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 have some 1099 income this past year made under an S corp which I will be closing soon with the help of a new accountant I found through this website.
1) I did not do payroll for the S corp, so I don’t think I can do solo 401K EmploYER contribution correct?
2) If I can’t do solo 401K EmploYER contribution, can I do SEP IRA contribution even though I did not do payroll for the S corp?
3) Can I then roll that SEP contribution into the solo 401K as I do maye backdoor Roth contributions every year.
Thanks!
1. $0 x 25% is always going to be $0.
2. I suppose you could.
3. I suppose you could.
Interesting work-around.
Thanks!!!
1) To do SEP IRA for an S Corp, would it be due March 15?
2) Can I roll a SEP IRA into a solo 401K at TD Ameritrade?
THanks!
Yes, that’s when the return is due.
I don’t know for sure, better check with them.
So in order to open an individual 401k with many of fund companies:
1. Need to be receiving a 1099? I currently get a W2 for main job and 1099 for a part time job. If I only went to a 1099 part time job, could I transfer my entire 401k from the W2 job to an individual 401k?
2. Or start an LLC S-Corp? Are costs very low year to year? Any extra benefits?
3. If I stop receiving a 1099 and switch to another W2 job, will I have to discontinue my individual 401k with say TD Ameritrade or Charles Schwab?
I am just at this point interested in protecting my large 401k from tax penalties if I leave my W2 employee job.
1. Yes. Yes, if your 401(k) allows in-service rollovers (it probably doesn’t) otherwise you’ll have to wait until you separate to roll over that 401(k).
2. You can if you want, but not needed just to open a solo 401(k). You can open it with a sole proprietorship no problem. There can be extra benefits for an LLC or S Corp, but they’re not usually worth for a doc doing a little part-time moonlighting.
3. No. Your business just didn’t have any income that year so you can’t make any new contributions. It can stay open though.
Most 401(k)s don’t require you to roll the money out of the 401(k) when you leave.
Interesting tax scenario I just thought of and am wondering what the group thinks… my spouse has modest sole proprietor income for 2020 (totally <$19,500). She has enough business deductions where she could basically get this down to $0 of taxable profit. Is it possible/legal to not actually claim her business expenses and instead just contribute all of her sole proprietor income to a solo 401k as an employee deferral? She doesn't have any other 401k contributions for 2020 at any other jobs. I'm thinking that the net effect of this would be she would not have to pay any taxes on her business income in either scenario, but in the later scenario we would be able to contribute more money to a tax deferred investment account.
Looking forward to feedback, thanks!
Yes, but why would you want to? You’re weighing never paying taxes on that revenue ever against paying taxes later on it. And choosing to pay taxes later on it. Does that make sense to you? 401(k)s are great, but they’re not that great.
As expected, a great point. I suppose for this to work out I’d have to have after tax gains > taxes due at distribution. Too complicated for me to figure out the chances that this would be worth it, so probably better to just lock in the guaranteed tax savings now and deduct expenses. Thanks again for your advice!
I agree that the approach of deducting expenses to the point that the small business has no taxable profit = no tax paid on that income.
BUT what if the i401k employee deferrals were ROTH, since that is an option. Then the decision is a bit trickier, since then she would pay tax on the income now, but have the opportunity for the money to grow tax free forever – right?
Roth money is tough to come by and limited annually using IRAs. If so many are looking to do a Backdoor Roth on $6000 of money every year, shouldn’t the opportunity to contribute $20,500 to a Roth i401k (as an Sole member LLC employee) account yearly be treasured and taken advantage of?
Roth is great, but not better than not paying taxes on the money when you earn it. It would take a lot of years of tax-free compounding to be worth more than not paying taxes on that money at all and then having it compound in a taxable account. Run the numbers and you’ll see. It would take decades if not centuries with a very tax efficient asset, depending on assumptions.
Thanks. That’s a good way to think about it. Given how much hype we give to the annual backdoor Roth conversion (which is just $6000 per individual annually), I just had assumed that any way to get Roth money should be taken. But I see what your saying.
In the same line of thought, if changing employers with an opportunity to rollover employer retirement accounts – I had considered doing a big Roth Conversion (and paying the taxes on the conversion of course). The tax bill for that would be costly, especially being in a higher marginal tax bracket currently, but I thought of just paying it to get the Roth money.
