguard.
As I write this, I am currently on a 1 hr. hold with the IRS office to get my question answered, but I relay what they tell me, if I get anyone at the IRS office who knows the correct answer.
To answer your question about what I need at Fidelity besides the rollover option, it’s that I can have a brokerage account and the ability to buy ETFs within the Solo 401K. Plus, Fidelity has the Spartan funds Advantage Class shares that are comparable to Vanguard’s Admiral shares.
I’ve looked at E-Trade and TD Ameritrade as options (using the summary guide weeks ago that you posted), but when I read reviews in previous posts on the Bogleheads forum, I got turned off by reports of individuals’ poor customer service experience, cost of certain trade fees, surprise fees, etc. that it seemed Fidelity would be the better option for opening a 401K. I had considered Schwab until I discovered that there were transfer fees with Schwab. And now I’m reading conflicting information about whether a rollover of my SEP could be done with Schwab.
I’ll still go with a taxable brokerage account with Schwab, but it seems intuitive and following the Boglehead principle of low-cost investing by buying Vanguard mutual funds directly with Vanguard that won’t cost me money to buy vs the cost of some Vanguard funds at Fidelity.
I don’t mind the extra few steps I’d have to take if I can have two custodians of my Solo 401 K in order to do what I want and too keep costs and fees at nothing or minimal. But I get your point that this may end up being a lot of trouble in the end when it comes time to filing my taxes. You have given me caution, though, so I’m duly wary until I get a definitive answer from the IRS telling me I can do this.
Although, I just got off the phone with Vanguard and Vanguard’s telling me that I need to keep all my assets of a Solo 401K if I choose to have their plan document. Fidelity did not give me such a limitation. But, then, on any given day, a different Vanguard and different Fidelity rep will give different information/opinions.
How do you know (i.e., where did you learn) that you cannot have a SEP and 401(k) for the same business in the same year? I cannot find any documentation to that effect anywhere. If anything, it appears that you can have a SEP and 401(k) for the same business in the same year even if you used IRS form 5305-SEP so long as the SEP was created before the solo 401(k). I would prefer to use my solo 401(k) plan only for making the elective contributions and then have my business make its contributions only to my long-standing SEP account at Wealthfront. The sum of the two would be the $53k IRS limit.
Good question. I went looking for a reliable source and didn’t find one in 2 minutes of Googling. It’s possible I’m wrong and you can do both in the same year. Why you would want to is a bit of a mystery to me though. Why not roll your SEP money into your individual 401(k) and start doing backdoor Roth IRA(s)?
I’m a solo practitioner early in my career with my business structured as an S-corp. My wife is also employed by the business as the office manager. Initially, my business only had a SEP in place and payroll was handled by our tax firm but recently we started using a third-party service to handle payroll. The use of this third-party made setting up a 401(k) much easier. The two main advantages to using the 401(k) are that 1. through the use of elective contributions, I can reach the $53k max at a lower salary than I could through the SEP and save on payroll taxes and 2. my wife’s much smaller salary can now save an additional $18k through elective contributions to the 401(k).
The reason I want to continue using the SEP for the business contributions is because I like the investment products available in the IRA market. Namely, I like low-cost robo-advisors like wealthfront, betterment, etc… In particular, I like the fact that Wealthfront and Betterment are able to provide free services such as tax-loss harvesting in our regular brokerage accounts by taking into account our IRA portfolios. Additionally, Wealthfront offers free direct indexing services that I’d like to utilize once my regular brokerage accounts are large enough. Additionally, peer-to-peer lenders, namely LendingClub, are offering SEP-IRA accounts and is a new, non-correlating type of investment vehicle that can be used to further diversify a portfolio. There’s nothing like these services in the 401(k) market.
The backdoor Roth strategy is great and one I definitely want to utilize however, any Traditional IRA contribution we make today is automatically going to be a post-tax contribution. We’re not eligible to make it pre-tax. So our plan here is to make Traditional IRA non-deductible contributions to a max of $11,000 for the two of us also at Wealthfront and then at some later date, years later, rollover those funds into a Roth. We don’t lose out on the tax-free growth in the interim and the need for tax-free withdrawals are at least a couple decades away for us.
I can’t tell from your comment whether you understand the pro-rata rule with the backdoor Roth. You do understand you can’t have money in a SEP and do backdoor Roth IRAs the way you want, right?
That said, a great explanation of some good reasons for using a SEP over a 401(k), several of which I hadn’t thought of before. One thing you could do, of course, is to do a “Megabackdoor Roth IRA” and convert your entire SEP to a Roth IRA each year. Might not be right for you though.
Yes, I’m familiar with the pro-rata rule. If and when we decide to do a Roth conversion of our traditional IRA accounts, we will first rollover the SEP-IRA funds to our 401(k). Because everything deposited in our remaining traditional IRA accounts will then be post-tax contributions plus their growth, the conversion to a Roth should incur zero taxes.
This process is not something I want to do annually for the same reason that I want to continue making contributions to our SEP accounts: I want our tax-advantaged dollars to grow within our Wealthfront SEP-IRA accounts. This is why our plan is to make post-tax contributions to a traditional IRA account and then at some point in the future do a one-time conversion. The triggering event for doing the back door Roth conversion will likely be something along the lines of impending changes to the tax code such as the back door Roth conversion being done away with or tax rates going up.
