By Dr. Jim Dahle, WCI Founder
If you work as an independent contractor, meaning you get a Form 1099 each pay period instead of a W-2, you're responsible for your own benefits, including a retirement plan. Your two main choices are a SEP-IRA or a solo 401(k), aka an individual 401(k). This post will help you decide which to use. If you want the TLDR version, the right answer for you is probably a solo 401(k).
But let's explore the issue further.
What Is a SEP-IRA?
Simplified Employee Pension Individual Retirement Arrangements, or SEP-IRAs, are a good fit for a small business owner with few to no employees or the self-employed. A sole proprietor under 50 can shelter 20% of net business profit, up to a total contribution of $66,000 for 2023 and $69,000 for 2024. If you have employees, you'll have to contribute an equal percentage of income into their accounts as you did into your own.
The amount placed into a SEP-IRA is 100% tax-deductible. You take this deduction on line 15 of Form 1040 Schedule 1. Whatever amount you put into the SEP-IRA becomes an “above the line” (the line is line 11 of Form 1040, aka “Adjusted Gross Income” or AGI) deduction.
Advantages of a SEP-IRA
While a SEP-IRA is usually the wrong choice for most independent contractor doctors, it does have some advantages over a solo 401(k).
- A SEP-IRA can easily be set up online with most major brokerage companies, such as Vanguard, and funded with a simple electronic funds transfer from your personal or business account. It took me less than five minutes when I opened one many years ago. (Note that I switched to a solo 401(k) later.) This simplicity is a significant advantage over a solo 401(k).
- Another advantage of a SEP-IRA is that the account can be funded after the end of the year AND it can be opened after the end of the year. However, this advantage was lessened by the Secure Act 2.0 legislation, which basically allows the same thing even for the employee contribution of a solo 401(k). You just have to open and fund the account before your tax date—usually April 15, but it can be as late as October 15 with extensions.
- Starting in 2023 and as a result of the Secure Act 2.0, there is now the possibility (if your SEP-IRA provider allows it) of Roth contributions into a SEP-IRA.
- You can roll over a SEP-IRA into a Roth IRA each year as a Roth conversion, too. There is no two-year waiting period like with a SIMPLE IRA or a SIMPLE 401(k). Most solo 401(k)s don't allow in-service rollovers out of the plan.
- Unlike a solo 401(k), you are not required to file IRS Form 5500-EZ each summer for a SEP-IRA, even once the account has more than $250,000 in it. While this form is not hard to fill out, the penalties for not doing so are massive.
More information here:
Best Retirement Savings Plans for the Self-Employed
How to Open a Solo 401(k) at Fidelity
What Is a Solo 401(k)?
Solo 401(k)s were introduced in 2002, and they are a good fit for the self-employed/business owners—even those who employ their spouses if there are no other employees that would qualify for the 401(k). Both the owner and the employed spouse must receive the same percentage of contribution.
Rather than limiting contributions to the usual amount of an employee 401(k) deferral ($22,500 per year in 2023; $23,000 in 2024), the laws allow you to also put in an employer contribution (really all the same money for a sole proprietor) for a total of up to $66,000 per year in 2023 ($69,000 in 2024), exactly the same total contribution as a SEP-IRA. If 50+, you also get an extra $7,000 as an employee catch-up contribution.
A solo 401(k), however, is a more complex beast than a SEP-IRA. You are required to have a plan document, for instance. This isn't a big deal, and the paperwork at most brokerage options walks you through it quickly, but it will take longer than five minutes. It is not unusual for it to take a few weeks to get it all set up. With that complexity, however, comes a number of options not available in a SEP-IRA.
Once there is more than $250,000 in it, you'll need to file Form 5500-EZ each year too. Do not forget this. It's due July 31 each year starting the year after it finishes the year with $250,000+ in it. Even if you have two solo 401(k)s (for some dumb reason) and the total is more than $250,000, you'll need to file this form.
If you are interested in “self-directed” retirement accounts (used to invest in non-traditional assets like precious metals, cryptocurrencies, real estate, etc.), both SEP-IRAs and solo 401(k)s can be used.
More information here:
7 Advantages of a Solo 401(k) vs SEP-IRA
There are at least seven ways solo 401(k)s are better than SEP-IRAs.
#1 Higher Allowable Contributions for Many Earners
As a sole proprietor, you only needed $217,500 in income to max out a solo 401(k) in 2023, but you needed $330,000 to max out a SEP-IRA. This is because part ($22,500 in 2023) of the total $66,000 [2023] contribution is an employee contribution and doesn't enter into the employer contribution amount calculation. This income ($217,500 or $330,000 in 2023) is net of all business expenses, including the employer half of the payroll taxes.
