[Editor's Note: This is a guest post from Kayla Sloan, a writer for ListenMoneyMatters.com. I've written on this subject before, here and here, but it has been 3-5 years and I thought it was perhaps time to address it again. I have no financial relationship with the author or the linked site.]
Being your own boss sounds great, doesn’t it? You get to set your own hours and decide how much you will work, where you work, what you do, and more. Although it sounds like a dream job, keep in mind there are drawbacks as well. There’s no employer withholding your taxes, nor do you have the benefits of vacation and sick days, health insurance, and a retirement plan paid by your employer.
Even though you’re on your own, there are ways to save for your future retirement. Here are three popular investing options for small business owners.
# 1 Simplified Employee Pension (SEP IRA)
The IRS allows you to contribute up to 25% of your earnings net of the employer portion of self-employment taxes and the contribution itself [basically 18-19% of gross income for most docs-ed], with a maximum of $53,000, into a SEP-IRA. These are pretax earnings, just like a retirement account through an employer would be. You can establish an account through your bank or through another financial institution of your choice [like Vanguard-ed.] Then, fill out an IRS Form 5305-SEP-Simplified Employee Pension—Individual Retirement Accounts Contribution Agreement.
One of the really nice things about this type of account is you can wait right up until you are going to file your taxes to set it up, allowing you to take advantage of knowing exactly how much your tax bill is for the year. If your tax bill is high, you can increase your SEP contribution and reduce the amount of taxes you have to pay.
There are drawbacks to this type of retirement plan if you have employees, however. You must establish SEP-IRAs for them if they are over 21 and have performed services for you in at least 3 of the immediately preceding 5 years. You don’t have to contribute every year, but if you contribute to one employee you must contribute to all, and employees can’t contribute to this type of account themselves.
[Editor's Note: A SEP-IRA is an acceptable option for a doc with no employees who has no interest in a Backdoor Roth IRA or who is willing to convert the entire SEP-IRA every year to allow for a Backdoor Roth IRA. It is also a useful one-year “band-aid” if you failed to open a 401(k) in time since you can establish it in April for last year, whereas an individual 401(k) is required to be open by the end of the calendar year.]
# 2 Savings Incentive Match Plan for Employees (Simple IRA)
If you have fewer than 100 employees, a good retirement option would be a Simple IRA. Like a SEP-IRA, your contributions to these accounts are tax-deferred until the funds are withdrawn. The maximum amount of money you can invest in one of these accounts is $12,500 for 2016, but if you are over 50 you can add another $3,000 to this figure. If you choose this option you must also contribute either a 3% matching contribution or a 2% fixed contribution to the employee. To get started, fill out the IRS Form 5305-Simple-Savings Incentive Match Plan for Employees of Small Employers (SIMPLE)—for Use with a Designated Financial Institution. If you plan to allow your employees to choose the financial institution, however, the form to fill out would be Form 5304-Simple-Savings Incentive Match Plan for Employees of Small Employers (SIMPLE)—Not for Use with a Designated Financial Institution. Then open a Simple IRA account through a bank or other financial institution.
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One drawback to this plan is that you must wait two years to withdraw funds or be subject to a 25% penalty. Instead of withdrawing funds, you could roll them over into another IRA without incurring any penalty. Another downside comes into play if you have a second job and contribute to a 401K plan. Any contributions to your Simple IRA are counted against your 401K plan.
[Editor's Note: The main problem with a SIMPLE IRA is the low contribution limit. For this reason, it's a lousy option for a doc without employees. It also counts against you when it comes to the pro-rata calculation on the Backdoor Roth. However, if you have employees AND really want to offer them retirement benefits, it's not the worst thing in the world. But chances are you're going to spend a lot of money on matching funds in order to defer your $12,500. I mean, assume you get a $5K tax deduction for your contribution but have to contribution 3% for your 5 employees whose salaries total $200K. You just paid $6K in order to defer $5K in taxes. Not exactly a winning formula unless providing for your employees' retirement is more important to you than providing for your own.]
# 3 Individual (Solo) 401K
Business owners and their spouses may choose this option because of the higher contribution limit of $18,000 per year for 2015 and 2016. If you are over 50 you can add another $6,000 in contributions. Again, these are pretax dollars. You can add an additional 25% of your net earnings [Same as the SEP-IRA, ~ 18-19% of gross self-employment income-ed] if you are self-employed, up to a maximum contribution of $53,000. There’s no minimum amount which allows you to control how much of your salary you have available as disposable income for the year and how much to allocate toward investing. If you have another IRA account that was a rollover from a previous employer’s 401k, you can roll them into this account as well [a great way to avoid pro-rata issues with a backdoor Roth IRA.-ed]
You may be able to borrow against this account in times of need. [50% of the balance up to $50K total, but be sure your plan document allows for loans, many don't.-ed] Restrictions may apply, such as a limit on how much you can borrow and how long you can take to pay it back. A disadvantage is that this is not an option if you have employees. You can only set up this type of investment account for yourself and a spouse.
[Editor's Note: I prefer this account over the SEP-IRA for the self-employed physician without employees because it allows for higher contributions for those with income below ~$285K than a SEP-IRA and allows you to do a Backdoor Roth IRA. Setting it up is slightly more hassle than a SEP-IRA, and fees at Vanguard are slightly higher (because you can only use the higher-priced investor shares where you can do admiral shares in a SEP-IRA) but I think it is worth it. There are other options for individual 401(k)s and you can even have one in addition to your employer's 401(k), so long as you have self-employed income.]