No one can predict the future, but I optimistically hope that my tax rate in retirement will be lower than my current tax rate. Assuming I’m correct, a “Megabackdoor Roth” conversion of my SEP accounts does not make sense at this time. But I also know that political winds can change tremendously over the next thirty years and I have to be open to changing strategies. A “Megabackdoor Roth” conversion would be a great option in the event of marked increases in tax rates.
In the meantime, converting only the post-tax traditional IRA dollars to a Roth would allow us to further diversity our retirement accounts by giving us a mix of taxable and non-taxable withdrawal options.
Remember you have to pay taxes on the growth in that non-deductible traditional IRA when you convert it.
Sounds like you’ve got a good handle on all this to me.
https://www.irs.gov/publications/p560/ch02.html
I believe that you can have both, but contribution limits have to be respected ($53k for both), though you have to be careful about various details:
https://ttlc.intuit.com/questions/2579983-as-a-self-employed-person-can-i-contribute-to-both-a-sep-and-individual-401k
http://benefitslink.com/boards/index.php/topic/43177-sep-and-401k-in-same-year/
Some model SEP plan documents DO NOT allow one to maintain another retirement plan in the same year, so please be advised!
Kon,
Thank you for your reply. I had seen that benefitslink.com thread before but don’t agree with the analysis of the posters. The most common (and only) model SEP plan document that I’m familiar with is the IRS 5305-SEP document. It can be found here: https://www.irs.gov/pub/irs-pdf/f5305sep.pdf
This model document establishes a SEP for a business. It is signed and dated by the employer and it very clearly states that this form should not be used if you “1. Currently maintain any other qualified retirement plan. This does not prevent you from maintaining another SEP.”
The document says nothing about establishing another qualified retirement plan, such as a 401(k), AFTER a SEP has been established using this form. That being said I suppose I could amend my business’ 5305-SEP to make it an “individually designed” SEP.
As opposed to a “prototype” SEP, an individually designed SEP would not require a pre-approval letter from the IRS as per http://www.irstaxattorney.com/irs-audits/72/447217_Simplified_Employee_Pensions_(SEPs)_Salary_Reduction_Simplified_Employee_Pensions_(SARSEPs).html See section 4.72.17.3.3
But I would still argue I don’t need to amend the SEP because I did not violated the terms of the model SEP plan at the time that it was established.
Thank you for pointing out that contribution limits would still need to be respected when maintaining both a SEP and 401(k) for the same business. I think that for a two spouse set up like my business, another thing that needs to be respected is that the business contributions to the need to be identically proportional for both spouses (i.e., if the S-corp business makes a 25% contribution to the SEP-IRA for one spouse, it must make a 25% contribution to the SEP-IRA for the other spouse.) It can’t make a business contribution to the 401(k) for one spouse and only a SEP-IRA contribution for the other because this would violate the terms of the SEP plan (and possibly the 401(k) plan).
Yes, it can get frustrating. Believe me – I deal with Vanguard almost daily. I had to get direct access to a resolutions department rep because things do get messed up all the time.
Bottom line is this: the more complex your arrangement is, the worse it is going to be for you in terms of mistakes, wasted time and conflicting requirements and information.
So here’s how the total 3 hrs, 43 minutes of total time on the phone with the IRS went – only 13 minutes of which was the actual interface time with a live person.
After selecting the business section option and waiting 1 hr. 43 mins,
1st Rep: Will you please hold while I find that information…I don’t have that information. I will need to transfer you to the ‘Tax Division’.
Me: [Huh?? A ‘tax division’ within the THE tax entity of the Federal Government???]
1st REP: By the way you applied for the wrong EIN type. You selected Sole Proprietorship, but you should have selected the EIN for profit-sharing.”
Brief exchange regarding the EIN, after which the 1st Rep tells me I will need to file Schedule H for the Solo 401K. [Me: OK. Don’t know what Schedule H is for, but duly noted and will file.]
Another 1 hr waiting for the ‘tax division’, then reply from 2nd Rep after I ask him my solo 401K question:
2nd Rep: We don’t answer that question here.
Me: Are you not the tax division that answers questions regarding solo 401Ks?
2nd Rep: Yes, but that question is not answered here.
Me: How am I supposed to know what your department will or will not answer? I’ve waited over 2.5 hours now and you’ve told me you do not answer this question. Is there some reason why you do not answer this question?
2nd Rep: That is not a question that we get training to answer.
Me: Oh, so you don’t know the answer.
2nd Rep: No, I didn’t say that I don’t know the answer.
Me: Are you implying that you know the answer but that your department just won’t give out the answer?
2nd Rep: No, I’m saying that this area does not receive training to answer your question.
Me: What questions do you answer, if not this question, since your own colleague sent me to your division to obtain the answer to this question?
2nd Rep: We do answer tax questions, but your question is not answered here.
Me (With my head about to explode): Do you or do you not know the answer to my question? It’s a simple Yes or No.
2nd Rep: No I do not know the answer. [Finally! It’s because he doesn’t know the answer, not because it’s some privileged secret that only special members get to know the answer to.]
Me: Then where can I get the answer to my question?
2nd Rep: There is a tax department that answers such questions. An email is sent to them with your question and then in 2 weeks to 1 month, you will get an answer.
For all those who might have a tax question for the IRS – I know! Crazy and unheard of, right?? – here’s the email address to direct a question in case you don’t want to wait 2.5 hours on the phone for the IRS tax department to tell you that they don’t answer your question in their tax department but that another tax department will: [email protected].