Here's a SEP-IRA calculator to figure out the annual contributions permitted. Sometimes this 20% number is phrased as 25% of wages, but for a sole proprietor, this is really the same number. It's 20% if you include the retirement plan contribution, and it's 25% if you do not include the contribution itself. Note that if you are an S Corp (or an LLC filing as an S Corp), you are limited to 25% of actual wages paid. Even if the business made $300,000, if you only paid yourself $100,000 as salary, your employer contribution will be limited to $25,000.
#2 Loans
You can potentially borrow money from a solo 401(k) but not a SEP-IRA. You probably shouldn't borrow from either, but at least the option is there in case of catastrophe. You can generally borrow up to $50,000 per year or 50% of the balance, whichever is less.
#3 Backdoor Roth IRAs
SEP-IRAs must be taken into the pro-rata calculation when converting non-deductible IRAs to Roth IRAs, but, thanks to the Secure Act 2.0, that requirement will be dropped in 2024 for the Roth portion of SEP-IRAs. Solo 401(k)s are not subject to that rule. As a result, most SEP-IRA users couldn't do a Backdoor Roth IRA and missed out on this great opportunity. Learn more with our Backdoor Roth IRA Tutorial.
#4 Roth Contributions
Inside a solo 401(k), your “employee contributions” (up to $22,500 for 2023 and $23,000 for 2024) can be designated as Roth contributions. This allows you some tax diversification benefits, and it also allows you to save more money in a tax-protected manner since after-tax money is worth more than pre-tax money. In fact, all $66,000 in 2023 ($69,000 in 2024) can be Roth if you do the Mega Backdoor Roth IRA process (see #5 below). The Secure Act 2.0 lessened this advantage, however, because starting in 2023, Roth contributions are now allowed in SEP-IRAs (although it's still hard for me to find one that actually allows it.)
#5 Mega Backdoor Roth IRA Contributions
Although SEP-IRA contributions can be converted into a Roth IRA each year, only a 401(k) allows a true Mega Backdoor Roth IRA contribution. These are after-tax contributions with either in-plan Roth conversions or in-service withdrawals with a conversion to a Roth IRA. These allow investors to put the entire $66,000 contribution into a Roth account. This can be very beneficial when trying to maximize the 199A deduction.
#6 Asset Protection Benefits
Although many states protect IRAs and solo 401(k)s equally from creditors, at least two (Minnesota and South Carolina) give additional asset protection to solo 401(k)s over IRAs.
#7 Catch-Up Contributions
Starting at age 50, an employee can contribute an extra $7,500 [2023 and 2024] into a 401(k) as an employee contribution. This cannot be done in a SEP-IRA.
That's a lot of advantages. I have used both types of accounts to good advantage at various times in my investing career. However, my general recommendation for an independent contractor is to use a solo 401(k) for the reasons outlined above.
However, if you don't care about any of those advantages, take a careful look at a SEP-IRA. You can always roll it into a solo 401(k) later.
If you have employees, choosing a retirement plan is no longer a do-it-yourself project. You should seek out professional help to study your business, understand what you want out of a retirement plan, and understand what your employees are likely to do if offered a retirement plan. The right plan for your business may be a 401(k), a SEP-IRA, a SIMPLE IRA, or no plan at all.
What do you think? Do you use a SEP-IRA or a solo 401(k) and why?
[This updated post was originally published in 2011.]
I am contributing 24% of my gross income yearly (excluding 529 plan). I started late but stayed the course. I have been doing this for a little over 10 years. As university employee, my salary is not that great but I am maxing it with extra shifts of moonlighting. currently, when I say 24%, it is from the total gross income I am making. Though that is the percentage, I am not maxing the 403(b) option I have. my ORP of 401(a) is of course there. I took to heart your article on budgeting. As long as I am contributing above 20% of my gross income, no credit card balance, no debt at all, as a family we indulge on the leftover a bit (your article on budgeting that I read is spot on my case)!!
I think your advise of switching to solo 401K is the best option. I will pursue that.
Thank you!
The decisions get harder when you’re not maxing out everything available, because now you’re choosing between Roth and tax-deferred (or tax-deferred and tax-deferred), rather than taxable and Roth/tax-deferred.
I got it when you say taxable and tax-deferred. I will first max the 403(b).
I have forwarded your blog to friends. You are truly a hero to us!
Dave
You’re welcome. It’s still a labor of love, it just happens to also be a profitable one now.
Army doc here. Max out Roth TSP, wife has 401k from prior job, both have Roth IRA’s. Moonlight and get 1099 income that I’ve been putting into SEP IRA, haven’t contributed for 2015 yet. For 2015 started a new moonlighting gig with W2 and maximize the 401A and 457B they have. Separating in 2016 and suspect I’ll be over income limits for Roth for 2016. 1. How does WCI recommend I proceed? Whether I’m employed or not I still suspect I’ll be getting some 1099 income going forward. 2. Are there any tax implications if I roll over my SEP IRA to a solo 401k? 3. If I get to the point where between the TSP/401a/457B I run up against the $50k limit, would I be better off reopening a SEP at that point?