Based on your comment here WCI, I’m now rethinking that I should just roll that over to a Individual 401k (Traditional). (I wouldn’t roll it into a Traditional IRA because that would mess up my Backdoor roth conversion annually) – as you’ve previously discussed.
The only reason we love the Backdoor Roth is that it beats non-deductible money in a traditional IRA and a taxable account hands down. When you have a tax-deductible option (or the option of not doing a conversion) then it’s a much harder choice and you have to make some assumptions and run some numbers. You’re probably right about your rollover.
Thanks again.
So you’d agree with rolling over to the Individual 401k?
I’ll run some models. Do you have a good website that allows input of various assumptions to compare scenarios?
Really not enough info for me to tell whether a Roth conversion is right for you or not, but that’s certainly the answer for most. No, I don’t know of a calculator. But the general rule of thumb is to do tax-deferred during peak earnings years and Roth contributions and conversions in other years.
Decisions, decisions…
The dilemma / things to consider:
– If Roth conversions go away at some point, will I regret not doing the conversion this year? Perhaps.
– Doing the conversion now during peak earning years carries a hefty price and would be taxed at 37% federal plus 7% state = 44%
– By doing the conversion now, the money used to pay the taxes cannot be invested elsewhere (where it would also have the opportunity to compound until retirement) – its just gone.
– If funds are kept in an Individual 401k and are NOT converted to a Roth IRA, the marginal tax rate in the future (17-18 years from now at age 59.5) is unknown – somewhat guessing on the future tax code / rates.
The hefty tax bill of doing the conversion this year, and the opportunity cost (can’t invest the money used to pay those taxes) makes me think the right choice is to roll the accounts to the Individual 401k.
Hey Jim,
I’m hoping you can verify my calculations in order to find my minimum W2 compensation be in order to max out my i401K for 2021 yet minimize my salary (while assuring it is close to 50% of total income).
I file as an S Corp. I have a $3,600 HSA contribution and a $5050.68 >2% shareholder insurance contribution.
1) On the forum the gurus verified that my compensation should be:
$38,500 / 0.25 = $154,000
2) I’m a bit confused by the term “net compensation” to determine this figure so I’m not sure if it is right and I’m confused about your $192,500 income figure (Not sure if you mean total income or if this has to do with my W-2 salary I pay myself).
3) For 2021, my understanding is W-2 Box 1 should be $145,349.32 (salary) – $19,500 (pre-tax deferral) + $3,600 (HSA) + $5050.68 (insurance) = $134,500
4) Box 1 must come out to $134,500 because I will max out my employer 401(k) contribution at $38,500 for 2021. Since the max employer compensation must be 25% of compensation (salary + health insurance + HSA = $154,000) the compensation must be $154,000 (i.e. $154,000 x 0.25 = $38,500).
5) I believe both the HSA and insurance should go under box 14 and that Paychex is incorrect telling me that the HSA should be under box 12.
6) If my salary is to be $154,000 then box 1 and box 16 should be $134,500 (154,000-19,500 401k pretax). Box 3, box 5 and box 18 should be $145,349.32 (154,000-3600-5050.68) as S Corp medical is exempt from SS MC and SDI . Quarterly salary for inclusive of insurance would be $36,337.33 ((154,000-3600-5050.68) X 25%= $36,337.33).
I have been beating my head against a wall for days trying to make sure I get the minimum salary correct. Can you please verify as much of this as possible? If it is wrong would you please show me the correct calculations? I know it’s a lot but I would be eternally grateful if you can help me with this.
Remember it’s a little different as an S Corp rather than a sole proprietorship.
Your maximum employer contribution as an S Corp employee is 25% of your salary. If you haven’t used up your employee contribution somewhere else, you can use it in your S Corp 401(k) (if not employees other than a spouse, that can be an i401(k)). Sounds like that is the case for you. So for 2021, $58,000 – $19,500 = 38,500. $38,500/0.25 = $154,000.
I don’t think you subtract employer paid health insurance from that or any employer contribution to an HSA. That’s in addition to the salary I believe. Employee contribution to health insurance and an HSA would count I suppose, but I haven’t been playing this game with an S corp before so I’m speaking from theory. I actually pay myself far more in salary than I have to in order to max out the 199A deduction.
Now the S Corp has to make enough money to pay the employer contribution too. So if the S Corp only made $10K in profit before the contribution you couldn’t max out an employer contribution because where would it come from? So the total of contribution plus your salary still has to be in the $190,000s range.
