Author Topic: solo 401K contribution?  (Read 1375 times)

JanF

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solo 401K contribution?
« on: August 03, 2017, 11:51:58 PM »
My husband is changing from full time employee to sole proprietor this month and I'm trying to set up a retirement account for him but I don't know how the max contribution is calculated? He does not have any kind of investment account or retirement account
Estimated figures:
AGI from full time employment: 50K (Jan to this month)
Expected net income from freelance work: 7K (this month until end of year)

Am I right to assume that he can only contribute net income from freelance work? In which case what kind of account would be best?

Heroes821

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Re: solo 401K contribution?
« Reply #1 on: August 04, 2017, 06:31:56 AM »
The personal cap under 50 (age) is $18,000 into a 401k, 403b, etc. 

So if your husband had two jobs he could do $9000 at one $9000 at the other or any combination that equals $18k.

If he has placed zero into an account like this at his employer then he should be able to place it into a solo 401k for his freelance work.  The only time the net income from the freelance work should matter is if you wanted to provide employER contributions from his freelance work, which would be limited to which as a sole prop is 20% of net sole prop income.

Which would be $1400 if your husband made exactly 7k in sole prop income for the year, which would theoretically let your husband have a total of $19400 into his 401k for 2017 (Contributions can be added before April 15th 2018.

ENT Doc

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Re: solo 401K contribution?
« Reply #2 on: August 07, 2017, 03:54:10 AM »
Keep in mind the max employer contribution is 20% of net income, which is defined by net income minus 1/2 of the self-employment tax.  See schedule SE for determining the SE tax, but there is also a worksheet for max employer contribution in one of the IRS publications on SEP plans.  Point is, it's not as simple as saying 20% x Net Income.

Roboturner

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Re: solo 401K contribution?
« Reply #3 on: August 07, 2017, 08:43:31 AM »
^this

but the employer portion can be contributed up to tax time,  not EOY like the individual contribution. so you have time to figure it out after finding out the full SE wages for the year.

http://www.bankrate.com/calculators/retirement/self-employed-401-k-calculator.aspx

this will give you a good idea
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JanF

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Re: solo 401K contribution?
« Reply #4 on: August 07, 2017, 12:35:23 PM »
oh boy...this sounds complicated...so it sounds like I can set up a 401K for my husband and then have his current employer send a portion of his pre-tax income into it, right? And then as the owner of his freelance business he can put in extra 20% of his freelance net income?

Heroes821

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Re: solo 401K contribution?
« Reply #5 on: August 07, 2017, 01:29:48 PM »
His employer is probably not going to do that. My point was that he can cap $18,000 before matching between his work and his sole prop work between 2 401ks just as if he left one employer for another employer.

The issue is how much room is left for the year.  If he was making roughly 85k (50k/7 * 12) then the 18k limit would be about 21% of his income spread over probably 26 pays.  If he got paid through July he's probably at 13 pays, so ~$9000 for the year into his $18,000 limit.

If he only makes $7000 from sole prop he's not going to cap his $18,000 this year before matching. We need more information, because if he doesn't have any retirement accounts at all then I don't see how the money made at his previous employer will matter. 

If you are starting from scratch then his sole prop should be 7000 minus SE tax (15.3%) [1071] = $5929.  Assuming you need $0 of his income for living and
He does not have any kind of investment account or retirement account

He could put all of that into a solo 401k, at least that's my understanding.  And if he did max a 401k at his previous employer, he could still put that much in from the freelance work ($9000+5929= 14929) which is below the annual limit.

JanF

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Re: solo 401K contribution?
« Reply #6 on: August 07, 2017, 02:48:32 PM »
his employer does not offer any retirement package. Mine offers simple IRA with 3% match which I plan to max out. Basically my goal is to lower our taxable income and pay less taxes, what is your recommendation for that?

ENT Doc

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Re: solo 401K contribution?
« Reply #7 on: August 08, 2017, 04:06:22 AM »
The SE tax is more complicated than multiplying net income by 15.3%.  Follow the SE schedule.  You first multiply by 0.9235 and THEN, assuming you're not breaching the social security wage limit, you multiply that number by 0.153 (although this is broken into two parts on the SE schedule).  Then, you multiply it by 0.5 to get the deductible portion.  The Employer contribution is then maxed at 20% x (Net Income - deductible portion of SE tax).

Heroes821

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Re: solo 401K contribution?
« Reply #8 on: August 08, 2017, 06:45:04 AM »
The SE tax is more complicated than multiplying net income by 15.3%.  Follow the SE schedule.  You first multiply by 0.9235 and THEN, assuming you're not breaching the social security wage limit, you multiply that number by 0.153 (although this is broken into two parts on the SE schedule).  Then, you multiply it by 0.5 to get the deductible portion.  The Employer contribution is then maxed at 20% x (Net Income - deductible portion of SE tax).

