Author Topic: Solo 401(k) vs IRA, contribution priority?  (Read 2836 times)

nereo

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Solo 401(k) vs IRA, contribution priority?
« on: September 26, 2016, 11:36:28 AM »
I've very recently started working as an independent contractor.  We are living off of my spouse's income and plan to divert 100% my earnings towards retirement.  Because there's only ~3 months left in 2016 my earning potential for fy16 is limited (plus, I'm still ramping up). This is our only income in $USD for 2016.

Question: Assuming earnings of ~$10k, is there a preference between putting that into our IRAs (up to the 2 x $5500 limit) or into a solo 401(k)? I'm leaning towards the IRA simply because we already have IRA accounts from previous years, but I'm not sure if I'm missing an advantage of the Solo 401(k).

BigHaus89

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Re: Solo 401(k) vs IRA, contribution priority?
« Reply #1 on: September 26, 2016, 11:40:46 AM »
From what I have seen, solo 401k plans have slightly higher expenses(account maintenance fees or whatever). If you are taking the deduction from a traditional IRA, I think the IRA is the preferred way to go here based on how much you earned. The solo 401k has a much higher contribution limit though.

Note that you can contribute to a 2016 IRA until the end of April 2017. With a 401k, you can only contribute until year end. Something to keep in mind.

nereo

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Re: Solo 401(k) vs IRA, contribution priority?
« Reply #2 on: September 26, 2016, 02:16:52 PM »
From what I have seen, solo 401k plans have slightly higher expenses(account maintenance fees or whatever). If you are taking the deduction from a traditional IRA, I think the IRA is the preferred way to go here based on how much you earned. The solo 401k has a much higher contribution limit though.

Note that you can contribute to a 2016 IRA until the end of April 2017. With a 401k, you can only contribute until year end. Something to keep in mind.

Thanks.  While I knew about the contribution deadline for the IRA, it does pose an interesting hypothetical; I might not make enough in 2016 to max out both of our IRAs, but it's entirely possible that I could earn enough in 2017 to max out both years' IRAs plus contribute a signifciant amount to the Solo 401 each year.
That does seem to favor contributing to the Solo 401 now and worrying about maxing out the 2016 IRAs from January-April next year. 

Kind of backwards from what I'd expect, but that makes sense, no? Ultimately it leaves more 'headway' for tax-advantaged accounts...

seattlecyclone

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Re: Solo 401(k) vs IRA, contribution priority?
« Reply #3 on: September 26, 2016, 02:45:49 PM »
Do you have much taxable money that you might prefer to have in a tax-advantaged account instead? One option to consider if so would be making Roth contributions to your solo 401(k). By doing that, then you still have some earned income that you could use for a deductible traditional IRA.

nereo

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Re: Solo 401(k) vs IRA, contribution priority?
« Reply #4 on: September 26, 2016, 03:07:56 PM »
Do you have much taxable money that you might prefer to have in a tax-advantaged account instead? One option to consider if so would be making Roth contributions to your solo 401(k). By doing that, then you still have some earned income that you could use for a deductible traditional IRA.
Hmm.... interesting thought, but I'm not clear on whether I could do this.  For simplicity, let's say that I earn $10k as an independent contractor in 2016.  Wouldn't that limit my total contributions to IRAs and Solo 401(k) to $10k?

I certainly would like to move taxable money into a tax-advantaged account... but from what I understand the law prohibits me from contributing more than what i earn in one calendar year.  Am I wrong?

seattlecyclone

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Re: Solo 401(k) vs IRA, contribution priority?
« Reply #5 on: September 26, 2016, 04:30:19 PM »
From Publication 590-A:

Quote
For 2015, the most that can be contributed to your traditional IRA generally is the smaller of the following amounts:
  • $5,500 ($6,500 if you are age 50 or older), or
  • Your taxable compensation (defined earlier) for the year.

"Taxable compensation" is defined earlier here. It does say that for self-employed people you have to reduce your compensation by the "deduction for contributions made on your behalf to retirement plans," but you don't take a deduction for Roth contributions. The full amount of the Roth contribution still counts as taxable income, so it should also count as compensation for the purpose of IRA contribution eligibility.

robartsd

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Re: Solo 401(k) vs IRA, contribution priority?
« Reply #6 on: September 26, 2016, 05:05:09 PM »
I certainly would like to move taxable money into a tax-advantaged account... but from what I understand the law prohibits me from contributing more than what i earn in one calendar year.  Am I wrong?
You're not wrong, but there is a small loophole with Roth contributions: although the contributions are limited by earnings, the taxes paid on those earnings do not need to be deducted from the earnings - giving Roth slightly more headroom.

terran

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Re: Solo 401(k) vs IRA, contribution priority?
« Reply #7 on: September 26, 2016, 08:50:44 PM »
Do you have much taxable money that you might prefer to have in a tax-advantaged account instead? One option to consider if so would be making Roth contributions to your solo 401(k). By doing that, then you still have some earned income that you could use for a deductible traditional IRA.
Hmm.... interesting thought, but I'm not clear on whether I could do this.  For simplicity, let's say that I earn $10k as an independent contractor in 2016.  Wouldn't that limit my total contributions to IRAs and Solo 401(k) to $10k?

I certainly would like to move taxable money into a tax-advantaged account... but from what I understand the law prohibits me from contributing more than what i earn in one calendar year.  Am I wrong?

It sounds like your spouse is also working, so you can contribute to the IRAs based on his/her earnings.

Either way, open the 401k and make its effective date january 1, 2016 -- as long as it's open by December 31st you don't actually have to contribute until your tax filing deadline (like the IRAs).

nereo

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Re: Solo 401(k) vs IRA, contribution priority?
« Reply #8 on: September 27, 2016, 05:48:28 AM »
Do you have much taxable money that you might prefer to have in a tax-advantaged account instead? One option to consider if so would be making Roth contributions to your solo 401(k). By doing that, then you still have some earned income that you could use for a deductible traditional IRA.
Hmm.... interesting thought, but I'm not clear on whether I could do this.  For simplicity, let's say that I earn $10k as an independent contractor in 2016.  Wouldn't that limit my total contributions to IRAs and Solo 401(k) to $10k?

I certainly would like to move taxable money into a tax-advantaged account... but from what I understand the law prohibits me from contributing more than what i earn in one calendar year.  Am I wrong?

It sounds like your spouse is also working, so you can contribute to the IRAs based on his/her earnings.

Either way, open the 401k and make its effective date january 1, 2016 -- as long as it's open by December 31st you don't actually have to contribute until your tax filing deadline (like the IRAs).

Spouse is working, but has no earned income in the US.  Hence the limited amount available to put into tax advantaged accounts this year.