Being self-employed does have some disadvantages, but the inability to invest doesn’t have to be one of them. By choosing one of the 3 investing options for small business owners, you can add investing to your list of advantages for self-employment.
Wakesurfing…almost as fun as finding out you're eligible for another retirement account
[Editor's Note: This is where the submitted guest post ended. But I think it ought to be extended a bit because there are at least three other good options. The remainder of the post is written by me.]
4. A Formal 401(k)
If you have no employees, the individual 401(k) is almost a no-brainer. However, if you have employees, things get a lot more complicated, especially if your goal is to maximize your own tax-deferral while minimizing how much you're spending on the employees. In fact, it can get so complicated that it is a good idea to hire a pro to do an analysis of your business and goals to determine the best way to proceed. But suffice to say that one commonly chosen option is to simply start a 401(k) like any employer may offer. This will probably allow you a higher contribution than a SIMPLE, while allowing you to spend less on your employees than using SEP-IRAs. There is a dramatic difference in how much you can spend on this, so look for low fees and experience with small practices.
5. Defined Benefit/Cash Balance Plans
Another retirement account you may use is a defined benefit or cash balance plan. This can be stacked on top of your 401(k). If you have employees, you're probably going to need/want professional help setting this up. If you don't, a personal defined benefit plan is an option. Schwab is one of the bigger names offering these. Fees are definitely higher than an individual 401(k), however. For instance, Schwab charges a set-up fee of $1500 plus $1500 a year. But for a highly compensated physician, especially an older one who is behind on his retirement savings, this can be a great option despite the higher fees.
6. Personal Savings
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Another option that many self-employed with employees choose is to simply avoid a plan all together. You don't have to offer anything to your employees if you do all of your savings in a personal Backdoor Roth IRA ($5500 a year, $6500 if over 50), a spousal Backdoor Roth IRA (another $5500-6500), and a taxable account (unlimited contributions.) However, before deciding to do this I would hire a professional to see just how much it is likely to cost you to implement a 401(k), it may be less than you think and you might even be able to reduce salaries or other benefits somewhat to help make up the difference in your cost.
What do you think? If you are self-employed, which of these plans do you use? Have you considered changing? Why or why not?
For what it’s worth, and I’m a CPA who works with small businesses, I think the Simple-IRA option is really good if you have employees and want to provide them a pension plan. Usually none of your employees wants to save more than the limit allowed by the Simple-IRA option… and when this is case, you pay too much in fees for the 401(k) to justify the increment benefit of a higher 401(k) deferral.
BTW in some circumstances, you can do pretty well with a Simple-IRA too. You may individually be limited to $12,500 or $15,500 contribution annually (plus that 3%). But if your spouse works in business and then you want to prime the pump of your three kids’ retirement savings via their summer jobs, you can actually move quite a bit of money into tax deferred accounts in a year even with this “no frills” option.
One comment about the SEP-IRA option, too. If you’re operating as an S corporation, the SEP can work well over time because all of the pension contribution comes from the S corporation and none comes from the employee. As a result, you get your S corporation reasonable compensation up a bit but without bumping your payroll taxes. E.g., you set your base salary to $80K and have 20K of health insurance and health savings account. In this case, your SEP-IRA contribution equals $25K which means your compensation is now up to $125K. And that will work in a lot of situations. If you made $175K, you’ll have saved roughly $8500 in payroll taxes via this structure.
I should also say that the SEP possibly works better than a solo 401(k) in this situation because it’ll work for longer if you ever add employees. E.g., you can hire an employee or two and for a while not worry about covering them.
I have a hard time getting excited about a $12-15K limit. That’s my main problem with a SIMPLE. Especially when it disqualifies you from a backdoor Roth IRA too. https://www.whitecoatinvestor.com/simple-iras/
Me too. But if you have employees and want to offer them a pension plan (so now you’re probably talking a very modest employer match), the situation is you’re paying maybe $3K a year for a plan that lets you move your elective deferral from $12.5K to $18K…
Employees who have worked less than 1 year can be excluded from a 401k. Due to the backdoor Roth limitations and the requirement to “match the match” for employees, I typically recommend a SEP only when an employer has not set up a plan by the 12/31 (11/2 for SIMPLE IRAs) deadline.
SIMPLE IRA – for doctors, pretty much only when starting out and cannot afford to fill out a 401k. Also good for moonlighting income of ~ $50k or less when covered by a 401k at “day job”.
The elective deferral for the 401(k) at the regular jobs uses up the elective deferral for the Simple-IRA for the sideline job. I.e., if you do $18K at your job, you can’t do any Simple-IRA elective deferral at another employer.
For more info: https://www.irs.gov/retirement-plans/how-much-salary-can-you-defer-if-you-re-eligible-for-more-than-one-retirement-plan
Also, the longer term issue I don’t like about 401(k) plan is the permanence requirement. You have a bit of wiggle room between hiring some person and later putting them on the pension plan with s SEP. Much less with a 401(k). So it seems like you’re more at risk with a 401(k) .
Note: I have not seen personally someone get into a “the 401(k) plan wasn’t permanent because employer cancelled plan once employer added a second employee” argument with IRS or Department of Labor. But I’ve talked with pension fund administrators at some of the big financial services companies about this. And they’ve told me, it happens.
I think some folks would appreciate a post on best options for side income. For instance they are w2 for the most part which already has a 401k but they make 50-100k via 1099.
Rex, because in your situation you’ve already used up your elective deferral, you probably want to look at option of a SEP-IRA. Basically, as post notes, you’ll be able to save a little less than 20% of your profit.