I know your right, but I don't see how that's really different than 15.3% when the OP already gave us the wage numbers. The spouse is not going to reach the SS wage limit between 50k and 7k.  And while doing the tax form way is the most correct, you can still estimate the taxes owed with 15.3% and know that since his retirement plans for the year are zero he can then limit his personal contributions by 7000 - 15.3% and throw all of the rest into a 401k. It's not like they have a complicated S-corp situation.

his employer does not offer any retirement package. Mine offers simple IRA with 3% match which I plan to max out. Basically my goal is to lower our taxable income and pay less taxes, what is your recommendation for that?

As far as this goes, really it never hurts to chat with a CPA. There are plenty here, but without a lot more specific numbers our help can only be kinda vague.  The Casestudy spreadsheet does some cool math with all your total income so you can see what taxes are looking like and play with numbers.

Personally I think the options to minimize taxes are mostly built into the investment order thread.

HSA,
401k to Match.
Solve the rest for your scenario.
This ordering is appropriate for investors in the US.

WHAT            
0. Establish an emergency fund to your satisfaction            
1. Contribute to your 401k up to any company match            
2. Pay off any debts with interest rates ~5% or more above the 10-year Treasury note yield.            
3. Max HSA             
4. Max Traditional IRA or Roth (or backdoor Roth) based on income level            
5. Max 401k (if 401k fees are lower than available in an IRA, or if you need the 401k deduction to be eligible for a tIRA, swap #4 and #5)            
6. Fund mega backdoor Roth if applicable            
7. Pay off any debts with interest rates ~3% or more above the 10-year Treasury note yield.            
8. Invest in a taxable account with any extra.            
            
WHY            
0. Give yourself at least enough buffer to avoid worries about bouncing checks            
1. Company match rates are likely the highest percent return you can get on your money            
2. When the guaranteed return is this high, take it.
3. HSA funds are totally tax free when used for medical expenses, making the HSA better than either traditional or Roth IRAs for that purpose.
    At worst, the HSA behaves much the same as a tIRA after age 65.
4. Rule of thumb: traditional if current federal marginal rate is 25%; Roth if 10% or lower, or if MAGI is too high to deduct a traditional IRA; flip a coin otherwise. 
   See Credits can make Traditional better than Roth for lower incomes and other posts in that thread about some exceptions to the rule.
   See Traditional versus Roth - Bogleheads for even more details and exceptions.  State tax (or lack thereof) should also be considered.
   The 'Calculations' tab in the Case Study Spreadsheet can show marginal rates for savings or withdrawals*.
5. See #4 for choice of traditional or Roth for 401k.  In a 401k there are no income-based limits for deductions or contributions.      
6. Applicability depends on the rules for the specific 401k            
7. Again, take the risk-free return if high enough.  Note that embedded in "high enough" is the assumption that your alternative is "all stocks" or a "fund of funds"
   (e.g., target retirement date) that provides a blend of stock and bond returns.  If you wish to consider separate bond funds, compare the yield on a fund
   with a duration similar to the time remaining on the loan, and put your money toward the one with the higher interest/yield.
8. Because any earnings, even if taxed, will help your FI journey.

Case study sheet is here: https://forum.mrmoneymustache.com/case-studies/how-to-write-a-'case-study'-topic/


Tracyl-5

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Re: solo 401K contribution?
« Reply #9 on: August 25, 2017, 03:26:17 PM »
but the employer portion can be contributed up to tax time,  not EOY like the individual contribution. so you have time to figure it out after finding out the full SE wages for the year.

I'm just starting the process of researching setting up a solo 401K for my mom and step-father.  She is a temp this year, with no access to a 401K, and he is an independent contractor/sole proprietor.  Trying to lower their taxes for them and increase their savings for retirement.  Combined gross income will probably be less than $120K.  My mom's company does take out for her taxes, and a lot for health coverage. And they've already maxed out an IRA for each of them this year, which should be deductible.

So, if I understand correctly, you have to decide what your personal contributions will be before Dec 31st.
But, you can wait until April to decide what EmployER contributions you will make?
And can the EmployER contributions be more than the EmployEE contributions?

Example:
They put $3K in each of their 401K accounts before Dec 31st and save the rest of their cash for paying taxes.
At tax time, they discover they could put another $5K in each of their accounts and still have enough cash left to pay taxes.
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dandarc

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Re: solo 401K contribution?
« Reply #10 on: August 25, 2017, 03:40:07 PM »
Point of clarification.  Is it $7,000 per month until the end of the year, or $7,000 total until the end of the year?

dandarc

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Re: solo 401K contribution?
« Reply #11 on: August 25, 2017, 04:00:32 PM »
I'm going to assume this is a $7,000 per month gig.  Since the employer offers no retirement plan, there was no deferral made there.  So only the business earnings matter.

