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.]
Please correct me if I’m wrong, but in many states (I’m thinking specifically of CA), I believe IRA’s are fair game for creditors as they are only protected up to what is “necessary” for retirement. Can anyone clarify if solo 401(k)’s are protected?
401(k)s, including solo 401(k)s, do get slightly better asset protection in many states.
This website/blog is a fantastic resource. I’ve learned so much and really appreciate all the comments. I’m (nearly) halfway through a 3 year fellowship with 6+ years of PSLF completed. My wife stays home with our 5 kids so until I started moonlighting this year I didn’t have to worry too much about keeping the AGI as low as possible for the sake of loan payments (currently in the REPAYE plan). My main goal (and probably most peoples) is to have the lowest possible AGI.
My question: Is it possible to start a solo 401k and SEP-IRA the same tax year if the total contribution is <54k?
Here's how it looks like it will shake up by the end of the year. I'm a little behind with the 457 because I didn't start that job until later in the year (the entire paycheck is now going to fund the 457).
W2 income: 146k
1099 income: approx 65k net
401a: 11,644
403b: 15,175
457: 9,750
Spousal IRA: 5500 (tax deductible since AGI will be <186k)
Previous comment from the esteemed WCI:
The White Coat Investor | April 11, 2016 at 3:35 pm MST
You cannot do both an individual 401(k) and a SEP-IRA for the same business in the same year. Hope that helps.
I'm finding multiple articles online saying you can have both as long as you don't exceed the 54k limit for 2017.
https://www.irafinancialgroup.com/can-i-make-contributions-to-both-a-sep-and-a-solo-401k-plan.php
https://www.ineedaloan.net/2015/04/making-contributions-to-both-a-solo-401k-and-a-sep-ira/
My understanding (using a solo 401k calculator) is that I can contribute $2285 (18k minus 15,175 in 403b) plus 12,080 (20% of 65k) to a solo 401k. I can also contribute 12,080 (2% of 65k) via SEP-IRA since this would bring my total contribution to the year to $42,160.
I've got about 60k in cash to invest, maximize tax deductions and minimize AGI. I've seen and read a ton of threads about solo 401k VS sep-IRA, but not a whole lot about doing both the same year.
Why would your goal be to have the lowest possible AGI instead of the highest after-tax income? The easiest way to get a low AGI is to stop working.
Are you actually going for PSLF or just trying to keep payments down for convenience?
At any rate, I would NOT use a solo 401(k) and a SEP-IRA in the same year. If you’ve made the usual mistake (a SEP-IRA when you should have used a solo 401(k)) just do the SEP this year, open the solo 401(k) next year and roll the SEP into it. But whether or not it is illegal for one business to have both in the same year, no, I don’t think so, but I’d double check that. It just seems unnecessarily complicated.
As far as your retirement accounts going forward:
It sounds like you could do Backdoor Roth IRAs for each you, plus $18K into the 403b, $18K into the 457, some amount into the 401(a), and perhaps $12K into the solo 401(k) as an employer contribution. The only reason for you to do a solo 401(k) over the SEP IRA is to facilitate the Backdoor Roth IRA. The contribution to the SEP and solo 401(k) would be the same.
Thanks so much for the speedy answer.
Why would your goal be to have the lowest possible AGI instead of the highest after-tax income?
Yeah, I see what your saying. REPAYE loan payments are based on AGI, so having running some numbers every 1k decrease in AGI results in about $100 of savings for that year. So maximizing solo 401k and sep-IRA together has the potential to save about $2400 in loan payments for the year. Maybe it’s not worth it and the money would be better off invested elsewhere. And not working – yes, that would be the ideal way to get AGI down 🙂 For the last 5 years I my monthly loan “payment” has been $0 per month (single income, wife and 5 kids) but maybe I’m focusing on the wrong thing.
Are you actually going for PSLF or just trying to keep payments down for convenience? I’m going for PSLF and trying to keepthe payments down to pay as little as possible until the 120 payments are done.
