Author Topic: Self-Employed 401K and maxing contributions  (Read 4496 times)

Credaholic

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Self-Employed 401K and maxing contributions
« on: May 14, 2014, 08:49:50 AM »
I just realized how silly it is that we're not maxing out my husband's 401K. I tend to direct that money into easier to access savings, even though we do have room for the savings. I decided to take a hard look at what we'd need to do to save to be able to semi-FIRE in 10 years at 40, and realized I need to set that money aside no matter what, and might as well take the tax break a 401K offers. Correct me if I'm thinking of this wrong, but if we pay say 25% in taxes, then our 401K contributions are essentially making a 25% return before they're even invested, right?

So then a stupid question. How do you set set it so that it hits exactly $17,500? If he works overtime (or takes a sick day outside of his paid time off for instance) his salary wouldn't be exact. Do people maxing out their 401Ks just set it so that it will be close?

I am an independent contractor. I don't have a separate LLC or Corporation set up, I'm simply 1099'd to my personal name. Can I open a self-employed 401K, and how much can I contribute? Does it work the same way where the contributions are pre-tax?

randymarsh

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Re: Self-Employed 401K and maxing contributions
« Reply #1 on: May 14, 2014, 10:29:02 AM »
Your 401k isn't really "making" any return, but you are saving money. In your 25% example, every dollar you put in your 401k saves you 25 cents.

Some employers will automatically stop your deduction when you reach the max. Some let you put in a dollar amount and not a %. I would have him ask HR.

You can set up a Solo 401k or SEP IRA. https://investor.vanguard.com/what-we-offer/small-business/individual-401k

They're similar, but the 401k can let you save more if your earnings are high enough. With the 401k, you can contribute $17,500 and then you (as the employer) can put in $52,000 but only (25% * compensation) is tax deductible on the employer side.

Cheddar Stacker

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Re: Self-Employed 401K and maxing contributions
« Reply #2 on: May 14, 2014, 10:36:44 AM »
You can also do a simple ira which allows up to $12K plus up to 3% of your profits from the independent contractor gig.

Correct me if I'm thinking of this wrong, but if we pay say 25% in taxes, then our 401K contributions are essentially making a 25% return before they're even invested, right?

It's not a 25% savings, it's a 25% deferral. You will most likely pay taxes on this eventually, but you can do it at a much lower rate later when you draw the money out. Read this: http://www.madfientist.com/retire-even-earlier/

So then a stupid question. How do you set set it so that it hits exactly $17,500?

Contribute the most you can as quick as you can. Track the amounts on your paystubs or your 401K website. Stop when you reach the limits. If he's a high wage earner (like $117K high) his contributions can be limited if certain factors are present within his 401K plan.

Credaholic

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Re: Self-Employed 401K and maxing contributions
« Reply #3 on: May 16, 2014, 07:58:17 PM »
After reading the Mad Fientist article linked to above, I'm even more committed to maxing out the retirement accounts. I haven't delved hard into the math yet, but if we max out the Roths and max out 401Ks for 10 years we'll easily be sitting on half a million even without investment return calculated in. If we can afford to do this, plus pay off a mortgage and put additional savings into a small rental property portfolio as is our plan, then FIRE-ing is definitely within our reach.

The question is, CAN we afford to do all of that?

The answer totally depends on my income as an independent contractor which is variable. At the moment my income does support this plan, but it could decrease. So, I think what is smartest is to continue maxing out the Roths and start maxing out my husband's 401K immediately. I will put aside funds for my own 401K in a targeted savings account, but hold off on actually putting them in the 401K until later this year when I know that money won't need to be directed elsewhere. That is assuming there's no rule against this? Is a self-employed 401K like a Roth? Can I wait until the end of the year and then fund it in full, or must I do it in smaller increments throughout the year?

Now, assuming that we're financially able, can someone explain the 25% employer contribution to me? I can contribute $17,500 myself, and then as my "boss" I can also contribute 25% of my compensation? I don't have a corporation or LLC set up paying me. I'm simply 1099'd by the company I contract with to my personal name. So say I am 1099'd $100K this year. Can I contribute $17,500 PLUS $25,000??? And can I wait until December to do that?

And one last question - taxes! My taxable income will be reduced by the $17,500 I contribute as an employee, right? Will it also be reduced by the $25,000 that my "employer" (me) contributes?

Sorry if I'm being a complete dunce. I suspect I might be because this all sounds too good to be true...

fmzip

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Re: Self-Employed 401K and maxing contributions
« Reply #4 on: May 16, 2014, 08:22:18 PM »
^^^^ IT IS TRUE! Setup a company/LLC :)


I have an S-corp set up. I am an owner, I am an employee.