Worst case scenario, why not pay yourself a little extra salary instead of beating your head against the wall? All it’s going to cost you is 2.9% in Medicare tax, no?
So I have a few questions, my husband and I are truck drivers running as a team O/O and receive a 1099 only in his name but we file our taxes together. I have a Roth IRA and a HSA and I just opened him one, but since I saw this online while googling I have questions. Which do you think would be best for us to open up and fund out of the SEP-IRA or the Individual 401K with each one of us having our own accounts?
Probably the i401(k) unless you’re still trying to contribute for 2020.
Hello,
I file as a sole proprietor (contract work with 1099s). I do not pay myself a set salary (w-2) throughout the year. Can I still open a Solo 401(k) and contribute as an employee and employer?
Yes. All you need is an EIN and to open an account. Hurry though as it’ll take at least a couple of weeks.
Hi,
I’m an academic medicine doc and my wife recently left her job as a therapist at the VA to start her own private practice. I’m trying to help her set up her retirement plan but as an academic physician the self-employed plans are all new to me and her. My wife started working this year in her solo practice while still employed by the VA. She has an LLC with an EIN and for this year her revenue from this part-time business is < $10 K. We are married and file jointly and expect to fall into the 24% maximum tax bracket this year. Fortunately, we have plenty of funds set aside so that she could contribute the maximum allowable to her retirement plan this year and next and live off income from other sources. It looks like the 401K(i) is the way to go, but I'm confused about the Roth component of this option. Is there any reason not to set up the plan as a Roth 401K(i) exclusively? Does this eliminate the option of doing a backdoor Roth? I also read in one of the posts that only the employee portion of the plan can go towards the Roth 401K(i). So perhaps she needs the traditional 401K(i) for the employer contribution and the Roth for her individual portion. Any input on why one would choose the traditional over the Roth 401k(i) would be greatly appreciated. Thanks for this site. It is an amazing resource as is the podcast.
You probably can’t have it be Roth exclusively. Doesn’t sound like you can even make Roth contributions since they’ll be employer contributions since she likely used up her employee contribution at the VA. I’m not sure you can get an i401(k) open by the end of the year. Might have to do a SEP-IRA for 2021 and then either roll it into an i401(k) next year or just convert it all to Roth.
No, the 401(k) has nothing to do with IRA contributions or Roth conversions. A SEP-IRA could cause proration of a conversion though. Be aware BDRs may not exist come 2022 depending on Congress.
It may have been my mistake to open up a SEP-IRA a few years ago and now I’m stuck. I’m 2 years out in practice after residency.
For 2021- my income is about 200k (120K from 1099, 80K from W2). I may only be 1099 in 2022 onward.
In previous years I have maxed out RothIRA and opened up a SEP-IRA (EMPLOYER contributions only) and maxed out.
2021 is the first year I do not qualify for the direct contribution into RothIRA. I realize I will not be able to do backdoor with an SEP-IRA due to the pro-rata issue. All my IRA accounts are with Vanguard.
My questions are:
1) Does the pro-rata rule apply for backdoor roth conversion even though my SEP is funded as EMPLOYER?
2) I am looking to incorporate (either LLC or PC) since most of my income comes from 1099, should I wait until I incorporate to open a solo401k or start the process to open up the solo401k immediately?
3) What can I still do for 2021? I am assuming I can still contribute $6000 into a traditional IRA until april15th and max out my SEP. Is there something else you suggest?
4) I cannot contribute yet to traditional IRA for 2022 until my SEP is cleared out and have solo401k set up. Is this correct? Or should I contribute to traditional IRA anyway in the meantime and let it sit.
Thank you!
1. Yes
2. You won’t get it done in 2021, so might as well take your time. You can just roll your SEP-IRA in there.
3. Yes, I think I’d probably do both of those. Then open a solo 401(k) for 2022, roll the SEP in there, and then convert the IRAs to Roth IRAs.
4. You can next week. You can even do the conversion next week. Then you have until the end of 2022 to move the SEP into an individual 401k to avoid pro-rata.