Again, assuming August - Dec - 5 months X $7,000 per month.  $35,000 this year in SE income.  So husband, a proprieter, can do the max:

Employee side: $18K unless over 50

Employer side: 20% of (SE income less 1/2 self employment tax)
$35,000 * .9235 = $32,322.50 - adjust your income down per IRS rules
$32,322.50 * .153 = $4,945.34 - this is self employment tax
$4,945.34 / 2 = $2,472.67 - one half of self employment tax
$35,000 - $2,472.67 = $32,527.33 - SE income less 1/2 self employment tax
$32,527.33 * .2 = $6,505.46 - Maximum Employer side contribution

Total max SoloK contribution on $35K of net self-employment income = $24,505 (rounded to nearest dollar)

Send at least $18K in before year end, then you can figure the exact amount and add the rest before April 15th.  What I personally do is keep a running total of $18K + 18.5% of my income as I'm paid a variable amount each month - send that in as money is available to do so.  Then I figure the exact amount and send a small amount to get right up to the limit in January.

Incidentally, if you meant $7,000 until the end of the year, then another limit comes into play - 100% of SE income less 1/2 SE tax.  That would be $6,505.  This limit is not often discussed, because most people contemplating a soloK have enough income that it doesn't matter.

bacchi

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Re: solo 401K contribution?
« Reply #12 on: August 25, 2017, 05:09:26 PM »
I'm just starting the process of researching setting up a solo 401K for my mom and step-father.  She is a temp this year, with no access to a 401K, and he is an independent contractor/sole proprietor.  Trying to lower their taxes for them and increase their savings for retirement.  Combined gross income will probably be less than $120K.  My mom's company does take out for her taxes, and a lot for health coverage. And they've already maxed out an IRA for each of them this year, which should be deductible.

So, if I understand correctly, you have to decide what your personal contributions will be before Dec 31st.
But, you can wait until April to decide what EmployER contributions you will make?

Correct.

Quote
And can the EmployER contributions be more than the EmployEE contributions?

Depends on how generous their employER is.

Quote
Example:
They put $3K in each of their 401K accounts before Dec 31st and save the rest of their cash for paying taxes.
At tax time, they discover they could put another $5K in each of their accounts and still have enough cash left to pay taxes.

Whoa there, pardner. Did she work in the business?

JanF

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Re: solo 401K contribution?
« Reply #13 on: August 25, 2017, 05:20:26 PM »
Quote
Incidentally, if you meant $7,000 until the end of the year, then another limit comes into play - 100% of SE income less 1/2 SE tax.  That would be $6,505.  This limit is not often discussed, because most people contemplating a soloK have enough income that it doesn't matter.

Yes, $7k (estimate) until the end of the year. But for example sake I'm going to bump it up a little

Basically we have this:
My gross income: $30K pre tax
  --> 5.5k goes into IRA
DH's salary with employer: $55K pre tax
  -->no employer retirement plan
DH's freelance business: $10 pre tax
  --> potential 401K/IRA.

Since the freelance business just started this year we'll be taking a 6k business expense deduction (programs are expensive) leaving up with a net income of 4K. I don't think the 401k is going to happen this year but theoretically would I be able to throw that net income of 4k into a 401K and avoid SE tax? Or will I have to give the gov their share first then put the rest in 401K?

Tracyl-5

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Re: solo 401K contribution?
« Reply #14 on: August 28, 2017, 03:09:19 PM »
Quote
And can the EmployER contributions be more than the EmployEE contributions?

Depends on how generous their employER is.

Well, since he's self-employed, we're hoping to be as generous as we can!  :o)

Quote
Example:
They put $3K in each of their 401K accounts before Dec 31st and save the rest of their cash for paying taxes.
At tax time, they discover they could put another $5K in each of their accounts and still have enough cash left to pay taxes.

Whoa there, pardner. Did she work in the business?

Yes, she helps out some after work and on the weekends.  From what I understand, a solo 401K can cover the owner and the spouse in a sole proprietorship?
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bacchi

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Re: solo 401K contribution?
« Reply #15 on: August 29, 2017, 11:07:34 AM »
Yes, she helps out some after work and on the weekends.  From what I understand, a solo 401K can cover the owner and the spouse in a sole proprietorship?

Yes, a SE business can be a "qualified joint venture" for a MFJ couple. Each participating spouse must work a minimum of 500 hours on independent tasks.

It's somewhat complex in that both must fill out Schedules C and SE. Is it worth it? From a $120k SE income, is there more than ~$37000 to contribute?

https://www.irs.gov/businesses/small-businesses-self-employed/election-for-married-couples-unincorporated-businesses