I’m not talking for me
I’m self employed with 401k/PS and a DB
You mean like this:
https://www.whitecoatinvestor.com/sep-ira-vs-solo-401k/
May surprise you, but at $50k of qualified income, a SIMPLE IRA will yield a higher contribution (assuming the $18k elective is used up at main work).
I don’t understand your math. Roughly, if you’ve used up your elective deferral, you can do 3% of $50,000 or $1,500 with a Simple-IRA if you’ve used up your elective deferral at main job.
With a SEP, you can do nearly 20% of $50,000 or nearly $10,000.
You know what, I totally blew that answer. You are correct, Stephen.
Don’t worry about. I will join you shortly, I’m sure. 🙂
This was helpful – thank you.
I’m full time at an academic center, but having been doing a modest but increasing amount of consultative work on the side.
My spouse and I already max out 401ks, backdoor Roths, and HSAs with an additional 457 for me.
It looks like 2016, my consulting income will be approaching mid five figures and setting up an individual 401k seems like it might be the best strategy to put further income aside for retirement.
Depending upon the amount of qualified income, this might be a case where a SIMPLE IRA would be easier and give you a larger contribution.
SIMPLE IRA has no Roth implications?
Not sure what you’re asking, but a SIMPLE IRA screws up your backdoor Roth. There are no Roth SIMPLE IRAs.
Exactly – yes, that was my question. Thanks so much.
Yes, contributing to a SIMPLE would prevent the back door, sorry I didn’t catch that.
Thanks
If you are frugal enough to be able to contribute $53k a year a solo 401k is by far the best option.
If you have a stay at home spouse you can hire that spouse for $24k/yr as well have another $22k+ to defer.
Add an HSA to the mix and add $6600
Add in a backdoor Roth IRA for the both of you and you have another $11000
You now have $92,600 in some for of tax shelter.
If you really want to go all out and looking to save $150k+ you can add in a defined benefit plan to the mix.
There are creative ways to set up these plans allowing for some really large deferments every year.
I think you want to include the payroll tax costs in your thinking about pension plan options. Hiring a spouse so you can add him or her to the payroll and then get another chunk of tax-deferred deduction only rarely makes financial sense in my experience.
You probably don’t really save taxes by paying $15K in FICA and Medicare to get a $20K deferral.
I mean BTW a $20K tax deferral savings. I.e., pay $15K in extra FICA and Medicare to defer $50K in federal income taxes and at a 40% tax rate get $20K of deferral savings.
Ugh! (See jfoxcpacfp? It only took me a couple of sentences?)
Let me fix that..
I mean BTW a $20K tax deferral savings. I.e., pay $15K in extra FICA and Medicare to defer $50K in *taxable income) and at a 40% tax rate get $20K of deferral savings.
Yah, the difficulty with the blog is that we can’t edit posts.
As we’ve discussed before, if the spouse has already maxed out SS taxes, it’s a no brainer.
Can you clarify that comment WCI? We’ve got a company 401k with profit sharing. I’ve got my wife on payroll and pay her $24K to allow her deferral max of $18K. Seems to work out beautifully and her payroll taxes on that salary are much lower than 15K. Where does this figure come from?
Right now we are right at the $92K tax deferral total that EnjoyIt lists above…
I didn’t say it wasn’t a good move if she hadn’t maxed out the SS taxes, only that it was if she already had. More details in this post:
https://www.whitecoatinvestor.com/why-i-gave-my-business-away/
OK, I think I maybe see where we’re seeing things differently. I agree with your math if the spouse is partner and we’re talking self-employment tax earnings…
Also if a spouse is made an employee and spouse has already maxed the FICA, the employee part of the FICA shown in the W-2 will come back as a credit.
But the employer part of the FICA won’t ever come back. Nor will the FUTA and probably other state level payroll taxes (if we’re talking true payroll.)
I think I took the comment about “hiring a spouse” very literally. But maybe people really mean sharing self-employment income via a partnership 1065 tax return?
Giant apologies if my dashed-off comments come across as even 1% snarky! 🙁
You’re right that there is a difference between the spouse being an employee and being a partner and it changes things.
How about a Roth 401k? Are there any precautions or objections why I shouldn’t switch from a regular small business 401k to a Roth 401k?
You usually just add a Roth option to the 401k you already have.
Any advice would be greatly appreciated . Husband is with a group practice made up of 9 physicians . Each MD is structured as S corporation. There is 401k offered through the practice, as well as a match. Husband gets a W2 from group practice, and a W2 from his own S Corp. Please guide as to how he can reach the 53k limit if allowed. He contributes the max limit on the 401 k (employee). The match for each MD is calculated by the accountant at the end of the year. He has never been able to reach that 53 k limit. Are we missing something? Is he able to establish a solo 401 k through his S Corp to at least max out the employer portion of the 401k? If this has been addressed before, my apologies. A link to the answer would be greatly appreciated. Have been a longtime reader but first time poster. Thank you!
So husband is employed by the group and also has an s-corp that receives distributions + 1099 from the group to s-corp? Distributions only? Trying to wrap my head around this one. Seems as if he s/b able to have a SOLO-k, also, but there’s a lot I am not privy to. Do you not have your own private CPA to talk this over with?
Sounds to me like the two businesses are related. Depending on the other employees and how the plan is set up, it’s possible he cannot get $53K in there.
Thanks WCI. That’s what I was afraid of.
This sounds to me like a partnership of S corporations. That’s maybe a little “adventurous”… but often pretty good tax planning.
The partnership can slice and dice profits at the partnership level however they want without worrying about S corp rules. And then each partner (an S corporation) plays the usual bookkeeping games there to save taxes.