I set up a solo-401K. I, the employee can contribute up to $17,500 from my annual pay into the 401K (unless you are 50 or over, you can add $5500 to that amount). This amount is not subjected to federal income tax. It is however subjected to FICA and Medicare tax on both the employee and employer side. So yes, whatever federal tax bracket I can say I gain instantly

On the business owner side, if you are a sole proprietor or single member LLC, you can contribute another 20% of the employees salary to the profit sharing portion of the Solo 401K, In my case it's 25% because I am not a sole proprietor.

Example, My company pays me a salary of $100,000K annually. The company can make a profit sharing contribution of $25,000 to my Solo 401K completely tax free. I, the employee can also make an elective deferral of up to $17,500 to the solo 401K from my salary, reducing my taxable income level by that amount. (The maximum total annual contribution of both cannot exceed $52,000 annually)

http://www.irs.gov/Retirement-Plans/Plan-Participant,-Employee/Retirement-Topics---401(k)-and-Profit-Sharing-Plan-Contribution-Limits

http://www.irafinancialgroup.com/solo401kcontributionlimits.php

It's best to max the profit sharing side first if you can't do both. Reason being? It's a 100% tax free deduction on the business side, no FICA, no medicare, no federal or state taxes... :)

So I would say, on the profit sharing side, the instant tax savings is rather large, 6.2% FICA tax on the employee side, 6.2% FICA tax on the employer side, 1.45% Medicare tax on the employee side , 1.45% Medicare tax on the employer side plus federal tax and state taxes, the savings is close to 35%. To me, that's an instant 35% return on investment!

Both profit sharing and elective deferrals can be made at anytime. The profit sharing contributions can be made up to the tax filing deadline of 2015 as well
« Last Edit: May 16, 2014, 08:54:50 PM by fmzip »

ender

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Re: Self-Employed 401K and maxing contributions
« Reply #5 on: May 16, 2014, 08:47:19 PM »
You might check with your husbands corp to see how their 17,500 figure, matching, and such are calculated.

I specifically asked about this, for my company the 401k system will prevent me from over-contributing and continue to give me the match (even if I'm not putting anything in due to IRS limits) so long as my contribution percentage stays above the match.

So I just put the amount at 50% (which is the maximum) and don't worry about it. I hit it early and continue to get the match regardless of overtime, bonus, or other factors.

Cheddar Stacker

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Re: Self-Employed 401K and maxing contributions
« Reply #6 on: May 16, 2014, 09:36:29 PM »
There are many options out there for the independent contractor. Clearly fmzip speaks from experience so read carefully and ask questions if you don't understand.

If fmzip's solo-401K plan sounds too complicated and you just want to stick with sole proprietor (what you are already doing) or LLC (which would not require any additional tax filings as an S-Corp would) and not have to set up payroll and other B.S., you have a few more options. I already mentioned a simple IRA above, and there is also a SEP IRA. Also something called a KEOGH plan but I don't know the rules.

You used an example of 1099's totaling $100K. That's not the important #, you need to calculate your profit (actually your SE income which is your profit x 92.35% I think). So let's assume you had $25K in expenses for a profit of $75K - this is the key #. Here's what you could do with these plans:

Simple IRA - $12K base contribution + 3% of profits ($75K*3%=$2,250) for a total of 14,250.
SEP IRA - 20% of profits for a total of $15K.

Last note - be careful with the Roth's. With the income number you used as your example, you might be approaching the limits where Roth's are no longer allowed.

bacchi

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Re: Self-Employed 401K and maxing contributions
« Reply #7 on: May 17, 2014, 01:45:39 PM »

Credaholic

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Re: Self-Employed 401K and maxing contributions
« Reply #8 on: May 19, 2014, 06:35:55 PM »
Thanks for the detailed responses, and also for the very helpful calculator. I did a lot more reading and searching over the weekend, and I couldn't find anything saying that a sole-proprieter such as myself couldn't set up a Solo 401K. I don't want to over complicate things with incorporating and paying myself a salary, payroll taxes, etc. But from what I've read (for instance on Vanguard's site here: https://investor.vanguard.com/what-we-offer/small-business/individual-401k) and from a phone call to Fidelity today, it sounds like all I have to do is obtain an EIN number which I would report on my schedule C. PLEASE correct me if this is wrong.

We've changed my husband's 401K now to max out for the year, and I'm setting up a targeted savings account for myself so that in December I can set up the Solo-401K and contribute what makes financial sense given my income for the rest of the year. I'm thinking that it may have been a mistake to max out my husband's 401K now if we're not able to max out a Solo 401K for me at the end of the year, since it seems the tax savings of the Solo 401K outweigh the tax savings of his regular 401K...

Again, correct me if I'm wrong, but if I contribute $20K on the employer side I report this on Schedule C as a Pension/Profit-Sharing Plan deduction, reducing my self-employed taxes automatically by $2826, as well as reducing my income tax. My employee contribution of up to $17,500 further reduces my income tax...?