Me: My second question is, What is the correct EIN type I should have selected when applying online if not the “sole proprietor” type of EIN in order to get a Self-Employed 401K?
2nd Rep: That question is not answered here.
Me (with my eyes bugging out and spleen about to rupture): OH.MY.GOD. Do you answer any questions at all???
I get transferred to the EIN department. Yes, there is a whole EIN department! But there’s not a department to directly answer questions about a 401K. That has to go by email to who knows where.
I get information from the EIN department that directly contradicts what the 1st Rep told me. After the 3rd Rep is not able to answer my question – she keeps reading the general booklet instead of telling me what correct EIN type I should get – a supervisor is nearby to hear the conversation and gets on the line. She was the most knowledgeable of all the 4 people I talked to at the IRS.
Her head almost explodes too when I tell her that Rep #1 told me I would need to file a Schedule H because of the Solo 401K. She vehemently apologizes for the grossly wrong information I was given and emphatically states that Schedule H has nothing to do with a Solo 401K, that’s it’s a domestic schedule for people who have employees like nannies or housekeepers. Wow, how could a Solo 401K have anything to do with a schedule for domestic nannies and housekeepers??
Almost 4 hours after I called, I still do not have an answer from the IRS. I should email them the details of what I posted here, in the hopes that their heads may almost explode too with the absurdity.
I have now forgotten what my original purpose for calling the IRS was.
P.S. The 1st Rep was wrong about my being wrong in selecting the “Sole Proprietor” type of EIN. Per the EIN Department supervisor, “Sole Proprietor” EIN for the purpose of setting up an Individual 401K is correct. The “Employer Plan (401K, Money Purchase Plan, etc.)” type of EIN is only if I have employees and must set up employEE retirement plans for them. Because it’s just me in the self-employed business, the other types of EIN do not apply UNLESS I have another business with employees.
Also, per this supervisor, for all self-employed who file 1040 only instead of S-corp self-employed individuals who also file an additional S-corp form, we are considered “individuals” still, rather than businesses because of the use of the 1040. So, if you ever have the unfortunate need to call the IRS, preface your question with “for my 1040” and then relay your related business-type question. Otherwise, the moment you say “Self-employed” or “sole proprietor”, you will be immediately bumped to the “Business” department and they won’t answer any question related to a 1040 in the business department.
I have now come to the belief that there is no improving of the IRS in anyway — with whatever corruption, malfeasance, or ineptitude present — because the sheer absolute bloat and inertia of this entity will prevent any effective change. It would need to just be completely dissolved and rebuilt from the ground up if its problems are to be fixed.
I opened a solo 401k in 2014 and I’m unclear as to how exactly to report my solo 401k employer contributions. I’m a sole proprietor and have not incorporated (I just applied for an EIN number so that I could open a solo 401k).
I’m a physician and have a main job in which I am classified as a K-1 partner and I use my personal SSN for this income. I maxed out the 401k contribution with this K-1 job.
For my 2nd job which started in 2014, I am an independent contractor. I opened a solo 401k so that I could contribute ~20% of income from this 2nd job to a solo-401k plan as “employer contributions.” Initially when I started this job, I just used my SSN for the 1099-MISC as I hadn’t acquired an EIN yet. My SSN (which, in a unrelated issue, is also listed incorrectly on the1099-MISC form) is still listed on the 2014 1099 MISC. I notified the payroll account that I now have a EIN. He stated that he can’t change anything for the 2014 tax year but will make note of that for 2015.
So I’m now doing turbo tax and am wondering when I need to use the EIN vs SSN.
Also, when I mail the solo-401k contribution checks to my solo-401k holder (TD Ameritrade), I’m unclear as to if I need to indicate just my EIN number or my SSN (or both?) on the deposit slip. TD Ameritrade actually uses an IRA deposit slip and I write over the “type of contribution” that it’s for a solo-401k and not a SEP Employer contribution or other contribution, but there is only space to write in a SNN, not an EIN.
Anybody gone through this experience and able to shed light?
I am in a similar situation. I don’t put the EIN on my tax return. I don’t fill out a slip for my solo 401(k) but Vanguard knows my EIN already. Pay the taxes you owe and I doubt you’ll have any issues with the IRS.
Ok, I figured it out. On TurboTax I listed my independent contracting business in a completely separate section (and an EIN was asked for) from my K-1 partnership business. Both areas allowed for itemized deductions separately and adequately.
The contributions for both the solo 401k and the K-1 partner 401k are listed in a section together where one can specify amounts for employer vs employee contributions, and later there is a question asking how much was attributable to each. I also have a defined benefit plan and figured out how to include it as well (under the Keogh heading, although it’s technically a cash balance DB plan), so I think I got credit for all of my retirement deductions.
It’s taken me a few years to figure these things out on TurboTax. Wish it was more straight forward, but Turbotax hasn’t made certain steps too user friendly yet. I also used a walk-thru guide from the Finance Buff’s webpage (with screen captures) that helped greatly with entering the backdoor Roth correctly.
I just wanted to clarify–I have a gov 457 and just opened a solo401K–my understanding is I can put 18K into EACH as employee(so total of 36K) but total of both plus employer part needs to be 53K.
457(b) and 401(k) have separate limits. So you can max out the solo 401k without regard to the 457(b). If you have a 403(b) and a solo 401k, then the limit is the same for both.