WCI – thank you for all your help. I have been using a SEP IRA for the past few years for a side hustle. This year, I decided to open a solo 401k (Fidelity) with plan of doing a back door Roth – not realizing I already contributed a small amount to my SEP IRA for 2021 tax year. Upon further research, I’ve learned that I should not have adopted a new plan for a solo 401k and SEP IRA in the same tax year. Are there any ramifications for having both of these plans at the same time? Is the back door ROTH out of the question for the 2021 tax year? There was a small initial contribution made to set up my solo 401k but still in settlement fund
Yea, that was a bad move. I think you are technically allowed to have both in the same year, but the contribution limit is the same. You can’t max out both of them. You can clean it all up and do your 2021 Backdoor Roth IRA during 2022. This year’s over anyway.
Just wanted to follow up on my post (#108). Thank you so much for your time.
Currently I have 30k in my SEP IRA.
I want to do backdoor Roth going forward. (assuming this is allowed)
1) If I do not contribute in 2022 in my SEPIRA and contribute $6000 to a traditional IRA for 2022, can I backdoor that without violating prorata?
2)When I do the conversion, am I just converting the $6000, or the entire amount (lets say it grew $5 in a day).
3) You mentioned I can open a Solo401k, roll the 30k SepIRA into there before 2023 to avoid Prorate. Is this rollover allowed in Vanguard? And will the 30k just stay in the solo 401K and grow from there?
4) I am not sure if I want to incorporate this year (currently 1099, making about 120k on it). Will there be any issues if I do choose to incorporate after my Solo401k is set up due to the change business name (just adding DDS to the end of my name)?
5) If the backdoor option has discontinued due to the bill, do you still recommend the solo401k over the SEP ira?
Thank you!!
1. Only if you don’t something with the SEP balance before the end of 2022.
2. Do the entire amount. You’ll owe taxes on the $5.
3. Yes, it now is (didn’t use to be). Yes.
4. No.
5. It will matter for fewer people, but some will be able to max out a solo 401(k) on less income than a SEP-IRA. More info here:
https://www.whitecoatinvestor.com/sep-ira-vs-solo-401k/
Followup from last post.
Since I cannot do backdoor in 2021 due to my SEP IRA balance, I will contribute $6000 in traditional IRA for 2021. And another $6000 in traditional IRA 2022. That is a total of $12,000. When I do backdoor for 2022, am I converting the entire $12,000 or just $6000?
Thank you so much!!
$12,000.
Hi WCI, thanks for all your help! I am primarily a W2 employee and have a 1099 side gig for which I make around $30-50k/yr. I opened a solo 401k and have been contributing ~20% of profits as an employER contribution. I wanted to make an additional employEE contributions into the solo 401k this year. Would I have to subtract the employEE contribution from the total profits of my 1099 work and then multiple it by 20% in order to get to my max employER contribution? Or can I still just take the total earned by 20% despite some of the earnings going in as employEE contributions.
Context – in my W2 401k plan, my employer contributes 14.5% up to compensation limit of $305,000 (=max $44,225). Given the combined employer/employee contributions cannot exceed $61,000, I am limited to $16,775 ($61,000-$44225) as an employee contribution at my W2 job. Therefore my understanding is I still can contribution a total of ($20,500 – $16,775) $3725 as an employee contribution into my solo 401k.
Thanks again for your help!
No. Total net income x 20%. Plus the employee contributions. That breaks down a little when employee contribution + 20% is more than you made (think someone that made $22K), but most of the time that formula works fine.
Great! Thanks so much for the quick response
Hi Jim,
Learned a lot from your site and blogs/comments. For the first time late this past year I setup a solo 401k and funded a small amount from my expected earnings from side work. I have a W2 from my main hospital job where i maximize my 403b. My plan was to the put in the remaining maximum ’employer contribution’ from the 1099s into the solo 401k this year before tax filing.
As i am figuring this out for first time this year on Turbotax desktop version I am uncertain if i am getting the right maximum amount input. My 1099s earnings after expenses come to around $15350. In TT, under “Self employed retirement plans”, i said yes to individual or roth 401k plans. Then in the next page, under amount there are a bunch of choices. The one closest to what i expected is “employer matching (profit sharing) contributions”. i presume thats where i put the amount. There is also an “elective deferrals” box that I left empty. Below it there is also a “maximize contribution to individual 401k” check box. If i check that box, TT is supposed to calculate maximum individual 401k contribution. It claims i can take $15145! I thinks thats the difference of the earnings and half SE. That makes no sense, as i have a W2 and work 403b that TT can see, so not sure why is it claiming I can take more or am I reading this wrong? To come up with the max amount myself, I deducted half self employment taxes, and multiplied total by 0.2, so it should be close to $3029. But I am not sure. Oddly i can increase this amount and TT isnt raising a red flag (as yet). Thanks for your help.