When we do this with clients, the partnership acts as a common paymaster and pays the S corporation’s employees. Also, the complete collection of entities (the partnership and the S corporation partners) are treated as a controlled group. That means one pension plan, probably “run” by the partnership.
If the partners (the S corporations) are doing this to save payroll taxes, they’re possibly saving more payroll tax money there than they’d save in income taxes using a bigger deferral pension plan.
Lots of doctor groups used to do this. But it is less popular lately. Any idea why? Did something change a decade ago or something?
I don’t know why it’d be less popular. With Obamacare tax, it’s actually even a more attractive option.
For what it’s worth, I like the idea of using “partnerships of S corporations.” Each “partner” can save $10K to $30K annual in payroll taxes if people’s shares are healthy six figure amounts. That adds up.
BTW, the two sweet spots for S corporations are when someone earns (say) high five figures or low six figures and so can save that 15.3% payroll tax on several tens of thousands of dollars… OR when someone earns so much money that saving 2.9% or 3.8% amounts to a lot of money (even though the wages are set high.)
Right, and the average doc ($200-300K) is right in the middle of those two sweet spots unfortunately.
Because the businesses are related you can’t do a separate 401k. We have something similar at our office, but we have like 20 employees so the matching adds up. I tried a lot of different ways to so if there was any way around it, but never found one as the s-corp is basically there the receive the money from the partnership and separate expenses etc. It’s not really a separate job, if I understand your situation correctly.
However, if everyone in the group is considered a Highly Compensated employee, since they all own more than 5% or make over 118k, I think that’s the current cutoff, then there should be no reason why those who want can max their 401k, provided he is making enough money to reach the max.
Man, I just read my comment, spelling spelling spelling… Sorry.
So the question is, what is the salary that they are getting? If the salary is not high enough, he won’t be able to max out the contribution at $53k. That’s probably what’s happening. WCI is right, you can’t have a solo 401k and treat that as a separate plans – both plans will have a single limit of $53k because of controlled group situation. And if there are any non-partner employees, he won’t be able to have a solo 401k anyway.
Thanks for the reply. Husband has an S Corp that receives the distribution only; from the distribution he gets a paycheck. No 1099. Will be meeting with the accountant (group’s accountant) in a couple days to discuss options . Have also discussed this with personal accountant but still awaiting for a response. Thanks again.
I’m a partner in a large private group and a few years ago we switched our partnership to an S corp. This saved us some money on payroll taxes. We now have part of our salary payed as a ‘distribution’ from the S corp and the remaining as salary. The tricky part as I understand it was to make the amount of the distributions that avoided payroll taxes low enough as to avoid suspicion from the Gov. We also have a defined benefit plan which allows us to put a significant amount away, but there are some in my group that are fearful of possible consequences of that defined amount in the future getting so large that it would put the groups finances at risk.
The tricky part is getting as much into retirement accounts as you want while still having a significant part declarable as distributions. If your income is only $200-300K and you want as much as possible into retirement accounts, especially with a DB/CB plan, there isn’t much of a distribution there. You’re only saving Medicare taxes (2.9% of the distribution.)
Thanks to everyone who commented on this matter. Great post/great discussion!
The big problem I see is that many groups adopt a DB plan without understanding the implications and without having proper advice in place to make sure that your plan is managed prudently. So I’d say that #1 thing to do is to get everyone together and get a complete understanding of what a DB plan is and how it is designed, and what happens if it is underfunded or overfunded, or when assets have to be sold at a loss. The next step is to figure out how the crediting rate is set and how the investments are selected and managed. The major problem of most group DB plans is that the investment portfolio is managed as a single account, not as an account for multiple people that has to withstand multiple risks that might result in your plan assets sold under unfavorable circumstances. Once that’s addressed, and your investments are managed correctly, your plan will have minimal exposure even if adverse events do happen. There are a number of such events (including being absorbed by a hospital, many older partners retiring, markets crashing, etc.) that can lead to big losses that have to be made up by plan participants. Minimizing these risks through proper ‘liability matching’ is a must for DB plans, and the big problem is that investment advice offered to small group plans is less than adequate when it comes to managing those types of risks (and the investment management itself is often done by either a committee or worse by non-fiduciary advisers).
What is the amount of self employment income needed to max out a solo401k? The math is trickier than it should be…
The math is very simple
max contribution is $53k
$18k comes from the employee.
$35k will have to come from the employer.
Max contributions by employer is 25%
therefor you need to have a minimum W2 income of $140k/yr
140,000*.25% = 35,000
The $35k must come from somewhere therefor the company had to have a $175 worth of profit to be able to pay you $140k plus $35k into your 401k.
Plus we can’t forget payroll taxes. The company will also need to pay the employer portion of SS and medicare
Social security is 6.2% on $118,500 (SS maximum) = $7,347
Medicare is 1.45% on $140K = $2,030
The total income the company needs to max out $53K into your 401k is $175,000 + $7,347 + $2,030 = $184,377
I hope it makes more sense now 🙂
Thanks for spelling this out! if we have already fully paid the social security tax through another w2 income or employer.. We don’t have to pay any more SS tax through the self employed business income… Correct? What about Obamacare tax? And is the max contribution really 25% ? Or 20 %
>And is the max contribution really 25% ? Or 20 %…
It’s either. Or Both. I.e., if you’re looking at the $140K, it’s 25%… that equals $35K.
And if you’re looking at the $175K, it’s 20%… that equals $35K.
Correct. You do have to pay Medicare tax and Obamacare tax, but that’s the same no matter which spouse gets the income.
I wish the math were that simple. While that’s the main gist, it’s all about the “net income”, net of payroll taxes. So it’s a little more than $140K and a little more than $175K to max things out. But you’re in the ballpark.