1. Convert the entire SEP to Roth IRA every year. When you separate, start doing backdoor Roths. Read up on what happens to that 457B when you leave. It may not be the deal you think it is if it isn’t governmental.
2. No.
3. I think you should read this article: https://www.whitecoatinvestor.com/multiple-401k-rules/ and this one: https://www.whitecoatinvestor.com/401-a/ and this one: https://www.whitecoatinvestor.com/should-you-use-your-457b/
You get one $18K employee contribution per year to a 401(k). But the 401(a) and 457(b) limits are totally separate. So is the employer contribution into a SEP or individual 401(k) at an unrelated employer. So if you were working for the military, on a W-2 for someone else offering you a 401(a) and a 457, and doing IC work somewhere, and had enough income at each place, you could:
Put $18K into the TSP (plus match now I hear)
Put $18K into the 457
Max out the 401a
Put $53K into an individual 401(k).
Most docs wouldn’t be able to do all that though- not enough income.
I think I’m in trouble…I’m 51 y/o, working on a 1099 most of last 7 years, have no retirement account at all and only about 20k in a “stashing” away for Emergency account. The sheer amount of information here is overwhelming..( I also have close to 200k in student loans!) I started reading the blog as research to identify what to do: begin saving for retirement vs paying off student loans, which so far, if I’m understanding correctly, I should begin creating some wealth and continue to pay my loans which are at 3.5 and 8.5 (ouch!).
I’m thinking the first step should be opening a solo 401K. What do you think? Am I in the right track?
Take a deep breath. You might feel “behind” when comparing yourself to those who found this site a year or two ago or who found it at age 35. But you’ve still got plenty of opportunity to right the ship.
I think the first step is to make a plan. You would likely be very interested in the online course that goes live on January 15th.
Presumably, no one else is going to pay those loans off. So you might as well refinance them. Especially that 8.5% one.
Is opening a solo 401(k) a good idea for you? Sure. But if I had an 8.5% loan I’d be eating 1-2 meals a day until it was paid off or refinanced! That’s a fantastic guaranteed return. Once you refinance it to 3-4%, maybe it makes a little more sense to max out the solo 401(k) first.
Swing by the forum and and keep asking questions. The WCI community can really make a huge difference in your life in a very short period of time.
I’m a fellow on W2 and 1099 for moonlighting. My understanding is that to open SEP-IRA 1099 is enough. I don’t need to open/register company etc. But when I want to open account with Vanguard, it’s asking me if I’m employed or self-employed. I probably should choose self-employed when opening SEP-IRA – but then it’s asking me for company name, address etc. In theory I could put my home address, but I haven’t officially registered anything at home. Any suggestions? Thank you for your help. Greatly appreciate your time helping all of us!
Yes, choose self-employed. Yes, put your home address. You’re a sole proprietorship.
I love your blog! It is so helpful and like many others, i just wish I had found your blog sooner. 🙂
I am a physician in private practice where in 2015, I received $200k on a W-2. Unfortunately, my employer offers no retirement plan (but does pay for my health and malpractice insurance). I also do some consulting services on the side, so received about $15k from a 1099-MISC. I anticipate that in 2016, my W-2 income will be slightly higher, around $230k and my 1099-MISC income about the same.
From before, I have about $20k in a Roth IRA and $5,500 in a Traditional IRA. Attempting to max out my retirement options, I am contributing $5,500 to a Traditional IRA and $3,350 to an HSA for 2015. It just occurred to me that because of my 1099 income, I could potentially open a solo 401k or SEP-IRA and put away more. Some questions for you:
1. I think it’s too late solo 401k for 2015, right? If so, I will open up a SEP-IRA for 2015. From what I understand, I can contribute up to 25% of income from 1099 to my SEP-IRA which in my case would be $3,750. Is this correct?
2. For 2016, is it more beneficial to open a solo 401K?
3. Is an EIN the only thing needed to open a solo 401k or SEP-IRA? Do I have to be an LLC, S-Corp, etc?
4. Do you recommend doing a backdoor Roth conversion for the $11,000 in my Traditional IRA and the amount I will contribute to my SEP-IRA for 2015? Or, if I open up a solo 401k for 2016, would it be possible to wait and rollover the money in my traditional and SEP-IRAs? Is that more beneficial? I am looking at the TD Ameritrade solo 401k.
5. Do you think I should stay as a W-2 employee or switch to 1099 for my private practice? Based on the numbers provided, I’m wondering if I should ask to switch to 1099 since I don’t have any retirement options currently as a W-2.
Sorry for so many questions, but I really appreciate any advice you may have!
1. Yes
2. Yes, you could put just about all $15K into it where you could only put $3K into a SEP. Plus the SEP would screw up your backdoor Roth IRA.
3. No, just an EIN and a sole proprietorship.
4. Both are reasonable options. With a conversion, you get more Roth money. With a straight rollover, you have lower taxes.