I’ve never found Turbotax able to handle multiple 401(k)s I’ve always had to go into Forms mode with the downloadable version and do an “override.”
Your max is your net income x 20%. Remember that is also net of the employer half of Social Security taxes.
Thanks for the quick response. Aah good to know its not just me with Turbotax. I took a look at the TT forms and it initially was confusing. TT calculated my SE taxes as $411. Initially i didnt get how TT got that number as i was getting a bigger number but now reading the SE form, I think i know where that may be coming from. The SE tax i believe is 0.9235 x net self employment earnings x 0.029 (medicare taxes). I take half of that (206) and subtract that from the net earnings and that is where i can calculate the 20% for the 401k. Please correct me if I am getting this wrong, thank you again.
Not sure your equation is right. 1.45% is medicare and 6.2% is SS (if you still owe it).
Thanks. That was a real quick reply. I had already hit SStaxes so only medicare for the SE part. Hmmm.. I was reading 2.95% medicare for SE taxes. The 1.45 you mentioned is exactly half of that. Are you saying SE taxes in that case is 1.45% and i should halve that amount further (for the 401 k calculation)?
To reiterate how I had earlier:
Side gig earnings : 15351 (edited)
SE taxes: 0.9235 x 15351 x 0.029 = 411 (at least that is what i see in TT under SE form and schedule 2 line 4).
Half of that: 206 (also in schedule 1, line 15)
For 401k: 15351-206: 15145. This mulitplied by 0.2, gives 3029
So you are suggesting the SE taxes should be even less if I take the 1.45% multiple… Let me read more. thanks
Net includes only the employer half of payroll taxes.
Thanks. I wonder if we mean the same thing. I listed above the numbers and the way i computed. I put the same info in another 401k calculator site and it came up with the same 3209 from what I can make out. https://obliviousinvestor.com/solo-401k-contribution-calculator/
Maybe. I’m not sure what you’re saying but it’s entirely possible.
Thanks Jim
My reply didnt go thru but I think we are talking about the same number (you are having the 2.9% for the net while I am first calculating the self employment at 2.9% and then having that to subtract from the net earnings).
i put in the same numbers as above on this site and it came up with the same 3029. https://obliviousinvestor.com/solo-401k-contribution-calculator/
Hi,
I am misunderstanding something.
For 2021, I have W2 income and 1099 income. I have a SEP IRA that I fund as an employer.
I funded traditional IRA 6000 as individual.
My accountant is saying that because I have a W2 income and that I funded SEP IRA as an employer, I CAN do the backdoor Roth without violating the ProRata rule. Is this correct?
Thanks in advance!
No. Your accountant is wrong. See line 6 of IRS Form 8606 for details.
Hi, thank you for all this information.
I am 100% 1099, about 180k after expenses is taxable income, practicing in NYC.
I want to set up a solo401k for 2022 onwards and want to do this correctly. I have a SEP IRA the last 3years because I did not know about the solo401k at the time.
2021 was the first year I made over the Roth contribution limits, but because I had a SEP IRA, I could not do back door.
By the end of 2021 tax year I will have about:
SEP IRA – $40,000
Traditional IRA- $6500 (only contributed in 2021 of $6000 and made about $500 from the investments)
Roth IRA- $36,000
Is this sequence correct in the solo401k/backdoor process for 2022 tax year onwards?
1) open solo401k at either vanguard/fidelity ( I believe they both let you roll over SEP IRA into it)
2) Roll over the full amount from SEP IRA into solo 401k
3) Roll over any amount over $6000 from traditional IRA into 401k (so ~$500 earnings I had from the $6000 I contributed in 2021)
4) Contribute $6000 into traditional IRA for 2022 for a total of ~$12000 balance
5) Use backdoor strategy the $12,000 in traditional IRA into RothIRA (assuming it is still legal in 2022)
If I am a sole proprietor and do not have W2 income. Will I only be able to contribute as an employer for the solo401k? How does the employer/employee portion work if I am self employed 1099, sole proprietor without any employees. Not incorporated either.
Thank you so much for your time.