If we want to be really precise, I think it’s only the employer share of the payroll taxes we need to adjust for…
And I’d be that precise if I was doing your tax return, I promise. But I’m going to be wanton in my rounding on your blog. 🙂
Thank you! That is what I have been getting but isn’t it quite odd math? This is important to me because I can work as little as I want for an hourly rate plus I’m trying to max out in 6 months post residency so my goal is $185k. The only thing wrong in your statement is I’m not W2. WCI do a post on the income needed to max these out!
I think it was covered pretty well in the comments section of this post. If it’s your only account (so you get the employee contribution) it’s $53K-$18K = $35K. Divide that by 20% and you get $175K. Add a “fudge factor” of $10K or so and that’s how much you need. ~$185K. If it is a secondary account (like you have a 401(k) at your W-2 gig and also an individual 401(k) at your moonlighting gig (so you don’t get an employee contribution to your individual 401(k), then you take all $53K and divide it by 20%. That’s $265K. Add the fudge factor and you’re at ~$275K. So in an S corp situation, you’d declare your salary as $275K. If you made $350k, you’d call $75K (or $165K if it is your only 401(k) a distribution, and save $75K*2.9% = $2,175 or $165K * 2.9% = $4,785 on Medicare taxes.
Hope that helps.
Plus if you already used your employee contribution elsewhere, you will need $53K/20%= $265K+ to max it out.
Question:
Can I contribute in the same year (2016)to :
1. Simple IRA (in a small side business where I am the only employee, my total yearly income was $9000 and I want to use it all as my contribution (employee and employer) )
2.401k ,my main job where I am employed by a big group (where I want to contribute my employee part max$ 18000)
3.Non-deductible traditional IRA (for me and my wife will be $11000 or so for this year)
That will be total of $27000 pretax and $11000 post tax, each goes in a different account
Thank you for your response
You can do it all. I wouldn’t however. What I would do is open an individual 401(k) instead of a SIMPLE IRA, put all $9K into it, max out the main job 401(k), and then do Backdoor Roth IRAs for you and your spouse.
If I remember correctly, SIMPLE contribution has to be coordinated with the salary deferral for the 401k, so $9000 into SIMPLE would subtract from the 401k salary deferral. Same for the solo 401k by the way, but the $9k can be contributed into the solo 401k after-tax.
http://finance.zacks.com/can-contribute-401k-simple-ira-same-year-2907.html
You also didn’t mention anything about profit sharing for your main group practice – that’s also something that should be used hands down (unless the practice has non-spouse employees, at which point the plan has to be designed to allow the group doctors to max out their contributions at $53k if that’s at all possible).
I’m an s-Corp with 5 employees. I pay myself $120k a year w2 and I have 4 employees who will make about $25-40k/yr for non officer payroll totaling $120k. I have another $300k in distribution.
Looking to set up 401k safe harbor. I’ve tried contacting different companies including online (employee fiduciary, Merrill edge, sharebuilder401k,etc).
One pension planner says he can do it for $1500 setup and $1200/yr. he points me to American funds where typical expense ratio is 1.5% or higher. I want low cost index fund. Will try a few others. Would these planners have access to Schwab etf’s and how much would scwab or other brokerages to set up? I contacted Schwab and they say I have to go through tpa.
Just a 401k with Safe Harbor? No profit sharing? I’ve written an article on the topic of selecting a 401k or SIMPLE IRA as a startup plan. My take is that a Safe Harbor 401k is not worth the hassle until you can max out the profit sharing component:
http://www.dentaltown.com//Dentaltown/Article.aspx?i=403&aid=5625
Yes, having a TPA is always a good idea especially if you want a custom-designed (‘cross-tested’) 401k plan for your practice. If your spouse is also on the payroll, a SIMPLE might be more than enough. It is definitely possible to have a 401k plan with low cost Vanguard index funds.
Here’s some more information about small practice plans that might be useful:
http://www.dentaltown.com/Dentaltown/Blogs.aspx?action=VIEWPOST&b=143&bp=579
http://www.dentaltown.com/Dentaltown/Blogs.aspx?action=VIEWPOST&b=143&bp=3376
If you are self employed, only have SE 401K but can’t max it out to 53K (35k+18K), does it matter which contribution you max out first? Employee vs. employer? Does it matter from tax standpoint, IRS/legal standpoint?
No, not really.
You can actually max it out even with a lower net income by doing after-tax contributions. You can contribute $18 salary deferral, profit sharing (as much as you can), while the rest (up to $53k) can be after-tax, so you only need a W2 of $53k to max out your solo 401k.
Of course, those after-tax contributions aren’t nearly as good as tax-free/Roth or tax-deferred contributions unless you have an easy method of converting them to Roth.
And that’s the last piece of the Mega Mega backdoor Roth ;-). Right now you can’t convert after-tax to Roth via a custom plan document. But this is definitely legal and will definitely be added in the near future. I’ve checked, currently there is no IRS guidance on that, so it is not part of the documents I work with, so the money has to be pulled out into a Roth (which isn’t that bad if your accounts are all in one place).
I know this is a complicated question- just wondering if someone could point me in the right direction. (Books, articles, etc.)
I receive a generous 6 figures as 1099 income, my only job. Spouse stays at home. Have set up an llc and plan to file as s Corp to take advantage of distributions. Also plan to set up solo 401K.
From here, I’m not sure what else to do to improve tax situation or take advantage of any other scenario. “Hire” spouse? What am I missing? Obviously battling a huge tax burden right now. Thanks.