Kon,
Thanks for your reply. It seems a lot of people are confused about this–so you are saying 18K in 457 and up to 53K in solo 401K===so total of 71K in 2015?
thanks and I enjoyed your talks on quantiamd
That’s correct. But most people with a 457 also have a 403B. You may be able to do that too.
Glad you liked it! It seems that the 403(b) rule is indeed not something that is commonly known (though employers are supposed to provide this information to the employees, and some do, from what I hear). WCI is right about the 403(b), though increasingly some providers choose 401(k) instead of 403(b). However, even if you have a 403(b) available, you do not have to participate in the 403(b), as most don’t even have a match. So it makes more sense to max out the solo 401k opened at Vanguard or Schwab.
For 2018 I’ll contribute $18500 to a 403b and I’ll get ~$21500 employer match in the 403b. I also have a 457b, but from the comments above it is clear that my contributions to the 457b don’t count towards the 415c limit of $55000 for 2018. My 403b employee and employer contributions of ~$40000 get me $15000 shy of the 415c limits.
I do have some 1099 income and have set up a solo 401k previously. Based on rule #7 in the post and comments 35 – 37 it is clear that I can’t use the employee contribution to a solo 401k since I used that up with my 403b employee contribution. I think my solo 401k employer contribution counts towards the same $55000 415c limit that is already $40000 used up from the 403b. Is that correct or is there a totally separate $55000 limit for the solo 401k given that I’m using a 403b? The plan administration for the 403b seems to feel the solo 401k is irrevalent from the standpoint of the 403b. However based on this post and the comments it seems that the combo of the solo 401k and 403b matter at least in terms of not being able to have two different employee contributions like I could if I had a 401k at my main job rather than a 403b and since that is the case, I assume I have to count the solo 401k employer contributions towards the 415c limit for my 403b.
I contribute 18k to my regular work place Roth 401(k).
I also moonlight and make around 40K a year. I open an Individual 401(k), but can only contribute the (self)-employer portion of 25% of the 40k to this account, since I have already max out the 18k contribution to my regular work place Roth 401(k)? Or can I still contribute the employee’s 18k to this Individual 401(k) account, for a total of 18k a year?
1. Unless you give yourself a W2, it is 20% of your SE income, not 25%
2. Unless your W2 401k has low cost index funds, I wouldn’t max that out. Instead, you can contribute just enough to get the match (if any), and put the rest of the $18k (yes, the total between the two has to be $18k) into your solo 401k plan.
Okay here is my situation. Thank you so much for you blog.
Job #1) W2 employee(Anesthesiologist) with 401k 100% match up to 6% of salary. I also have a 403b account with this job and contributions over $15,900 get kicked over to this account via some rule in the plan. I am currently contributing 18k a year to this plan.
Job#2) Will be starting a job in Jan 2016 as medical director of plasma center as 1099 employee and gross salary of 36k/year.
Job#3) Additionally I will be doing some independent contractor work at another hospital unrelated to my 1st job making about 14-20k/year gross.
Am I right in that I can open solo 401k plan for both jobs #2 and #3? I am thinking I could open a solo 401k plan for job #2 and contribute 20% of profits to make it 7.2k/year and separate solo 401k plan for job #3 to contribute 2.8 -4k/year? Do you see any other potential ways of saving for retirement besides the roth IRA which I will do and HSA that I don’t qualify for? Thanks so much for your blog and love reading it.
I suggest you look at your retirement accounts for Job # 1 more closely. It is very odd to have both a 401(k) and a 403(b) for the same job. Are you sure it isn’t a 403(b)/457(b) combination?
There is no such thing as a 1099 employee. If you are paid on a 1099, you are not an employee.
Since you are the only owner of your two businesses (#2 and #3) you only get one contribution limit for them. That’s fine since you don’t have enough income to max out an individual 401(k) anyway.
Yes, you can open a Solo 401(k) for jobs #2 and 3. If your employee contribution is used at Job # 1, and it probably is, your contribution to your solo 401(k), all employer, would be around $10-11K.
I guess you could look into a personal defined benefit plan, but I don’t think I’d bother. I’d probably just max out whatever you can at Job # 1, do backdoor Roth IRAs, do the solo 401(k), and if you want to save more for retirement, do it in a taxable account.
Thanks for all the information. Between WCI and Bogleheads, I am finally getting a handle on my scattershot investment methology. But I was hoping for a some help and quick clarification that seems to be touched on in a few recent comments.
My situation – I am 42 and had been a private practice radiologist for 10 years then our hospital closed early 2014. Had always been on a W2 and had a group retirement plan with the max contribution 53K per year, and had no other income source, so it was pretty simple. Unfortunately had to roll that plan to a traditional IRA – so no more back door roth for me 🙁
But now…
1.) Employed radiologist at a local independent hospital since March 2015 – have both a 403(b) and 457(b) plan to which I will contribute 18K to each account this year (will get a match next year). So total there is 36K
2.) Also 1099 income from teleradiology which I did full-time for a about a year in between regular jobs – will likely have a $175K gross this year (was full-time in Jan and Feb 2015 then part-time), more likely 100K-ish in 2016 and going forward. So my two questions…
First question – (in two parts) – I opened an SEP-IRA for my 1099 income last year because I dragged my feet and missed the Dec 31st date for the solo 401(k). Can I open a solo 401(k) this year for my independent contractor job – as in does it matter that the same job has the two different accounts open? And if I can open the 401(k), would I just leave the SEP-IRA there for now or would I roll it to my traditional IRA?