Hello,
Just trying to finish up taxes and my wife opened up a PLLC in the Fall of 2021. I’m trying to see if we have missed the deadline for employee contributions to her solo 401K. We established the account last year with Vanguard but we did not fund it, in part because we didn’t know what her income for the year would be. I’m seeing different information online about the deadline for employee contributions. Some sites say they must be made by December 31 of the year of the contribution. Others state that both the employer and employee contributions can occur until you file tax returns. Does anyone know the answer to this question? It seems like Vanguard will still accept contributions on the website, but I’d like to make sure I’m doing this properly. Thanks in advance for any help
Yes, you missed it. It’s supposed to go in within a few weeks of the last paycheck of the year (which it was taken out of) so it would be hard to justify a contribution after January in my mind. But the IRS doesn’t specify an exact date so maybe try it and see what happens. The IRS has bigger fish to fry.
thanks. I agree, though it’d be nice if they had the funding and resources to fry them…
Anyway, here’s one website that suggests that donations can still be made though I realize I should employ caveat emptor when relying on a site obtained from a google search:
https://directedira.com/2021_solo401k_contribution_deadlines/?__cf_chl_tk=1BnGzQ.KLbVKtihf.va7J9wLpPZgT_T3.h27jPO2K30-1650219940-0-gaNycGzNCeU
Interesting. Wish I could find somewhere on IRS.gov that says the same thing. I’ve had the same experience as you, but part of the problem is that most of what you find about 401(k)s is not specifically about solo 401(k)s which often get more leeway.
Hello WCI Community. Here’s a question about an Individual 401k.
A physician does consulting (and this is done through a Single Member LLC) on the side. For the Individual 401k, the Employee Contribution limit is 100% of the employee’s compensation. If the all of the Physician’s 1099 income is considered compensation, can this entire amount be contributed to the 401k?
And on top of this, can an additional 25% of this be contributed as a Employer contribution?
Moreover, if the single member LLC has a bit less than $20,500 in Revenue for the year, could it still theoretically ‘compensate’ its single member $20,500, then contribute the entire thing as an employee contribution, and 25% of that as an employer contribution?
Not quite. I believe those two have a complex interaction that limits the total contribution. I’m not sure I understand exactly how to do the calculation, but if you earned $25K, you couldn’t contribute all $25K. It would be something between $20,500 and $25,000. $21,866 to be precise. But I don’t quite understand the math. It’s not just $20,500 + 25% * ($25,000-20,500). Mike Piper does though. Here’s his calculator that I think you’ll find useful.
https://obliviousinvestor.com/solo-401k-contribution-calculator/
Don’t forget that if that doc has another 401(k) in which he or she used the employee contribution, he doesn’t get another one.
WCI – Thank you for this information and for the link to Mike Piper’s calculator – this is a very helpful tool. I’ll keep the link handy. Would love some input on this current scenario. To add more detail:
– The physician just recently a few months ago changed from one W2 “day job” to a new one.
– He has 1099 income in addition to this for this year (and typically) is approximately $15-25k annually (though this is typically completely or nearly completely negated by expenses associated with this). This is managed through a sole proprietor LLC (has an EIN).
– From the prior W2 job, he has a 457b account, a 401k account (employee deferrals), and another 401k (all from employer contributions). All of these were funded with pre-tax money (Traditional).
– Also from the prior W2 job, the employer has funds from a Defined Benefits Pension plan available to rollover to something else. (Not enough years of service to be worthwhile leaving the funds in the pension plan)
– The new W2 job has a 403b (employer will match contributions to 6% or the $20,500 maximum, whichever is applicable – the $20,500 will be the relevant value here. Employee contributions can be Roth or Traditional. Matching Employer contributions must be Traditional.
– The new W2 job has a 457b (no matching available – all employee contributions. Can contribute Roth or Traditional.
– The physician has no current Traditional IRA accounts (does Roth conversion every year, as does spouse).
HERE IS THE PLAN for this year, 2022, and moving forward to navigate the job change and new retirement plans. Please comment on anything you’d do differently or recommend on the following:
1) Max out New Employer Contribution to 403b ($20,500). I chose to do this with Roth Contributions – would you do this with Traditional? Chose Roth to have a blend of Roth and Traditional accounts. Open to suggestions.