I haven’t setup a solo 401k or SEP yet, but I know I need to setup the solo 401k prior to the year ending. So I’m trying to explore options…
Okay, so if you’re going for PSLF it probably makes sense to max out whatever tax-deferred options you have, even as a resident in order to maximize forgiveness. Better hurry on the solo 401(k). You can’t do it in 10 minutes like a SEP-IRA.
As an aside, regarding dealing with a SEP IRA that was mistakenly created when perhaps a solo 401k was in order…
I originally started this topic because of a personal error. I opened a SEP IRA early this year for a 1099 job I was doing part time. I hadn’t gotten great advice, and later realized I would no longer be able to perform backdoor Roth contributions without paying extra due to the “pro rata” rule. So I wanted to figure out the best way to deal with this.
Fortunately, my prior employer’s 403b (through Fidelity), allowed continued rollovers into the account, and actually allowed be to roll my SEP IRA over into the 403b after I finished making contributions to the SEP.
Just a thought – for anyone trying to get rid of an IRA balance like I was, call your pre-tax retirement plan servicer and they may be able to help!
That’s a great solution. Another good one is to simply use the SEP-IRA this year, put off this year’s conversion step of the Backdoor Roth IRA to next year, start a solo 401(k) next year, roll the SEP-IRA in there, then do the conversion step. Lots of ways to skin this cat.
And by “started this topic”, I meant posted a question on this topic. Far from started the topic… thanks, WCI, for all the great education through the years.
I am a veterinarian, so don’t have quite the earning power of most of your readers, but do have 1099 income from a side job I have doing house calls a few days a month. Currently, I make about $160k/year (115k W2 income working ER and 45k 1099 income). For this year, I will max out my 401k at work, max out back door Roth IRA, and max out HSA (currently single so no spousal accounts). Going forward, it seems that it would make sense to open one of these 2 accounts if I have additional funds that I’m able to contribute rather than using a taxable account. Since I am using the backdoor Roth, would it make more sense to do the Solo 401k? And am I calculating it correctly that I would be able to contribute about $9k to that account (20% of income from 1099)? I will likely continue to max out my current 401K as I have access to good Vanguard index funds there and also get a match. I’m also not sure how any of the new tax laws will impact the business deductions I’ve previously been able to take (for drugs and supplies purchased and vehicle usage) and if that would affect the amount I am able to contribute to a Solo 401k or SEP IRA.
Thanks again for all of this information that you make available, Dr. Dahle. It has been invaluable and has completely changed my approach to handling retirement savings/finances in the past 2 years since I stumbled upon your site.
Why oh why couldn’t I have found this website when I was still in med school or even residency, instead of 5yrs out and almost 40yrs old?!
Anyway. I have a 401k from my W2 main job that I’m maxing out at $18k plus an employer match that I also maxed out this year at $13k. I also have about $40k in 1099 income. Based on what I’m reading here, I could open a solo 401k and contribute around another $8k? And that $8k would be another above the line deduction?
Also my 1099 income varies so what’s the best way to contribute to the solo 401k? Put in 20% with each check I get? Wait until the end of the year to see exactly how much 1099 income I have so I’ll know exactly how much to put in? Estimate how much 1099 income I think I’ll get for the year and contribute most in a lump at the start of the year and then reassess at the end to see if I over or under did it? Or does it really matter much at all?
Thanks!
Because I wasn’t very good at SEO yet?
Yes, $8K sounds about right. Yes, it’s above the line.
I’d probably just wait until later in the year. You could send in a check once a quarter. It’s really up to you. Not supposed to front-load it before you make the money though apparently. But you definitely DON’T want to overcontribute employer contributions.
I’ve been reading up on establishing a solo 401k the last few days and my head is swimming a little.
So I need to apply for and get an Employer ID number from the IRS. Then do an application on Vanguard or wherever, correct?
But is there a need to actually establish a “sole proprietorship” with the state or feds or is that already essentially done since I’m already an independent dr getting 1099 income? I think I only need to establish something if I want to call it something other than my actual name, correct?