Second, and bigger question – Would the solo 401(k) (or SEP-IRA even) contribution be limited to 17K for the “max overall contribution” of $53K that I always read about, or are the plans technically separate, and I can exceed the $53K “limit”, maxing out the solo 401(k) based on income factors, etc… It seems some post above says you can go over the magical $53K.
And I am not talking about the regular IRA yearly $11 for myself and my spouse, which we always do anyway.
Thanks again and love the book and the blog!
You can open a solo 401k and move your SEP and traditional IRA into your solo 401k. I’ve described how you can do this at Vanguard here:
https://www.whitecoatinvestor.com/improving-the-vanguard-individual-401k-with-a-customized-plan/
However, your solo 401k and 403(b) total contribution will be limited to $53k, but this might not be a big deal for you given that with $100k you can’t max it out anyway. Going forward you’ll need to figure out where to contribute your salary deferral. If there is no match in a 403(b), I’d put the salary deferral into your solo 401k if your 403(b) investments are too expensive and there are few if any low cost index funds.
Do only the 401(k) and 403(b) count to the 53k? or is the 457(b) part of that 53K too?
So in other words is is the overall total from my scenario $53K (401,403 and 457) or is it $71K (53K from 401 and 403 – and 18K from 457)? Thanks again!
Next year I do get a match, and the investments in the 403 do have some low fee Vanguard and T-Rowe price investments (although not a great selection). My other stuff is at Fidelity in Spartan funds.
$71K.
$53k for 401k/403b, plus $18k for 457b.
You definitely should open an individual 401(k). You definitely should roll as much tax-deferred IRA and SEP-IRA as possible into it and try to isolate any basis for non-deductible IRA money, then convert that. Then do backdoor Roths going forward. You definitely should get any 403(b) match possible. Then be sure to get the total $53K into the individual 401(k) + 403(b). (Unfortunately, as noted in the post, 403(b)s are a little different from 401(k)s in this respect). If you can still save more, use the 457.
Yes, you can have a SEP-IRA and a 401(k), but I don’t think you can contribute to both in the same year. And there’s no reason to have both. Just roll the SEP money into the individual 401(k). But get on it. It takes a few weeks. Make sure the individual 401(k) accepts IRA transfers/rollovers.
Thanks. WCI – I may have written the post above while you were responding to me. So if you could comment there, I would appreciate it. It sounds like the 457 plan can be above and beyond the 53K total for 403(b) and the 401(k)
So if I understand your last post – I can roll my traditional IRA – now with a high six figure balance – into my new 401k, since that will allow me to once again take advantage of the backdoor Roth? Thanks – I didn;t know that was possible and my accountant never mentioned it when we last talked…
Appreciate the help
Yes, you can roll IRA money into an individual 401(k). It gets a little tricky if some of the IRA money is non-deductible.
All of the money currently in my traditional IRA came from my old retirement plan rollover when my private practice group dissolved after the hospital closure. All other previous contributions from the that account had been back-doored already prior to 2015, if that make a difference…
That’ll make it easier.
Accountants in general don’t have much knowledge about solo 401k plans, and even less about how to coordinate various types of retirement plan contributions.
As WCI said, just make sure you segregate deductible money from non-deductible. This is something your accountant should help you with.
I was reading more up on the solo 401k regarding my 1099 job and I’m getting confused about the contribution definition. I was under impression that I could contribute 20% of my compensation into a solo 401k. I will make about 36k gross and was thinking I could contribute 7.2k roughly to it. However, lot of my readings indicate that I can contribute 20% of net adjusted business profits which I don’t understand, any insight on how that impacts me? Additionally, I don’t need to open an LLC or S/C corporation to complete opening a solo 401k for my 1099 position right? Again, thanks for everything.
Chad
If you get a W2, it is 25% (and you can only do that if you pay yourself as an employee, via an entity such as an LLC taxed as S-corp). If you are a sole proprietor (or LLC taxed as sole proprietor) then it is 20%. Of course, 20% will be from your net business profit, which is your gross minus various deductions if any. No need for an entity to open a solo 401k, though I would get an LLC to protect your personal assets from liability (if allowed by your state).
Kon-
What liability do you think the LLC is going to protect a doc from? It won’t protect them from malpractice as that is always personal, no matter the entity. so it’s business liability only, and most solo docs don’t have any of that.
True, good point. LLC would be useful for non-medical businesses.
You do not need an LLC or Corporation, but you do need an EIN, at least with Vanguard. If you have no other 401(k)/403(b) to which you have made the employee contribution, then with $36K of income you can make an $18K employee contribution plus ~$7K employer contribution. It works out to be about 18-19% of gross. The reason it isn’t 20% is that it is 20% of “net adjusted business profits” (meaning profits after payroll taxes) not 20% of gross. If you have already used your $18K employee contribution elsewhere, then it’s just the employer contribution.
My husband and I are both physicians. His work offers a profit sharing 401K plan and defined benefits plan, which we plan to maximize (up to 83K total). I do part-time group practice and am an independent contractor. I plan to open a solo 401K and maximize then do personal and spousal backdoor Roth conversions. I am confused as to whether the money we put into these tax deferred accounts actually lower our taxable income since we are high income earners? Or is it considered a non-deductible retirement account? And how exactly is the backdoor Roth advantageous since we would be paying close to 40% on the funds we convert from our traditional 401K? Btw, have learned so much from this site and TIA!