2) Employer will match the 403b contributions ($20,500) – this will go to a traditional 403b
3) Max out 457b plan in new W2 Employer account. BUT – this will be the total of $20,500 – since the prior W2 job also had a 457b plan, the employee can contribute a TOTAL of $20,500 between both accounts. In subsequent years, max out $20,500 in the W2 Employer plan. Did this with Traditional 457b. Agree or disagree? Would you do Roth?
4) Open Individual 401k using EIN from Sole Proprietor LLC). Since ‘profit’ (after expenses) = 0, then Employee contributions will be 0; and the Employer Contributions will be 0. This could be different in later years. But this year, $0 for both.
5) Rollover prior employer 401k (both of them) 457b, and funds from Defined Benefit pension into the Individual 401k. (Traditional). Need somewhere to roll these accounts into – and it CANNOT be an IRA, since that would affect ability to cleanly do a yearly Backdoor Roth IRA for $6000.
6) Vanguard seems to be a great spot to hold the Individual 401k and also the Traditional IRA account (just to do the Backdoor), as well as the Roth IRA account (which will ultimately hold all IRA funds year after year once Roth conversion gets done). Will use target retirement date mutual funds – low expense ratio. Think there’s a better custodian? Better fund strategy?
7) Question – since the W2 job offers a 403b that will be maxed out – will never be able to contribute to Individual 401k as the employee, regardless of small business profit – but maybe be able to contribute from the Employer side of things. This is correct right? The 403b and 401k employee contribution limit is $20,500 TOTAL for both?
Looking forward to thoughts on all this or any critique! Actually quite a bit of fun to figure out. Is it wrong to feel that way?
6) Vanguard is my usual default. Whether there’s a better strategy depends on how much one values simplicity.
7) Yes. You should read this post too: https://www.whitecoatinvestor.com/multiple-401k-rules/
Given the stock market in decline, it seems to me borrowing $50K from an i401K is something to consider. My understanding the interest expense is paid to the i401K. So ultimately, it is a no interest loan. Of course the risk is the market improves dramatically. I am investing in ST debt with my borrowings and will pay back upon debt maturities.
You can always just invest your 401(k) into ST debt if that’s what you want.
Thanks for everything that you do. This is an incredibly valuable resource.
Question – I will have some 1099 income (under $1k) this year. I also have W2 income with an employer who offers a 401(k) plan (assume that I have contributed the maximum $61,000 to this plan, having hit both the 402(g) and 415 limits).
Theoretically, would it be possible to open a Solo 401(k) plan, contribute $61,000 (all on an after-tax basis) and roll that over to a Roth IRA (the mega-Backdoor strategy)? This amount would, of course, be well in excess of the 1099 income, but I am wondering if after-tax contributions are exempt from the income limit.
No. You could open a solo 401(k) plan and contribute $200 as an employer contribution and $800 as an after tax employee contribution though. Or you could contribute $1000 as an after tax employee contribution. But you can’t make $1K in self employed income and then contribute $61K to a retirement account from it. It doesn’t work that way. Sorry.
I used to be a hospital employee and everything was easy…now, I have a new situation this year and was hoping for advice on how to structure my retirement accounts.
I’m an ED doc for a private group and part of our contract is 25% of our earnings automatically goes into a SEP-IRA. I expect to make $200k w4 income from this job.
I also expect to make $100k in 1099 locums income.
Does this plan work:
-Let the $50k automatically go into SEP-IRA
-Open a solo 401k and contribute $22,500 (thats the max right?)
-Cry because I can no longer do a backdoor $6000 roth IRA conversion because the SEP-IRA messes up form 8606
-Still do a $6000 backdoor roth IRA for my wife (earns 70k) because my SEP-IRA doesn’t affect her form 8606
Thank you either confirming my plan or setting straight my confusion!
You could also contribute an employer contribution to the Solo 401(k) of about $20K, so $42.5K. Or if you get one that allows it, put another $23.5K in as a Mega Backdoor Roth IRA contribution.
You’re right that Backdoor Roth IRAs and SEP-IRAs don’t play well together. Weird that your group chose that. Might want to get a study of the practice to see if that’s really the right plan for you. These folks can help:
https://www.whitecoatinvestor.com/retirementaccounts/
https://www.whitecoatinvestor.com/the-mega-backdoor-roth-ira/
https://www.whitecoatinvestor.com/multiple-401k-rules/
Does your comment in #3 “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” mean that Backdoor Roth IRAs and SEP-IRA/SIMPLE-IRAs will play together nicely for the 2024 tax year?