5. I like self-employment, but if you get paid exactly the same either way, and with the SE option you have to pay for your benefits and both halves of the SE taxes, I’d stick with the W-2. If you can get them to pay you ~10% more, then I think it’s reasonable to go 1099.
First time poster, financial planning newbie! We broke up w our residency financial planner due to high fees once I finished, so I’m doing it alone.
My main source of income (about 65% of gross) is a W2 job with a 401k without any employer match, to which I am not even eligible to contribute until I have worked 1,000 hours – given my part time schedule, this won’t be for at least 2 years.
So my question is – SEP IRA or solo 401k? Seems like solo 401k would allow a larger contribution given that my total 1099 income will be around $50-60k/year (less this year due to maternity leave). Can I contribute $49,000 each year regardless of income? How do I set one up? Must I be an S corporation? So far, I am just an individual. Is there a way to contribute post-tax income to
a solo 401k? And if not, am I not better off just saving for retirement in regular old index funds with post-tax dollars, which is what I am doing now, and not setting up a solo 401k at all?
I don’t foresee being able to afford to contribute more than 50k per year for several more years. But I very much need to know the best options for retirement savings given that I spent so much time in PhD and residency training that I am 39 with very little saved! I so appreciate the help. Have purchased your book and really like it so far.
Solo 401(k).
The limit is now $53K per year but you have to have enough income to justify it. With no other 40(k) and $60K in income, you could get about $30K in there if under 50.
You can open one at Vanguard, eTrade, TD Ameritrade, Fidelity etc. All have advantages and disadvantages as noted here: (be sure to read the comments) https://www.whitecoatinvestor.com/where-to-open-your-solo-401k/
It can be done mostly online but if you need help, call them up and they’ll walk you through it.
No, you don’t have to be an S corp but you do need an EIN.
You can do a Roth solo 401(k) for the employee portion of the contribution ($18K this year but if you use your work 401(k) later, then you won’t be able to do both employee portions).
No. You’re better off using your available tax-protected accounts prior to taxable accounts.
Ideally, you should do your work 401(k), your individual 401(k), a backdoor Roth IRA, and then if you want to save more each year for retirement, in a taxable account. Be aware you’ll need to roll that IRA into a 401(k) (preferably your solo one) or convert the whole thing in order to do backdoor Roths.
You’re 39. $5500 a year isn’t peanuts. If you put $5500 a year into a Roth IRA from now until you’re 65 and it grows at 8%, that’ll be worth $474K at age 65, or an income of about $20K a year in retirement. If you’re married, double everything. A million bucks in Roth IRAs is more than most people retire with.
I dont think anyone should be expecting 8% a year in returns going forward given current valuations and interest rate levels. maybe 5%. still 5500 a year at 5% tax free is good.
What does your crystal ball say future returns will be?
https://www.whitecoatinvestor.com/making-different-choices-due-to-low-expected-returns/
If you really expect such terrible returns for stocks going forward, you should consider alternative investments such as real estate. But consider that Rick Ferri is still calling for 5-7% real long-term returns on stocks:
https://portfoliosolutions.com/latest-learnings/blog/portfolio-solutions-30-year-market-forecast-2015
Now if you mix that with a big chunk of short term treasuries with a 2% yield, then sure, 5%. But otherwise, bear in mind there are very real consequences to living your life assuming your portfolio won’t even make 5%-working longer, saving more, spending less in retirement etc.
Thanks very much for the info. I am now wondering, though, wouldn’t a backdoor Roth rolled into a 401k still be subject to the same contribution limits (i.e., I could contribute a max of 18k/year to all 401ks?) Seems to me the reason for a solo 401k is the ability to contribute the employer portion as well, thus increasing my total contributions. And if I have more to save, a SEP IRA?
Also looks like my 1099 income this year will only be about $33K, not $50K, so I’m calculating I can get about $23K in my solo 401k (after doing the IRS math to figure the employer contribution).
I was going to say, I have my regular IRA in the Vanguard Target Retirement 2060 fund…and the rate of return over the last 10 years has been maybe 4%. Of course, that is a risky fund at this time due to its high stock composition…but I don’t think I’ve seen anything like a sustained 8% return over the last 10 years! So I want to save as much as I possibly can while I’m still >20 years out from retirement. (Hoping to retire closer to 60….my husband has been maxing his IRA, 401k, and employee stock purchase options at his software company for 8 years, so I think we are on target to hit 1 million well before we retire).
It’s a little hard to follow what you’re talking about, and I think it’s because you are confused about the various limits and how the retirement plans work.
The employee contribution to all 401(k)s is $18K total. The maximum contribution to any given 401(k) is $53K. The IRA limit is totally separate. If you can’t deduct an IRA contribution, and can’t make a direct Roth IRA contribution, you should do a backdoor Roth IRA. In order to do that, you need to either convert or rollover into a 401(k) any existing SEP, SIMPLE, and traditional IRAs. You cannot do both an individual 401(k) and a SEP-IRA for the same business in the same year. Hope that helps.