Yes, these are tax deductible, that’s the idea. Your tax liability is definitely lowered by the amount you contribute.
The idea behind Roth contribution is that you want to diversify your future tax liability. If all you have are tax-deferred accounts, eventually you will need to pay Required Minimum Distribution (starting at age 70). This can potentially be a large amount, and you’ll pay taxes on this distribution whether you use the money or not.
Ideally, you want to have as much of your assets in Roth accounts as possible, however, given your high tax bracket it would be advantageous to have tax-deferred assets as well as Roth and after-tax. The Roth component might be small in the beginning, but later on when you are retired (or not working as much), you might consider converting some of the tax-deferred assets to Roth. You should also not neglect after-tax assets, because you will want to pay any taxes on Roth conversions using after-tax money.
Yes, the money you put into his 401(k), your individual 401(k), and his defined benefits plan all reduce your taxable income and thus your taxes. The money that goes into a non-deductible IRA and is then converted without any additional tax does not reduce your taxable income this year. It’s still a good idea because the earnings on the money in the Roth IRA will never be taxed. If you choose to convert pre-tax money to a Roth IRA, rather than non-deductible money to a Roth IRA, there is a tax cost to that. So it isn’t generally a good idea during your peak earnings years.
regarding solo 401k contributions. My wife puts in the max employer contriubtion (18k) at her full time job. she is also self employed (IC) making approximately 15k this year. when calculating the amount she can contribute to the solo 401k, I understand it is 20% of ‘net profit.’ I am trying to clarify what net profit means. Is this the amount she makes after subtracting off business expenses (ie computers etc) and SE taxes? Or is it based on the total income – SE taxes?
which example would be correct:
A) 15k profit. SE tax would be 2,119. Therefore 20% income would be based on 12,881 and could put 2576 into solo 401k
B) 15k profit SE tax 2,119. Business deductions, for example, of 5k.
12,881-5k = 7881. 20% of ‘net profit’ of 7881 would then be 1576
Try this:
https://personal.vanguard.com/us/SbsCalculatorController
Click below on ‘how did we get these figures’.
Yes, take your gross profit (income minus expenses) and then subtract out your SE taxes and take 20% of what’s left. So B.
By the way, you’re using the word “profit” incorrectly. Profit is what’s left AFTER expenses, not before.
Thank you for the great article. I was hoping you can give me some advice on my situation. I am two years out of school and am the sole owner of a dental practice. My wife has an administration job at the local university and has a 403b but is also being paid through my practice for website and marketing management. At her administration job, she has a 200% match of 3% of her salary. The first year of practice, we max out my simple IRA, my wifes 403b, and did Roth IRA’s for my self and my wife. I am not planning on doing a Roth IRA next year due to our tax rate and large student loans. I am looking to move to a 401k with profit sharing next year in my practice. Is there any way to set up a 401k for my wife at my office and have her total contributions between the 401k and 403b be greater than 18k without her emplyeer contributions? If you see a better way to structure our retirement that advice is also much appreciated. Thanks!
First, I don’t like SIMPLE IRAs due to their effect on the backdoor Roth. So I think your move away from that is good, although if you have employees at your dental practice you probably need professional advice on this topic to see what the best option is for you.
Second, yes, she gets an $18K employee contribution, plus the match at the regular job. She can get an employer contribution at your practice equivalent to almost 20% of what she makes there. But be aware there are rules regarding how much you have to give the other employees.
You can also make Roth contributions to your 401k (or do in-plan Roth conversions). I would still consider doing backdoor Roth contributions. However, the question of whether you should have a 401k or a SIMPLE is not that simple. I’ve written an article for the last Dentaltown Magazine issue specifically to address this important point:
http://www.dentaltown.com//Dentaltown/Article.aspx?i=403&aid=5625
As WCI says, it all comes down to your practice demographics, so before you consider doing a 401k with profit sharing, you’ll need someone to do a thorough analysis of your personal/business finances to make sure that it would be an appropriate plan for you given what you are trying to accomplish. Part of that analysis would be a comprehensive design study to make sure that your practice demographics allows you to have a plan that is cost-effective for you and where your employer contribution to the employees is reasonable and manageable going forward.
I would also consider NOT doing 403b salary deferral contributions into your wife’s plan if the investment choices there are not very good vs. doing it into your plan instead (and contributing only enough to get a match, if any, into her 403b plan).
Hello WCI and Kon,
I have read through ALL of the comments on multiple posts and cannot find any situations that are similar enough to mine; thus, I am in need of your expert advice.
I was working as a W-2 employee anesthesiologist up until October 1 of this year. That employer made 3 quarterly contributions ($13,250 for $53K IRS max) for 2015 in a Fidelity non-prototype “pension” plan. It required no contributions on my part, so I made NO employee contributions to the plan.
I got married in October of this year. I turned 36 earlier this year.