Also I’m already doing backdoor Roth IRAs because my income is too high to do a Roth IRA straight up. Does that prevent me from doing Roth employee contributions to the solo 401k? Although I’m not sure it would make sense to do that since I’m already maxing out my 401k with my current main employer pretax and thus switching some of that to a post tax Roth 401k contribution would raise my AGI negating some of the benefits I’d get from making solo 401k employer contributions.
Thank you for humoring my questions
When you get a 1099, you become a sole proprietor. You don’t have to do anything special to be one. Yes, you’ll need to get an EIN and fill out an application.
No, a Roth IRA and a Roth 401(k) are totally different entities. But you only get one $18.5K employee contribution no matter how many 401(k)s and only employee contributions can be Roth contributions. The employer contribution can’t go into the Roth side.
What happens to the solo 401k if you no longer have self employed income? (you go to work for an organization, take a year off, retire, etc) Can you keep it open and keep rolling things over into it, or do you have to close it? I know you can open one by doing surveys/whatever to generate a bit of income, can you then keep it open indefinitely or do you have to generate self employed income every year to keep it going? I ask because I came across a job that looks promising except the group uses SEP-IRA rather than 401k for their retirement plans, which messes up the backdoor roth option. I wonder if I open a solo-401k one year, if one could just keep rolling over the SEP-IRA annually into the solo-401k then contribute and convert the backdoor roth once it’s empty?
Yes, you can keep it open.
Yes, you probably could do an annual SEP-IRA rollover in there.
I’m full time W2 employee with a side legal consulting LLC. I max out my 403(b) and 457(b) [38k/year] from my main job. My spouse and I both have traditional IRAs and old Roth IRAs. The latter we have not contributed to in years due to income restriction. We have too much money in the traditional IRA to convert to Roth IRA. Discovered the WCI and bam, the backdoor Roth smacks me in the face. My questions: 1.) Should I start a solo 401k via my side hustle then roll my traditional IRA (Vanguard) into the new solo 401k. When that move is complete proceed with the backdoor contribution to the old pre-existing Roth IRA. For the record, the legal consulting work is very limited so very little money from this endeavor.
2.) Second question, my wife is a stay at home mom (toughest job on the planet) can we do the same for her when she has zero 1099 income?
Thank you in advance.
1. Yes.
2. What are you going to do with her traditional IRA? She doesn’t have a 401(k), doesn’t have 1099 income, and you don’t want to pay to convert it. So I’m not sure you’re going to want to do a Backdoor Roth IRA for her.
With the tax law changes, I do not see where one takes a deduction for a solo 401k or a SEP-IRA. Any ideas?
Form 1040, Schedule 1, Line 28
Thank you. Your site is always so helpful. Keep up the amazing work!
https://www.irs.gov/pub/irs-pdf/f1040s1.pdf (link for those that had the same question as I did)
I have a W2 job where I max out my 401K ($19,000 this year)
I also have a Personal Corporation (PC-S Corp) where I make money on the side for various opportunities. The amount I make varies from year to year.
Am I allowed to have another 401K for my S Corp and if so, how much am I allowed to contribute, if any, if I already max out my 401K though my W2 job?
Thanks!
Yes. 25% (max 56%) of the salary paid to you by the S Corp. That can be no more than 20% of net income of the business of course. See this post:
https://www.whitecoatinvestor.com/multiple-401k-rules/
Thanks so much!
Currently, November 2019, which brokerage do you think is the best for an individual 401K?
I saw a few years ago you felt E Trade was the best.
I’m relatively new to your website, and trying to read as much as I can!! Still lots to go!!!
Thanks for all you do!
Depends on the features you need. Here’s that post:
https://www.whitecoatinvestor.com/where-to-open-your-solo-401k/
eTrade is certainly often a great choice, but if you already have money at Vanguard or Fidelity and don’t need a feature etrade offers but those other two don’t, then they’re also great choices. If you need a self-directed 401(k), none of those are likely the best choice.