Thank you!
I would expect them to “play nice” only if you’re making Roth SEP IRA contributions.
Hi,
Thanks for all the info.
2022 is my first year with 1099 income on the side. When discussing with my accountant, he still recommended SEP-IRA over solo 401k. He thinks it is simpler, and that I can avoid the pro rate rule by rolling my SEP-IRA into my roth every year.
Here’s his thoughts on the subject:
“You must aggregate all your IRAs, SEPs and SIMPLEs to determine a ratio that determines the taxability portion of a conversion. This also creates basis In your SEP that lowers your taxes when you withdraw the SEP funds.
The easiest way to avoid this complexity while enhancing your retirement income is to also convert your SEP into a ROTH. For example, if you contribute $6,500 to your traditional IRA and $12,000 to your SEP, you could convert the entire 18,500 to a ROTH. A great way to superfund your ROTH each year.”
Any thoughts about this advice over the solo 401k?
Thank you in advance.
Well, he’s right on those two points. It is simpler. And you can avoid the pro-rata rule by rolling it into a Roth every year.
At many income levels people can contribute more to a Solo 401(k) than a SEP-IRA. Whether that is true for you or not I don’t know. Also you would at least have the option for tax-deferred contributions. And you wouldn’t have to do a Roth conversion every year. But if a SEP works for you, it’s fine to use it.
Hi,
I’m curious where you see the new rule in the Secure Act 2.0 that says SEP IRA will be excluded from pro-rata calculations in 2024. Or are you just saying that you could have Roth SEP IRA now, so it would be possible to convert fully (though with tax implications)?
Is that for tax year 2024 or filing year 2024?
Thanks!
The latter. Nobody talks about “filing years,” it’s all about tax years. So if it is 2024 it’s for the 2024 tax return year that runs Jan 1-Dec 31 2024.
Ah, understood.
I still don’t see where in the law it says this rule will be changed though, do you have a source on that?
https://www.finance.senate.gov/imo/media/doc/Secure%202.0_Section%20by%20Section%20Summary%2012-19-22%20FINAL.pdf
Title VI – Revenue Provisions
Section 601, SIMPLE and SEP Roth IRAs. Generally, all plans that allow pre-tax employee
contributions are permitted to accept Roth contributions with one exception – SIMPLE IRAs.
401(k), 403(b), and governmental 457(b) plans are allowed to accept Roth employee contributions.
18
Section 601 allows SIMPLE IRAs to accept Roth contributions too. In addition, aside from
grandfathered salaried reduction simplified employee pension plans, under current law, simplified
employee pension plans (“SEPs”) can only accept employer money and not on a Roth basis.
Section 601 allows employers to offer employees the ability to treat employee and employer SEP
contributions as Roth (in whole or in part). The provisions in Section 601 are effective for taxable
years beginning after December 31, 2022.
Hi Jim, thanks for the incredible information! Still confused please help.
Primarily W2 – income 300K. For 2023, will max employee 401k contribution at $22,500 and 403b at $22,500. I have a 2% match on employee contribution. Will do backdoor Roth of $6,500.
Moonlighting 1099 income of 75k.
Can I still open a solo 401k and how much max can I contribute to it? Also can I make this into Roth and which kind?
Wait what? You have a 401(k) and a 403(b) from the same employer? You sure about that?
But as far as the 1099 income, you could open a solo 401(k) and do either of the following:
1) Get a standard solo 401(k) and put $75K*20% = $15K into it as a tax-deferred employer contribution or
2) Get a custom designed 401(k) and put $66K into it as an after-tax employee contribution and then immediately convert it to Roth within the plan (the Mega Backdoor Roth IRA)
An IRA contribution for you and your spouse are completely separate.
This is a great post for employed physicians with a side gig. Wondering if you might update since it’s been a long time. If I understand correctly, one can max out employee and employer contribution at W2 job and still contribute 18% of 1099 to solo 401k. Where does the 18% number come from? Is that considered employer contribution? Thanks.
It works out to around 18% for most docs. Recognize that 18%*1099 income isn’t the calculation though. Here’s a great post and calculator that helps make it:
https://obliviousinvestor.com/solo-401k-contribution-calculator/
Not too much else to update other than the new rules under the Secure Act 2.0, most of which aren’t showing up in 401(k)s yet.
https://www.whitecoatinvestor.com/secure-act-2-0/