Starting on November 15, I started a new job with a group that required me to set up a PA (professional association) that will file with the IRS as an S-corp. They also recommended that I set up a solo 401k plan (and not SEP)–which benefits me because I do a backdoor Roth every year (and it’s my understanding that SEP’s can interfere with this). The group pays my PA $335k/year for contractor “salary”. I then will pay myself W-2 wages from this PA that I own. They recommended to me to pay half of the $335k as W-2 wages ($167,500) and then keep the other half in the PA (to keep the IRS happy). From the other half that remains in my PA, I would pay expenses (computer, cell phone, internet, CME, car mileage, work entertainment/meals, etc), health/dental insurance, malpractice insurance, and solo 401k funding–all pre-tax. Whatever is left over in the PA after all of that, I would take as a K-1 distribution (thus saving me the self employment taxes on that portion). They have instructed me to withhold at a higher rate on my W-2 wage payments to account for federal withholding that will be paid on the K-1 earnings.
I have the following questions:
1. Does splitting the $335k into 50% wages and 50% PA/expenses/K-1 make sense? E.g. Would it avoid ire from the IRS? Should I consider a different breakdown–more in wages/less in PA or less in wages/more in PA?
2. Since I have made no employee contributions to a retirement plan in 2015, would I be able to have withheld from my W-2 wages for 2015 some or all of the 18k IRS max for employee contributions? If so, what would be the most I could contribute for the 1.5 months of wages I will receive for 2015? Would changing the breakdown of wages vs. PA FOR 2015 make sense to max out retirement for 2015 taxes, given that employee contributions have to be made before 12/31/15 (and then potentially changing the amount of W-2 wages for 2016 if necessary)?
3. How much could I contribute from the PA for the “employer” contribution for 2015, given the fact that I have until the PA taxes are filed in 2016 to make “employer” contributions for 2015? According to what I have read so far, the $39,750 (75% of 53k IRS max for 3 quarters of employment) that my previous employer contributed to my previous “pension” plan should not affect the separate $53k max that I can contribute from my PA as the “employer” contribution for 2015? Would the amount I can contribute for 2015 be 25% (because of S-corp status) of W-2 wages pre-tax or net/after tax?
4. For 2016 (and I guess for 2015 also), how much W-2 wages would I have to be paid from the PA in order to maximize both the EMPLOYEE and EMPLOYER contributions to the solo 401k?
5. When setting up the solo 401k, would it matter if I used TD Ameritrade or Etrade? My plan is to just invest in no commission ETF’s. Would there be any way to include my spouse somehow in the solo 401k (since she is 50% owner of my PA–see #7 below)? Does the plan need to be covered under ERISA?
6. As mentioned, I have the pension from my previous employer that has about $105k (pre-tax EMPLOYER contributions). I also have an old 401k from a previous job that has about $45k from years ago (pre-tax employee/employer contributions). Should both of these be rolled over directly into the new solo 401k that I will be setting up? Would there be any advantage in rolling these into a different type of account (IRA/SEP) before ultimately rolling them into the 401k (keeping in mind that I still want to retain the ability to do a backdoor Roth)? Would there be any advantage for me to start a defined benefit plan instead of a solo 401k in order to defer taxes on larger amounts of money?
7. With my new marital status, are there any ways that I can defer further taxes with my new “married” status (other than possibly starting to fund a backdoor Roth for my wife)? My wife is finishing nurse practitioner school but for a few different reasons, she may not be practicing when she gets done. Thus, she is not employed. However, because of Texas laws, she is 50% owner in the PA with me; she owns 50% of the PA/S-corp, and I own 50% (according to how the PA/S-corp was required to be set up). Are there any opportunities to take advantage of for retirement/deferring taxes by having her as 50% owner of the PA/corporation? Am I missing any other spouse opportunities for tax savings? Any advantages to finding a way make my spouse an employee of the PA?
8. I also contribute the IRS max every year to an HSA account. Am I myself missing any other opportunities for tax savings?
I realize have asked SO MANY questions, but I am grasping at straws at this point because every expert I have consulted has little to no knowledge regarding my particular situation (or regarding professional associations in general). If any of the above questions are hard to understand, I am happy to provide clarification.
Thank you SO MUCH in advance for any help/advice you can provide. I am forever grateful.
1. Seems reasonable. The more you claim as distribution the more you save in taxes. The less you claim the less likely the IRS is to disagree with you. The 50% rule is good.You want the salary to be high enough to max out retirement plans because you can’t put distributions in there.
2. $18K. + 20% of net salary (net of SE taxes)
3. The 20%/25% number is basically the same number as the 25% doesn’t count what you put in and the 20% does. Sorry they make it so confusing. It’s net of SE tax, not income tax. But if your salary is more than 50% for the rest of 2015, you could put more in there for this year. Don’t know if you can afford to do that though.
4. $35K*5= $165K. Add a little more to make up for the SE tax. Maybe $175-180K or so. Takes less money to max out a 401(k) than a SEP-IRA.
5. There are subtle differences, but both are probably fine. I’ll leave the ERISA question to Kon. It’s not clear to me why your wife would be 50% owner. That seems a little squirrelly. I’ll leave that one for Kon too.
6. I’d roll them into the individual 401(k) (assuming the pension is eligible, which it probably is.) No advantage to stopping in a SEP-IRA that I can think of. I would only stop in a traditional IRA if it was somehow required and I don’t see why it would be. I would not use a DBP instead of an individual 401(k). I’d use it in addition if I were going to use it at all.
7. The problem with being an owner is that money can’t go into retirement plans, which is the biggest tax savings. She would have to be paid a salary to do that. I’ll try to think if there is some other tax-saving opportunity there but I can’t think of one right now.