What is the difference between a Self-directed 401k and a Solo-401k?
WCI is da man!
A solo, or individual 401(k) is the broad category. People generally open one of these with Vanguard, Fidelity, or eTrade. The investments are typically mutual funds. Within that category is a subcategory of self-directed individual 401(k)s, where you can invest the money in mutual funds or anything else you like such as a private real estate syndication or fund.
Hope that helps.
Which of the 3 brokerages do you recommend? From your experience, which one has the best features, lowest fees, best customer service, etc…? I recall reading somewhere in this thread that Vanguard does not allow you to roll over IRAs into your Solo-401k, is this still true? So better to avoid Vanguard if you’re interested in doing a Solo-401k?
Thank you for your guidance!
https://www.whitecoatinvestor.com/where-to-open-your-solo-401k/
Depends on what features you need, but eTrade seems to be at the top of most people’s list. I was happy with my Vanguard one until I needed a feature that wasn’t offered by any of those three (Mega Backdoor Roth IRA contributions).
What about the new Schwab- TD Ameritrade brokerage?
Haven’t looked into the various solo 401(k)s since they combined. What do you think of their product?
Hello,
I currently work in a private group that allows profit sharing to reach the yearly max for employee and employer contributions. We also have a cash balance plan account. I do extra moonlighting with a 1099. Can I contribute to a SEP or solo 401K?
Probably, but you didn’t give me quite enough details. And you would want the individual 401K not the SEP-IRA so you could do a Backdoor Roth IRA too.
thank you for the reply-
More specifics-
I am a shareholder/owner and therefore employer in a private ER group. I contribute the employee max contribution and employer max contribution -56K , it is considered a 401k. (terminology they use is profit sharing plan)
I also contribute max to traditional IRA and then do immediate backdoor Roth ira conversion (vanguard)
Since I already contribute max employee yearly to the 401k plan and the max employer contribution as I am considered an owner am I allowed to also contribute further employer contributions via sep-ira or solo 401k. I am seeing different opinions on the ability to have separate employer contributions even though they would be separate plans.
I guess if I say I need more info I should specify what that info is. At any rate, sounds like two unrelated employers so two separate $56K limits.
Just to make sure I am understanding correctly.. I already maxed out tax-deferred 401k at main W2 job, but I am planning on contributing 20% of net earnings from my 1099 into a solo 401k for the year. However, with this 20% I am contributing, none of it will be tax-deductible regardless of whether tax-deferred or Roth since I have already maxed out the “employee” $19.5k for the year through my W2? Am I even able to do a Roth contribution in my solo 401k in this scenario?
No. It can still be tax deductible. but you won’t be able to do Roth contributions to your solo 401(k). More details here:
https://www.whitecoatinvestor.com/multiple-401k-rules/
Is this article still accurate 9 year later? I feel from the podcasts lately, you recommend a solo 401k over a SEP-IRA. If so, it would be great if you can re-write this article.
Thanks!!
Why does it need to be rewritten? 9 years ago I recommended a solo 401(k) over a SEP-IRA. Today I recommend a solo 401(k) over a SEP-IRA. Seems pretty evergreen to me.
But if you don’t want to do Backdoor Roth IRAs and already have a 401(k) elsewhere and forgot to open something during the calendar year, you can still do a SEP-IRA. It isn’t like it is a bad thing. It just isn’t the best thing for most.
Here’s my question (probably similar to some others).
I have a W-2 job (primary employer) and I also do 1099 moonlighting and locums work.
My primary employer offers a 401k but no match which I contribute to. I currently max out the 401k yearly (19,500 in 2020). I also have been doing backdoor Roth for the last several years for myself and my spouse.
Am I able still able to set-up a Solo 401k (say through Vanguard) and if so, what is the total I’m able to contribute?
Yes.
20% of net self employment income up to a total contribution of $57K.
