Author Topic: Help me decide: Run small business money through solo 401k or owners draw IRA?  (Read 1660 times)

MichikoMustache

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Happy New Year Mustachians!

I own a small business and usually run all the profits through my solo 401k. We fund our IRAs through my husband's income. I pay payroll tax on the profits then my investments are tax deferred and do not count towards income tax.

However, this spring we are having a baby and building an addition to our home (for said baby). So his (current) income is tied up in emergency funds for the labor and delivery, maternity/paternity leave and building materials.

My question: We would like to front load our IRAs, if possible. Should I do an owner's draw from the biz profits to fund our IRAs or fund them later in the year after the Kid and the building are paid for? If I pull money out of the business, I don't do payroll tax (I think) but I will have to pay income tax on that money.

Any advice would be appreciated!

maizefolk

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What kind of legal structure does your small business have? Assuming it's something like an S-corp, I think you'd owe self employment payroll taxes (15.3%) as well as income taxes on profits you didn't put into your solo 401k.

If you'll have enough money from your husband's income to fund the your IRAs before the end of the year, my suggestion would be to keep putting your business profits into the solo 401k. You'll lose up to a year of tax deferred growth by end loading instead of front loading, but you'll be able to use the full IRA contribution limit ($11,000), plus contribute as much as your business profits allow to your solo 401k. The other way around, you'd have $11,000 less in total tax deferred contributions at the end of the year.

401k contributions also reduce your income for the purposes of calculating whether you're eligible to contribute to traditional IRAs, so check to make sure you and your husband aren't close to the phase out. It'd be a real shame to pull $11,000 from your business to max out your IRAs only discover that the extra $11k in joint income was enough for the IRA deduction limits to start phasing out.

MichikoMustache

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Thank you so much for your help. My business is an S Corp and we won't max out the 401k limit between the two of us. We probably can find the $11k in my husband's income to fund our IRAs by the end of the year although we are not close to the deduction limits so that's not a worry.

It sounds like we should keep running every dollar of biz profit through the 401ks and scrape together the IRA money as soon as possible.

Thank you so much for your advice! Happy new year!

seattlecyclone

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Yeah, I agree you don't need to do anything different with regard to the business profits. Front-loading the IRA is nice, but it sounds like you have some bigger priorities in the short term. Fund the IRA later when the baby-related expenses are paid.