You could hire spouse if you have work for him/her to do, but bear in mind the benefit of having an additional solo 401(k) might be eliminated by the extra SS taxes due. Be sure to deduct your health insurance premiums and HSA contributions. Do backdoor Roth IRAs too.
You have several planning options, as WCI began describing for you. A CPA and/or fee-only CFP should be able to pay for himself or herself with the value of advice specific to your situation. Since you plan to set up an Scorp, I presume you are already working with a CPA? If so, you should have this discussion with him/her.
Yes, indeed, hiring a spouse is an option, and you also have the possibility of opening a solo Defined Benefit plan and make an even larger contribution. This link has more information on this topic:
http://quantiamd.com/player/ygvmhdmbm?cid=1467
This post is great. WCI, would you agree with the very first comment that for S corp physicians, SEP-IRA is better because you can increase your reasonable compensation in a tax-deferred manner? If someone is planning on contributing max ~20k, do you still prefer the Solo 401K? (I ask that since you indicated your preference for solo 401k was due to the higher limit, but if the intention is to contribute under the SEP-IRA limit, then unsure what the advantage is)
Yes, I prefer the Solo 401(k) for a self-employed doc with no employees or only a spousal employee and/or employees that won’t qualify for the plan like your kids. At some incomes, the contribution limit is higher and at all incomes you preserve the option to do a backdoor Roth IRA. The only reasons to choose a SEP are # 1 slightly less paperwork and # 2 you can still open the account and contribute the maximum contribution right up until tax filing date. I think you’re supposed to at least have the employee contribution to a solo 401(k) in by the end of the calendar year. But you for sure have to establish the plan before the end of the calendar year.
Also, if you ever want to do a Defined Benefit plan, as many groups would do, you can’t have a SEP IRA and a DB plan together, so a 401k plan (not a ‘solo’ 401k plan) should be implemented instead. A ‘solo’ 401k plan will also NOT work with a DB plan, but it is a good starting point, definitely better than a SEP, because you can also have catch-up contributions with a 401k plan while you can’t have that with a SEP. You can also max out a solo 401k plan with a much lower contribution.
If the group ever has non-spouse employees, both SEP and solo 401k plans don’t work: SEP becomes prohibitively expensive and solo 401k can’t work with non-spouse employees.
Here are the links with more information on this topic:
http://quantiamd.com/player/ygvmhdmbm?cid=1467
http://quantiamd.com/player/ygrmdgmtk?cid=1467
If you are self-employed with no employees you can use a personal defined benefit/cash balance plan with an individual 401(k).
For those who are interested, I’ve put together a comprehensive course on retirement plans that can be accessed via QuantiaMD:
1. Retirement plans for employees (hospitals, universities, other practices):
http://quantiamd.com/player/ygfrbeyty?cid=1467
2. Retirement plans for small practice owners:
http://quantiamd.com/player/ygrmdgmtk?cid=1467
3. Retirement plans for solo owners (no non-spouse employees) and contractors:
http://quantiamd.com/player/ygvmhdmbm?cid=1467
4. Retirement plan case studies (examples of plan design including 401(k), Defined Benefit and Cash Balance):
http://quantiamd.com/player/yewvnfqav?cid=1467
These presentations will address many questions on how to maximize your contributions, how to coordinate contributions into various types of plans, and how small practice plan designs that allow owners to max out their contributions work, and will also cover all types of plans including solo 401k and Defined Benefit. Last link also shows some real life examples of small practice plans.
Question on 401ks. My main job is an employee where I contribute the max 18k of employee contributions and receive an 18k employer contribution match. I have a 1099 side job where I will earn around 40k after deductions. Can I contribute an additional 10k (25% of the 40k) on top of my employee and employer match? I will still be well under the 53k max but I’m not sure how the employer contribution might affect contributions from my 1099 job. Thanks!
You can contribute $8k (20% of your 1099 income) as a sole proprietor/LLC.
Actually, you might be able to contribute the entire $40k, 20% of it tax-deferred and the rest after-tax (and that part can be converted to Roth by rolling it out of the plan). For that you will need a custom plan document for your individual 401k plan. Otherwise, only 20% can be contributed.
It’ll work out to just less than $8K, not $10K. It’s 25% of the net (of the employer side of payroll taxes) total not including the contribution or 20% of the total including the contribution.
Thanks for the quick feed back! So the limit is 20% for tax-deferred contributions? For the Roth conversion, do I set that up with the plan and then convert directly into a Roth (i.e. no need for a back door conversion)? I’m using Vanguard for my solo 401k. That’s a little more money than I am planning for this year but a great thing to consider for 2017.
Kon is talking about the “mega backdoor Roth”. You can’t do it with just a standard vanguard individual/solo 401(k). You’d need a custom designed plan (which Kon does.)
https://www.whitecoatinvestor.com/the-mega-backdoor-roth-ira/
No need for a custom document unless you are routinely maxing out your 401k (and/or you have a relatively large IRA that you might want to rollover). For smaller amounts I’d stick with Vanguard’s standard account.
Hi
I would appreciate your advice on this. I have a 403 b plan and 457 b plan from my employer, both of which I have maxed out for past 2 years and will do this for this year as well. I started a SEP IRA last year and now I anticipate that more than half of my income will be from 1099. how much can I actually contribute in the SEP IRA (assuming earnings of 200,000 from 1099). I do have a LLC for my 1099.
Also my spouse (household manager) has an IRA but from 5 years ago but we stopped contributing not knowing how to go ahead.