8. Personal DBP would defer a lot of taxes. Obviously being married, especially to a non-working spouse, saves you tons because you now use the married tax brackets. Plus if you don’t make too much, you get another exemption. Plus the standard deduction is larger. Those are the main benefits.
Lots of good questions. This is basically an entire ‘case study’ from start to finish. What entity should one set up? What salary is reasonable? Should spouse be a part owner or and/or an employee? How much should the spouse be paid? Where is it better to open a solo 401k plan? Should you roll over your old SEP/401k accounts into the new plan? Should you add a Defined Benefit plan to your solo 401k? At what age would that make sense? All great questions – the answers will depend on specific individual situation.
I imagine the 50% ownership of wife is a Texas (community property) rule. There are 7 states that are community property states. WCI readers would probably do well to consult with an estate planning attorney in those states to make sure they fully grasp these rules. Some are beneficial (asset protection) and some are not.
As far as saving on the SE tax, remember that you are only saving on the SS portion of that tax when your W2 wages are over the wage base. In essence, every dollar of SCORP distribution (as opposed to W2 wage) over the SS wage base is saving 3.9%, not the full 15.3% SE tax. So if you need to claim a higher W2 wage it doesn’t hurt as much tax wise.
If you pay your a salary then you will end up paying the full 15.3% SE tax on her wages, including federal income taxes too. As an employee she would pay 7.65% and your business would pay the other half. She could then defer her 18k into the plan and you can added profit sharing into her account as well. Is it worth? Probably, but the 15.3% SE tax makes the comparison less favorable in my opinion.
It’s not as if she isn’t getting something for that 12.4% SS tax. She gets SS earnings and additional quarters.
Hi guys,
So I’ve read this blog quite a bit and still a bit confused, probably because everybody has different scenarios. Anyways, wanted to make sure I was correct. So I was employed with Hospital A from Jan 1 to June 30 as a W2 employee with the option of 401k (unfortunately did not make any contributions), then July 1st to Dec 31st I am employed with Hospital B with the option of 403(b) (I made $18k contributions), also from Jan 1-Dec 31st I have a 1099 from Hospital C (Not sure how much I can contribute here and to SEP or solo401k — thinking 20% of my gross profit to max of $53k). Please let me know if I am right or what I should do…Thanks guys!
Yes, sounds right. 20% of 1099 income net of SE taxes into a SEP or individual 401(k) (since you used your employee contribution at hospital B 403(b). I recommend the 401(k) to preserve the backdoor Roth option.
If you have a 403(b), your TOTAL contribution to that and a solo 401k can be no more than $53k, unfortunately. If you had a 401k for the W2 job, you could have $18k + match AND another $53k via profit sharing.
Good point. I forgot about the unique 403(b) rule.
Very interesting article and very helpful. I have a couple of question for WCI
1. Could you use a Mega back door Roth in an individual 401 K plan to get to the maximum 53K. Hypothetical situation of a doctor who has W2 income of 350K and maxes out the hospital 401 K employee deferral of 18K. He has a 1099 locum job that brings in an additional 60K. He puts 12K (20% of 60K employer contribution) into the individual 401K plan. Could he then put an extra 41K as an after tax Mega back door Roth into the individual 401K retirement account.
2. Does the IRS permit putting extra 18K as employee contribution to the individual 401 K or is this a gray area open to interpretation?
Thank you.
1. No. I don’t know of an easily available 401(k) that allows the Mega Backdoor Roth option. But if the plan allowed it, I don’t see why you couldn’t do it. You might even be able to have a custom-designed individual 401(k) that specifically allowed that. Great thought. Other good resources on that topic include Kon Litovsky, who helps design custom 401(k)s at Vanguard, and The Finance Buff blog, who has written all kinds of good stuff about the Mega Backdoor Roth.
2. You only get one $18K employee contribution, no matter how many 401(k)s you have. So if you used it up at your W-2 job, you can’t use it again in your individual 401(k). Not gray.
Right, as WCI said, it is possible to convert your plan assets to Roth inside the solo 401k plan with a custom plan document, but unless you have a big balance in the plan and/or you are making large contributions, I wouldn’t bother with that. I would suggest making your salary deferrals into your solo 401k plan instead as I’m sure your investments will be lower cost and better quality at the likes of Vanguard, Fidelity and Schwab and you can do Roth salary deferrals ($18k a year), and backdoor Roth ($5,500 per spouse), and this will probably be enough. If you really wanted to do mega backdoor Roth, you might be able to roll your solo 401k contributions periodically and convert them to Roth outside of the solo 401k plan, which is also an option (though not sure if all solo 401k plan providers allow for this, and it might also have to be added to the custom plan document, in which case you might as well get one that allows in-plan Roth conversions).
They’re talking about a Mega Backdoor Roth- so the custom plan document would have to allow both after-tax contributions beyond the employee contribution and employer conribution and in-plan conversions. Can you design an individual 401(k) that allows that? Basically, it would allow someone with a $60K 1099 income to put $53K of it into an individual Roth 401(k).
YES! In fact, with in-plan Roth conversions, you no longer have to take the money out, and you can convert after-tax contribution to Roth inside your plan. Not bad! This probably makes a custom plan document definitely worth it now regardless of where the solo 401k plan is.
I’ve asked the TPA to give me a set of rules on what exactly can be done, as much of this is relatively new so there isn’t as much written about it yet.
For the right person, absolutely, but there are many more right people if you can do this. This is a big deal.