If you don’t want to use 8% in your projections, use whatever figure you feel comfortable using. But bear in mind that a 10 year period is a relatively short period and any 10 year period that includes 2008 is going to look worse than any period that doesn’t include it. For example, the TR funds that were started after 2008 have returns of 9-10% a year. The one started in 2006 is 6% a year and the one started in 2003 is 7% a year. Those all basically have the same asset allocation- the differing returns are simply a function of the start date.
Wanted to edit above comment but unable to figure out how to do so. I also do not understand backdoor IRAs at all; I have a regular IRA which I max out, but $5500/year is peanuts at my age. How would SEP IRA vs solo 401k vs backdoor Roth work for me?
Hi Jim,
If one is in 50% partnership in an LLC filing as an S-corp (hence both owners get W-2), do you know if one can still open a solo 401k? I haven’t found much clarifying info on this matter.
Thank you!
If the partner is your spouse you could. Otherwise, no.
I have a W2 job and plan on getting a 1099 independent contractor job. Can I open up a sep-ira with the 1099 job income on top of the 401k I fund with the W2?
Yes, but you probably should do an individual 401(k) instead so you can do a backdoor Roth IRA too.
can you do sep-IRA for self employment (20% as employer contribution) if you have already been doing the Backdoor entry ROth 5500 $ at Vanguard. Can I open SEP IRA with VANGUARD and put 20% of my self employment income in it
My husband is physician makes about 520000 from his employment where he puts 18k with no match in the 403b provided via his employer.
I puit 18k with 5 % match in TSP at VA.
We both put 5500$ for each at Vanguard by opening traditional non deductible and then roth- and converting it to Roth using back door entry for past two years at Vanguard.
This year my husband started working in private clinic getting paid on cash and checks (1099) and estimate income of 40k for this year with potential growth to 70-80k next year.
Since he already maxed out for his contribution at 18k ; and backdoor entry roth at 5500;
Which will be a better option for us- SEP IRA or solo 401k
Yes.
Yes.
Solo 401(k). The SEP-IRA will screw up your backdoor Roth IRA unless you convert the whole thing each year to a Roth IRA.
Ok, I have tried to figure this out but I’m having trouble keeping it all straight, so if you could clarify I would be SO GRATEFUL:
I am active duty military, and I max my TSP every year. In addition, I max my IRA for the year every January and do the background conversion. (Not sure if it makes a difference, but my spouse does the same)
Recently, I started moonlighting as an independent contractor, and I would love to take advantage of either a SEP or Solo 401K as well, but I’m having trouble figuring out which is better. (Anticipating between 24-48K/yr 1099)
The SEP seems easier, but am I going to run into trouble since I also have a Backdoor Roth?
Also, from a couple calculators, it seems like I could put much more into a Solo 401K- true?
The SEP is easier, but you should still do a solo 401(k). Hurry. You need to have it set up before the end of the year. If you don’t make it, do a SEP for this year (you have until April for that) and either convert it all (not a bad option in the military) or roll it into an i401(k) next year.
So, I just realized that I may have been a little confused, and possibly messed things up a bit here. Here is what I have been doing:
(1) I maxed out my employer’s 401(k) ($18,000 max) for the year
(2) Last month, I rolled over my traditional IRA to my employer’s 401(k). Then I contributed $5500 to the traditional IRA in anticipation of doing a backdoor Roth IRA conversion in the near future (i.e., in the next 9 days)
So far (I think), so good…Until I realized…
A few months ago, I opened a SEP-IRA, and contributed ~18% of the net income from my moonlighting gig (~$9000). I did this not realizing that the SEP-IRA would be included in any pro-rata calculations (duh!)…
So now, I think am stuck with two options: (1) (quickly) rollover the SEP-IRA to my employer’s 401(k) and then proceed with backdoor Roth IRA conversion (do I even have enough time for this?) -or- (2) Keep the money in the traditional IRA, and not have any tax benefit for that contribution (double taxation); but still claim the tax-deduction for the SEP-IRA contributions against my 1099 income. Any suggestions?
On a related note, I did not open a Solo 401(k) because I was under the impression that I needed to form an LLC (or similar corporate structure) in order to qualify for this benefit? I am an independent contractor for a hospital in the area, and I do not have my own EIN; the 1099 is reported under my SSN. Do I qualify for the Solo 401(k) without establishing an EIN?
Thanks for the help! And thanks so much for all of your advise on this website and in your book- I recommend it to all of my friends!
1) You probably don’t have time.
2) There’s no double taxation, you can do the conversion step next year if you like.
You have a third option- convert the SEP to a Roth IRA before the end of the year.
You don’t need an LLC, just an EIN. But the EIN is free and takes 3 minutes.