Thx
If you have a 403b that either a solo 401k or a SEP you can only contribute a maximum of $53k into both, so you can only contribute the difference between $53k and what you contribute into your 403b (including any employer contributions). It might actually make sense not to contribute to a 403b if you have no match or if you can max out your SEP (I wouldn’t use a SEP, but rather a solo 401k instead). Using a solo 401k would also allow you to continue making Roth via ‘backdoor’. Then you can easily contribute $53k into a solo 401k with your level of income. You can still max out your 457b plan regardless. The SEP would have to be rolled over, either into your solo 401k or into your 403b to allow backdoor Roth though.
Thx. Can I have a 401k and SEP-IRA. I cannot immediately rollover my IRA as it is with lending club. I presume I will have to wait for lent money to come back into account before I can rollover.
Also what would your advice be for my spousal IRA plan.
Thx
There is no problem if you have both plans. You can even make contributions into both at the same time, but it is much more efficient to just use one plan at a time. Of course you can do a spousal backdoor Roth. You can even add a spouse to the payroll and contribute into the solo 401k on her behalf. Just make sure there is an official job description. This way you can contribute $53k + ~$20k or so together into a solo 401k.
You might try selling the notes if you want to invest the money in something else. You could even sell them in the IRA and buy them from yourself in taxable if you like.
Agree with Kon about adding your spouse to your plan, but be aware that your spouse has to actually work for you. Also, you can’t do a tax-free back-door Roth for your spouse until you either convert the IRA from 5 years ago into a Roth or do a reverse rollover into her SOLO-k she contributes to as your employee.
Agree with Kon that you should consider hiring your wife, but be aware that she has to actually do work for you and be paid a reasonable wage for her duties. Since she has an IRA hanging around from 5 years ago, you cannot do a tax-free backdoor Roth conversion until she has either:
1) converted her TIRA into a Roth (and paid taxes) or
2) done a reverse rollover of the TIRA into her SOLO-k that she contributes to as your employee (no current taxes due).
Thank you all. This is great advise. I will sell the notes .
Ali
Does my wife has to be an employee. Can she be an independent contractor to my LLC.
No, she wouldn’t qualify to participate in your employee retirement plan as an IC.
But can she have her own 401k
If she is legitimately self-employed (as an independent contractor) then yes. But make sure she meets the definition of independent contractor.
The LLC doesn’t matter.
If you convert or roll the IRAs and SEP IRAs into 401(k)s you can do backdoor Roth IRAs, so be sure to learn about those.
Unfortunately, 403(b)s aren’t 401(k)s, so Kon is right. $53K total between employee and employee contributions to the 403(b) and SEP IRA contributions. So probably $18K into the 403(b) and $35K into the SEP-IRA. You should have enough income to do that. However, you should do a solo 401(k) instead of the SEP IRA to preserve the backdoor Roth option.
Hello everybody
I’ve learned so much from this blog.
I have a question regarding my situation. I have my office which is a PA, S corp. I have 10 employees including 3 NP with 100k salaries. I also take calls for the hospital and I get a 1099 for that for about 60k. In addition, I do some consultant work and I get another 60k a year. I have an LLC with my husband where we hold 4 rental properties with a yearly gross rental income of 180k. My husband went back to school to become a CRNA (not currently working). At this point, I can’t offer a 401k through my office because it would be too expensive for me. Can I use my 1099 for the calls and for consulting work to open a solo 401k? Would it be better to open the solo 401k through the LLC and give my husband a salary so we can double the retirement? Any suggestions are appreciated
You have a controlled group which means that all of your businesses are treated as a single business for the purpose of having a retirement plan so any retirement plan you open for yourself and/or your husband has to include your employees.
That said, if your NPs make over $120k, they would be considered HCEs, and you can exclude them. You might also be able to exclude some
Sorry, hit reply too soon. You might be able to exclude NPs, but I’m not 100% sure, will need to check on that. Other than that you are out of luck. If you owned a business 50% with someone else (not related to you), you could have had a retirement plan for that business alone, and not for the practice.
To really get an accurate answer it would be necessary to do a design study for your specific practice, otherwise it is all theoretical. For one thing, you can have all of the 1099 income go to your practice as that would allow you to give yourself at least $270k W2 which might allow you to minimize employer contribution. If your W2 is too low, you might be paying too much in profit sharing for the employees, but without doing a design study it is impossible to say what your W2 should be. Also, your husband can be employed by your practice, and this can also allow you to increase your 401k plan contribution. So there are many ways this can be handled, and it might come out that a plan is just too expensive for you (or that we can find a way to make it cost effective).
Thanks for the quick reply. I was reading the post were WCI decided to share his 50% of his blog with his wife and give her a salary and get a 401k. Can I do that with my real estate business? It’s a different LLC than my office, different area of business and it’s owned by me and my husband
First, real estate is passive income and can not be contributed to a retirement plan. But even if you were a professional real estate investor (which would allow you to get paid for working in real estate), you can not escape the controlled group that any of your businesses will form as per IRS rules.
WCI has a ‘day job’ and a 1099 job. That’s different. He does not own the hospital. He’s an employee, so there is no controlled group there and he can set up a retirement plan for his business (and split it with his wife, which also allows him to amplify his retirement plan contribution).
You can do the same thing within your practice. Your husband can get a 50% of the net profit, and you can channel all of your 1099 income to the practice. This way you can potentially increase your 401k plan contribution to $53k x 2, but the devil is in the details as I described above.
I’m not technically an employee. I’m a partner. But I only own like 1/150 of the business partnership for my practice, so it isn’t a controlled group.
Is your real estate business a brokerage/realtor or do you own real estate for rental? If your business is selling properties for a commission then your income is not passive and you can set up a retirement plan. However, if you own both the business and the practice, then you will not be able to contribute more than $53k per year per person ($59k if age 50+).