I am an employed physician, maxing out my 401k and backdoor Roth every year. My wife mainly stays at home, but she makes about 2K in 1099 income a year. I would like to do a spousal IRA backdoor Roth contribution for her, but I have been unable to do this because she has a traditional IRA with money that was rolled over from a prior job.
My plan is to open a Solo 401k for her and roll over her traditional IRA into this. If she contributes 100% of her 1099 income into her Solo401k, can I still do the 6k spousal IRA contribution for her? Or does the fact that her earned income is only 2k somehow limit my contributions to one or both of these accounts?
Thanks!
Yes.
No.
“hypothetical” situation…. 50 y/o doc.
maxes out 401K with regular job (including the extra $6500 for making it to 50!)
has PLLC, makes 30% of income from that (various activities)
Have SEP, never done back door Roth. No Roth, period.
should I move more towards back door Roth?
seems having both SEP and individual 401K complicates things?
I’m all about the tax breaks!
Roll the SEP into 401(k) and do Backdoor Roth IRA(s).
excellent Tuesday classic! I actually used this last year when I became financially literate thanks Jim! read your book Jan 2019, went down the rabbit hole of learning personal finance and opened and contributed to SEP-IRA before April 15th 2019, then opened up Solo 401k and rolled my sep into there. But as you mentioned only fidelity allows ira rollovers, which is strange, and now I do all my investing through Fidelity. Is there some complication or cost where Vanguard chooses not to allow rollovers?
also I am happy to report my solo 401k is above $250K!!! but I have to now file a form 5500 or get penalized heavily, correct?
It’s not only Fidelity, but Vanguard doesn’t. I still can’t figure out why not. It is so easy to incorporate that into even a cookie cutter plan.
Yes, don’t forget that 5500-EZ. https://www.whitecoatinvestor.com/irs-form-5500-ez/ You’ll file it by July of the year after you first hit $250K.
I missed it when it rolled up on me for the first time this year, learned about the ability to file “delinquent” paperwork with a penalty and sent it in, but it’s been two months and the check hasn’t been cashed, and I haven’t heard anything.
– I am a partial employee so not allowed for company 401k. If I get 30k 1099 income, can I contribute both employee and employer contribution from it and put in vanguard solo 401k part. Where do I contribute to employee part. does it need separate account?.
-Where is it reported on tax file. How do I make it pre tax contribution instead of Roth.
Yes. The Vanguard small business website has you specify whether it is employee or employer when you make the contribution and you also specify if the employee contribution is Roth or not.
As a sole proprietorship, you report the contribution on line 15 of Schedule 1 of Form 1040.
Thanks Jim for all your insight. I’m 16 years out of residency and only discovered your forum back in March 2020. Maybe the pandemic woke a bunch of us up!
(In more was than we will ever know).
I’ve been an IC my entire career. My business has been classified as a C Corp since 2005. Is there any reason or value to reclassifying my business as a S Corp? I can’t seem to get any straight answers from the CPA’s. Tax laws seem to change and they waffle back an forth. Happy Holidays!
I see little reason for a doc to be a C Corp. Why did you choose that?
The main advantage of an S Corp for a typical IC is to reduce your Medicare tax by splitting your pay into salary (pays payroll taxes like SS and Medicare) and distributions (does not pay payroll taxes). So for every $100K you call distribution, you pay $2,900 less in Medicare tax.
https://www.whitecoatinvestor.com/llc-filing-taxes-as-an-s-corp/
Thanks! Unfortunately, I didn’t choose the C Corp, some business lawyer chose it for me back in 2005. Still attempting to correct past mistakes. Is it fairly simple to change from a C Corp to a S Corp? Thanks for all you do!
Dunno, never done it. Seems like a good question for an attorney. But I don’t think it’s very hard. You just file form 2553 and voila, you’re an S corp.
https://www.irs.gov/businesses/corporations/filing-requirements-for-filing-status-change
https://www.irs.gov/pub/irs-pdf/f2553.pdf
Apologies if someone else pointed this out elsewhere, but I’ve read through half the comments and haven’t seen it. The deadline for an employee to elect to defer their salary is 12/31, but the actual deadline for the employee contribution is still the tax deadline for the business (4/15 for most sole proprietors, unless they get an extension).