Thank you for this awesome website.
I’m a resident at a county hospital, and I also moonlight.
For 2016, I maxed out my employer’s 403(b) (18k), and 457 (18k) plans, both pre-tax, and I received an employer match (6%).
My moonlighting income was ~10k reported on 1099 misc.
I opened a solo 401(k) in Dec 2016. I understand that I cannot do any elective deferrals in the solo 401(k) because I have already maxed out the 403(b).
Am I correct in my understanding that I can contribute a maximum of 20% of the adjusted net profits (net profits – 1/2 of SE tax) from my 1099 income as the profit sharing component of the solo 401(k)?
Yes. Just remember the maximum into 403(b) + individual 401(k) is $53K total for 2016 and $54K total for 2017 due to a unique little 403(b) rule discussed here:
https://www.whitecoatinvestor.com/multiple-401k-rules/
I’m amazed at how much you’re saving as a resident.
Thank you for such a prompt reply.
So, the 457 contributions do not count towards the 53K, right?
Thank you. Being married, and not having to depend on my income to run the household helps.
That’s right, the 457(b) has a totally separate contribution limit.
You forgot one important difference. With Solo 401k you can retire at 55 and start taking out money penalty free. With SEP you have to wait until 59.5
Thanks to the SEPP rule, that’s not a big deal, but is worth noting.
https://www.whitecoatinvestor.com/how-to-get-to-your-money-before-age-59-12/
First of all, thank you for all the great teaching and information! Really invaluable for newbies like myself.
I am fortunate to have a reasonable employee/partner income from my w2 job, and a good side income from my 1099 consulting work. I currently contribute the max allowable to my employer sponsored 401k plan ($18k per year) from my annual salary, and my group makes the maximum allowed profit sharing contribution of $15.9k/year. My employer/physician group (where I am a partner and an employee), also has a cash balance/defined benefit plan. I have been contributing $20k/year for the past 2 years to this defined benefit plan from the profit-sharing/bonus component of my W2 income (I believe that for my age, the current annual limit per year is about $66k).
First, from what I’ve ready, the above employer/group sponsored defined benefit plan does not impact my ability to contribute from my 1099 income to a solo 401k, or to a SEP-IRA? From the information that I’ve read, I would not be able to contribute any addition money from my 1099 work to the salary deferral portion of my solo 401k as I’m already at the 18k maximum, but can I still contribute to the profit sharing component of it?
Also, I goofed and it sounds like its too late to establish and contribute to a personal 401k for the 2016 tax year as either an S or C corp or sole proprietor? But what about establishing a SEP-IRA now (March 2017) for the 2016 tax year and contributing the max to it for 2016? I believe I still have until April 15th to do this?
That’s correct.
Yes, it’s too late to do a solo 401(k) for 2016, but you can do a SEP for 2016 then immediately roll it into a solo 401(k) so you can still do backdoor Roth IRAs.
Thank you for GREAT advice and the quick reply.
I read all the above posts and related articles, and wanted to make sure I have it correctly. From my understanding, in my particular situation, there does not seem to be a big advantage to the solo 401-k vs. the SEP-IRA in how much I can defer (in 2016 I made ~$185k from my 1099 income, and hopefully expect around the same or slightly less in 2017; I have and will max out the $18k limit in my w2 job’s 401k plan for both years regardless of my SEP-IRA vs. solo 401k decision). Do I understand it correctly that in this case, either a SOLO 401k or a SEP IRA will allow me to defer the same ~$37K of profit sharing, and no more?
If so, my thought was to stick to the SEP-IRA for both 2016 and 2017, is there something I’m missing re additional advantages of the solo 401k? My understanding from one of your excellent articles was that the solo 401k’s allowed Roth contribution is only for the $18k of “employee contribution” component, so in my case it would not apply anyway?
For both 2016 and 2017, I’ve already completed the “usual” back-door Roth conversion (full $5500 limit) after contributing to a traditional non-deductible IRA. How will this impact my SEP-IRA for 2016, or either the SEP-IRA or SOLO 401k for 2017? Is there a difference in how or how much backdoor Roth conversion can be done in the SEP-IRA vs. the 401k, given my situation?
Thank you again!
Yes.
Yes, there is another advantage- you can do a Backdoor Roth IRA. The backdoor Roth IRA is not the same thing as a Roth 401(k) contribution.
If you’re doing Backdoor Roth IRAs while you have money in a SEP-IRA you’re going to have an unpleasant surprise when you go to fill out form 8606.
Here’s the Backdoor Roth IRA Tutorial: https://www.whitecoatinvestor.com/backdoor-roth-ira-tutorial/
Got it! Thank you! For 2016 and 2017, I have already completed the backdoor Roth IRA (full $5500 converted from a traditional IRA).