They have a controlled group situation, so it would not be possible for them to contribute anything to a retirement plan even if they were real estate professionals.
My focus was on the passive income comment. All real estate businesses are not passive. A realtor’s office is an active business (not talking about real estate professional which is a specific IRS definition). I think we sometimes jump to passive for all real estate activities but commissioned sales of residence and commercial is not passive. Some people would describe that as having a “real estate business” and I was only clarifying.
Can I have multiple SEP accounts, even with one self employed job
No.
Any thoughts on physicians who own a practice, have no employees, and those who do work in the office are leased employees from the hospital? Is there a requirement to provide retirement contributions to the leased “employees” if their w2 is filed with the hospital and their salary comes from the hospital rather than directly from the physician practice? Would the physicians be required to contribute to an SEP IRA or 401k for the leased “employees”? Thanks for any advice.
Probably so. See “Definitions You Need to Know” in IRS Pub 560 https://www.irs.gov/publications/p560/ch01.html
Really? By leased he seems to be saying that he has contracted with the hospital to provide some services and makes a 1099 payment to the hospital. That requires you to provide benefits separately for the hospital’s employees? That seems pretty odd. But that’s what Pub 560 says (unless the hospital provides them a pension):
Yes. If they are classified as leased employees, you MUST provide something towards their retirement if you want to open a plan for the practice. We encounter situations like this often. However, if they are already covered by a retirement plan at the hospital, you might be able to get away with giving them a lower contribution, provided that your plan is designed correctly. This stuff can get tricky, so details matter.
Looking for thoughts regarding this.
I am an employed physician. I was eligible to participate in my employer’s 401K as of last year so I maxed out my 401K contribution. The summary plan description documents the company offers a safe harbor match and profit sharing plan. So I was expecting a safe harbor match made on my behalf by the company. However I recently received notification that my mandatory pension contribution would be deducted from my income next month. When asked about this, it was explained that x amount was for safe harbor match and x amount for profit sharing. These were things I thought were employer expenses and contributions made on my behalf. When I explained this I was told that in my employment contract there is a statement saying “Net Collections …is less all refunds, recoupments, offsets, pension plan contributions payable on behalf of Physician …etc” So yes, there it is in my contract. Unfortunately I was not very financially savvy when I signed this thing and I guess every day learning something new! I never thought “pension plan contributions” would mean the 401k match. I just didn’t put that together.
I guess I am just looking for reassurance that “pension plan contributions” should be interpreted to mean the safe harbor match and profit sharing contributions.
ANd if this is something commonly done or unusual…having an employee pay for these things themselves/not be an expense to the employer.
I don’t know if it is common or not, but I agree it isn’t much of a match if it is subtracted from your paycheck. I’ve never gotten a match, so I’m not exactly an expert in them. All of my pension plan contributions come out of my pocket.
Seems lame, but I guess their defense is “You signed the contract.”
Thank you for the reply.
So yes, I signed that. I am still just not sure that it is legal. As an employee I know I am allowed to put in 18k but technically I would be contributing more than that if I pay my own match. Seems like they are getting around that by paying in on my behalf a match but then holding the amount of that match from my income. That is how they worded it. I would be reimbursing them. So I suspect they will use this matched amount as a deduction. But then will take pretax dollars from me to reimburse themselves.
I am also not sure where to go next for a definitive answer. And obviously not sure how much I want to rock the boat with this issue but this could amount to a significant amount of money over the years.
Again, thanks for your response. Have learned so much from you.
I don’t think I’d rock the boat at all. Now that I think about it, this is the situation our pre-partner employees find themselves in. They can match themselves, but we don’t give them money like we do our PAs.
HCE employees can be fully excluded from matching and profit sharing, contract or not. It is typically something that can be found in the plan document. I wouldn’t say this is a good thing. If your employer wants to offer a good benefit they can at least give you a match. So while this is allowed, it is not the best solution. They are simply trying to reduce their retirement plan costs, and this is typically done by a smaller practice.
That said, often plans simply don’t allow HCE staff to make those contributions, but in your case at least you can make a matching/profit sharing contribution, but it is taken out of your pay, so that’s probably a better way to do this than completely disallowing matching and profit sharing, at which point you are stuck with only a salary deferral.
Sure, of course happy to have more tax sheltered space and that is fine. Just also seems questionable to me in terms of legality. I am only able to put 18k yearly into a 401k. But technically I will now be putting in 18k + the match. So my company is getting around this by contributing the match amount and then deducting that amount from my check. Is that cool with the IRS?
This thread was very helpful last year increasing my retirement contributions and saving me money on taxes. Thank you! I have a different tax situation this year and I’m trying to wrap my mind around maxing my pretax 403b/solo 401k employee/employer contributions. I worked part of 2017 as an employee and contributed around 7,000 in employee contributions in a 403b. I had a 7,000 employer match for which I’m only vested 25%. I switched jobs in early 2017 and I am now working as an independent contractor. I will have about 250k of 1099 income. I already maxed the remainder of my employee contributions with an additional 11k in my solo 401k and also added an additional 28k in employer contributions. That puts me at 18k employee and 35k employer contributions across the two accounts. Since the 250k qualifies for a higher employer contribution – 47,753 according the bankrate calculator – can I include this whole amount as an employer contribution in my solo 401k (making sure I don’t exceed 54k total in the solo 401k)? This would add an additional 15,000 beyond the 28k I already put in (I’m subtracting the 11k I added as employee contributions). I like the idea – it would save me over 4k in taxes!