Directly from Publication 560: “Elective deferral: Due date of employer’s return (including extensions).”
I think there are 401(k) rules that say an employer can’t hold on to the employee’s 401(k) contributions for an unreasonable period of time before contributing them. 4-8 months would be an unreasonable period of time. How would you like it if your employer did that?
I have a W2 job where I max out a traditional 403B (19,500). I opened a Vanguard solo 401K for a 1099 job on the side. I only plan to put EMPLOYER contributions in that. Can I choose a Roth option in the solo 401K for the employer contribution? Wasn’t clear on that point. Thanks!
No. Only the employee contributions are able to be Roth. All employer contributions must be tax-deferred
I have a W2 job where I max out a traditional 403B (19,500). I opened a Vanguard solo 401K for a 1099 job on the side. I only plan to put EMPLOYER contributions in that. Can I choose a Roth option in the solo 401K for the employer contribution? Wasn’t clear on that point. Thanks!
No. Employer contributions are always tax deferred. Mega Backdoor Roth contributions are a possibility though, but not with a cookie cutter Vanguard plan.
All valid points. I use a SEP IRA because it is easier to set up than a 401k and accomplishes my goal. I have less than 10k 1099 income per year that qualifies so when I do my taxes and calculate what I can do for the prior year its usually $500-2,000. I put that in and the next day roll it into my Roth IRA. So basically its just a way to increase my backdoor Roth ability. If you roll it over you can still do the backdoor Roth. So the advantage is how easy a SEP is to set up and use compared to a 401k (which isn’t hard but more work than a SEP).
Do we get any tax forms from vanguard/fidelity after contributing the employer or employee part. I did not get any tax form and forgot to claim it on my 2019 taxes.
my assumption was that vanguard/ fidelity will be providing some tax documents (both employer and employee part) both to us and to IRS to show how much was contributed. Kind of the same concept that our W2 shows how much was contributed to 401k/457 and it gets reported both to us and IRS.
Refile the taxes. I honestly can’t remember if they send you anything, but I don’t recall getting anything other than the form to help me file form 5500-EZ.
Remember when you’re self-employed, you’re the one filing the W-2 or equivalent! So you’re responsible for the tax forms.
Dr. Dahle, I’m reading the following paragraph and am lost:
“As a sole proprietor, you only need $192,500 in income to max out a Solo 401(k) in 2021, but you need $290,000 to max out a SEP-IRA. This is because the employee contribution less of the $58,000 contribution has to come from the “employer contribution”, where it is limited to 20% of net self-employment income. This income is net of all business expenses, including the employer half of the payroll taxes.”
I keep pouring over the rules for both types of the accounts on the IRS website but still can’t understand where you are getting these figures. If you don’t mind spelling out the math.
$19,500 goes in as an employee contribution. You have $38,500 left to contribute for 2021. You know you can only contribute 20% of the net income of the business. So $38,500/20% = $192,500.
I have a SEP-IRA with Vanguard. If I want to rollover to a solo-401k but I prefer Vanguard, can I rollover my SEP into a solo-401k with Fidelity and then sometime in the future roll it over or transfer into a new solo-401k with Vanguard? Seems like a pain, but I do prefer Vanguard and have other accounts with them. I would like to start doing backdoor Roth contributions though so having a solo-401k instead of a SEP would make that easier.
Also, for a spousal IRA which I would then do a backdoor Roth with, this doesn’t take into account any of my IRA money right, since these are individual, not joint, if married? Just want to make sure since I’m worried about the pro rata rule and haven’t found too much information on doing backdoor Roth with a spousal IRA. Thank you.
Yes, you could do that.
IRAs are all INDIVIDUAL Retirement Arrangements, so what is in yours doesn’t affect your spouse’s.