So, my thought now is to open my 2016 SEP-IRA for the maximum allowed at Vanguard (where I have my backdoor Roth dollars), and before April 15th, open a solo 401k at Fidelity and roll into it my Vanguard SEP IRA dollars (I read your excellent “Where to Open Your Solo 401k” blog). Any additional thoughts/advice on this? April 15th 2017 is my time limit to do this?
Also, can 1099-misc net income from rental property be included along with 1099 consulting income in the total dollars used to calculate the solo 401k/SEP IRA deferral calculations? In either case, my designation is a sole proprietor.
You need to make the SEP contribution by April 15th, but you have until the end of the year to open the 401(k) and complete the rollover.
Only earned income can go into retirement accounts. Rental income is not earned income.
Thank you again.
Just for everyone’s information, I spoke to my Vanguard “small business representative” today, he did not know anything about the pro rata issue and the SEP-IRA closing the door on the backdoor Roth conversion…gave me blatantly false advice on this. So than YOU guys for setting it straight
I receive all my income as a 1099, set up as a sole proprietor (SP). Separated from the military in early 2016.
SEP-IRA for 2016
401k for 2017 and beyond.
1) The backdoor conversion of 401k dollars to a Roth IRA (already set up at USAA) is the main benefit, tax-wise, of the 401k vs the SEP-IRA, correct?
2) Any thoughts on tax prep? My accountant doesn’t know these things (advantages of i401k over SEP-IRA, defined benefit plan, etc.)
3) Can I set up a defined benefit plan on my own as a SP? From a cost standpoint, does it make much sense?
Love the website, and rec’d the book to everyone.
1) No. There are three main benefits-
You can max out the 401(k) ($54K if under 50) with less income in some situations compared to a SEP-IRA
You can do Roth 401(k) contributions if you like (can’t do that with a SEP-IRA)
A SEP-IRA screws up your Backdoor Roth IRA due to the pro-rata issue
2) If you’re going to pay an accountant it would be helpful if they knew something about physician-specific issues. If they’re willing to learn, fine. If they’re not, get someone else. Remember these issues apply to very few of your accountant’s clients.
3) You can do a personal defined benefit plan. I know Schwab offers one but I’m sure there are others. There are definitely additional expenses in addition to an individual 401(k), so to know whether it made sense for you or not would require more information.
Hello! For 2016, I’ve gone ahead and contributed the max allowed to a newly opened Vanguard SEP-IRA (for my 1099 income). I’d like to keep contributing from my 1099 income into a Fidelity 401k for 2017 and beyond, and rollover the Vanguard SEP_IRA into it (since vanguard solo-401k does not allow incoming IRA rollovers). Question is: should I keep the Vanguard SEP IRA funds in a money market cash fund and roll that over into the Fidelity 401k, or can I go ahead and purchase an Index fun with the Vanguard SEP IRA and roll those over into the Fidelity solo 401k “in kind” (as opposed to liquidating it into cash for the rollover). My concern is market fluctuation risk and buying high selling low in the latter situation…I did call both Vanguard and Fidelity in this regard and got conflicting advice from them. One person told me that the rollover would indeed be “in kind,” the other disagreed and told me that it would be a cash rollover….would really appreciate your thoughts! Thank you
I’d probably just leave it in cash and make it as simple as possible so they don’t screw it up. You may come out behind, but you may also come out ahead.
First of all, thank you for the wonderful help, I have been reading WCI for years and it has helped me learn much of my financial knowledge!
I am posting for the first time to get some advice regarding SEP IRA and Backdoor Roth. I am three years post-residency, I have been maxing out my 401k and doing a backdoor Roth for the last few years, in addition to being fairly aggressive with loan repayment. For 2017, I will have roughly 70k in additional income from a locums gig. An adviser recommended a SEP IRA since I’ll have a 1099, so I opened one and started with 10k contribution last month, planning to contribute the full 20% by the end of the year. I had already done my backdoor Roth for 2017.
I think I may have jumped the gun and backed myself into a corner regarding the pro-rata rule… The 1099 income will only be for 2017 as I don’t plan to continue with the gig. Aside from the Roth, I have no other IRA. By opening a SEP, would I be best off never performing a Backdoor Roth again since I will have to pay taxes due to my SEP? Any advice you might have would be greatly appreciated.
Sounds like you need a new advisor or need to educate the one you have. He should have recommended an individual 401(k), not a SEP-IRA. You have three options- roll the SEP money into a 401(k), preferably before Dec 31st, convert the entire SEP-IRA to a Roth IRA (obviously you will no longer have the tax deduction you thought you would get for 2017), or stop doing backdoor Roth IRAs.
Thank you for your quick response! I originally posed the question of SEP vs solo 401k and the advice was that ongoing fees for the solo plan would make that a worse option…
Since I will be using a SEP only for this tax year and don’t anticipate continuing, it seems like rolling over into a 401k before December 31st will be my best option. Is there any disadvantage to this? My SEP is with Vanguard and my new job’s 401k (starting in July) will be through Vanguard so hopefully this will be an easy process. Thanks again…
Perhaps the accountant wasn’t aware of just how inexpensive a solo 401(k) can be. The only fee for a Vanguard solo 401(k) when compared to a SEP-IRA is you have to use the investor share instead of the admiral shares.
Hi, I need some advice. my first post here.
I am self employed (scorp) W2, and I max employee contribution for 401K and max myself profit sharing to 53K. I have 1099 job for medical directorship of dialysis centers and have SEP for that. I have TIRA account with 200K+ from previous employment. I want to do back door roth. My FA states that you can better “invest” in TIRA than in 401K, thus doesn’t recommend rolling over to my w2 401K or open solo 401K account. He recommends SEP.
1. Is it true that you can have better investment profile in TIRA than in 401K?
2. if I open solo401K and roll TIRA money to be able to do backdoor roth, is it too risky for audit? I was told that nephrology practice and medical directorship at dialysis center may be considered related.
3. I also own JV on dialysis centers, and LLC separately, and will have K1 income. If I am okay with #2 above, what else can I set up for retirement account? if not for me, how about for my spouse? He has W2 from his main employer only.
Thanks in advance!
First of all, your two companies are related so you only get one $54K limit between your 401(k) and SEP-IRA. Are you aware of that?
Second, regarding your backdoor Roth IRA, you can either 1) Convert the entire TIRA, 2) Roll it into a 401(k), or 3) Not do a backdoor Roth IRA. Your financial advisor is correct that expenses are often lower and investment choices often better in an IRA than in a 401(k). You have to weigh that against the ability to do a backdoor Roth IRA.
Third, why would you open a solo 401(k)? You already have a 401(k). If you want to do a rollover, just do it there.
Fourth, you need to get your head wrapped around the idea of having related companies. All your different companies that you own are really just one big company that is only allowed one $54K 401(k)/SEP-IRA contribution. So yes, if you try to have more retirement accounts, you will lose in an audit.
Fifth, your spouse is stuck with a Backdoor Roth IRA and whatever his employer offers unless you hire him. Then he can put some money into any retirement account you offer him too.
I am an employed physician and get a W2. I maximize my pre-tax contribution ($18,000 per year) to an employer sponsored 401k and get an employer match of $13,500 for a total of $31,500. I also have moonlighting and side income for which I get a 1099. Compared to my overall income, it is a small amount (~$10,000). However, I still want to try and maximize any retirement funds I can and also defer taxes on any current income given I am in a very high tax bracket. I am considering opening a solo 401k (not a SEP-IRA so I can still do the backdoor Roth).
1. How much can I contribute to the solo 401k? My understanding is that it is 20% of my 1099 income?
2. When I contribute to a solo401k, is that considered a pretax contribution?
1. Yes, about $2K or so.
2. Yes, since you already used your employee contribution, a Roth contribution is not an option, only a pretax one.
My husband is a W2 employee and maxes his 401k. He has a large amount in his IRA which precludes him from a Backdoor Roth IRA. He will probably get a small amount of 1099 income this year (< $1000) so he can open a solo 401k and rollover his IRA to there. Does he need an S-Corp, or can we do it with an EIN? This will probably be the only year he has the 1099 income so we can do this.
Yes he can do a solo 401(k). Or just roll the IRA into the 401(k) at his regular job.
He would need an EIN to do the solo 401(k), but he certainly doesn’t need to incorporate.
Hi, I posted this question somewhere else but I think this is the right place for it.
I have a part time job that pays me W-2 and my wages for this year is around 50K
I also work as a Locum that pays my S-corp 1099. My total 1099 pay will be around 350K this year.
I have 100K in expenses and I will be paying myself around 110K in payroll. The rest of the profit will be around 140k which I Will pass trough (K1). So my total W-2 income will be 160K (50K from one Job and 110K from my S-corp).
I would like to Max out my retirement account so I need to know if Solo 401K or Sep-IRA would fit me more.
Individual 401(k). But you only get to count the self-employed income toward it, so if you don’t qualify for a 401(k) at your part-time W-2 employee job, and you’re only going to use a salary of $110K, you’re only going to be able to put in something like $18K employee contribution + 20% * 110K = $40K if under 50. But in a SEP-IRA, you’d only be able to contribute $22K.
Any thoughts as to why I can’t use a SEP IRA similar to a back-door Roth IRA? Meaning, if I set up a SEP IRA for my side 1099 income, then convert it each year to a Roth along with my back door IRA as well. Does anyone know of any pitfalls I should know about with this strategy? (please ignore the pre-tax vs post-tax implications)
Yes, you can do that. But it’s a totally different question as to whether that’s a good idea. I mean, a Backdoor Roth IRA is taxable vs Roth. A SEP-IRA or individual 401(k) is tax-deferred vs Roth. Different calculation.