Author Topic: Self-employed mustachians: is a self-funded 401k worth it?  (Read 4202 times)

lpep

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Self-employed mustachians: is a self-funded 401k worth it?
« on: August 31, 2015, 05:13:55 PM »
I'm looking for a full time job, but for the time being I'm doing some contract work. I've dabbled in freelancing before but not to the point where it was my entire income, so I have more self employment dollars coming in than ever before. The contract just started and goes another two months, at which time I might be hired full time. I think that's likely.

In the meantime, is it worth setting up a self-funded trad. 401k and channeling most or all of my contract earnings into it? It seems like a good way to mitigate some of the self-employment tax and get more $$$ into a tax-advantaged account. Do I need to form an LLC? Is the 1099 enough? Am I even asking the right questions?

Just assume I don't know anything about being self employed, because I really don't.

Thanks in advance!

Gin1984

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Re: Self-employed mustachians: is a self-funded 401k worth it?
« Reply #1 on: August 31, 2015, 05:15:29 PM »
It is called a individual 401k (i401k) and it is great because you can put money in as the "employer".  I'd have to check but it was either 20 or 25% of your profits minus your SE tax.

terran

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Re: Self-employed mustachians: is a self-funded 401k worth it?
« Reply #2 on: August 31, 2015, 06:39:42 PM »
It's as good as an employer sponsored plan except you get to control the contributions (up to the limits Gin1984 mentioned) so you can contribute even more.

Just to clear up one thing you mentioned: You still have to pay self employment tax -- you don't pay income taxes on the contributions though.

Telecaster

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Re: Self-employed mustachians: is a self-funded 401k worth it?
« Reply #3 on: August 31, 2015, 06:44:47 PM »
It is called a individual 401k (i401k) and it is great because you can put money in as the "employer".  I'd have to check but it was either 20 or 25% of your profits minus your SE tax.

Exactly.  The individual contribution is up to $18,000, plus 25% of compensation for the "employer" part.    So potentially quite a bit of money.   

protostache

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Re: Self-employed mustachians: is a self-funded 401k worth it?
« Reply #4 on: August 31, 2015, 07:08:50 PM »
It's as good as an employer sponsored plan except you get to control the contributions (up to the limits Gin1984 mentioned) so you can contribute even more.

Just to clear up one thing you mentioned: You still have to pay self employment tax -- you don't pay income taxes on the contributions though.

It's... complicated. You can contribute the $18k plus 25% of your net profit minus one half of your self employment taxes. Your self employment taxes depend on how much you contribute. The IRS worksheet has a method for determining how much you can contribute for an arbitrary raw percentage (this method has 21 steps). They also have pre-computed values for every whole-number percent between 1 and 25, but it boils down this: you can contribute up to 20% of your net profit before self employment taxes as the employer.

Of course, if you elect S-corp taxation this gets a whole lot simpler. You can contribute up to 25% of your W-2 income plus $18k.

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Re: Self-employed mustachians: is a self-funded 401k worth it?
« Reply #5 on: August 31, 2015, 07:17:53 PM »
...Do I need to form an LLC? Is the 1099 enough?...

Thanks in advance!

No LLC needed.  Yes, the 1099 is enough.  You can verify that fairly easily at irs.gov.

Good luck.

milton

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Re: Self-employed mustachians: is a self-funded 401k worth it?
« Reply #6 on: August 31, 2015, 08:13:25 PM »
You might also look into a SEP IRA, which would allow you to contribute up to 20% of net earnings as a sole-proprietor (you will want to look up the current limits as it's been a few years since I checked). They are relatively simple to use; I set up mine online through Vanguard.

Telecaster

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Re: Self-employed mustachians: is a self-funded 401k worth it?
« Reply #7 on: August 31, 2015, 11:12:44 PM »
You might also look into a SEP IRA, which would allow you to contribute up to 20% of net earnings as a sole-proprietor (you will want to look up the current limits as it's been a few years since I checked). They are relatively simple to use; I set up mine online through Vanguard.

The advantage of the SEP IRA (and as far as I can tell, sole advantage) is slightly less paperwork.  The disadvantages include much lower contribution limits, no catch up contribution (I know, the MMM community wants to retire well before 50, but still), and you take a loan against it.  While 401k loans are generally a bad idea, you could do it if you needed to. 

lpep

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Re: Self-employed mustachians: is a self-funded 401k worth it?
« Reply #8 on: September 01, 2015, 06:03:51 AM »
Thanks for the responses! Here's what I'm hearing:
  • I can open an individual 401k without taking any other steps first, like forming an LLC or anything like that.
  • I can contribute up to $18k on my own plus some employer percentage (it doesn't matter because I won't even hit $10k, most likely). This means I can put in everything I make!
  • I still have to pay self employment taxes, but contributions I make are pre-income tax, so deductable.

Is this correct?

Does this mean I can't put in every cent I make, because I have to calculate self employment tax first? That shouldn't be hard, but I don't want to over-contribute and get hit with some kind of penalty.

Gin1984

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Re: Self-employed mustachians: is a self-funded 401k worth it?
« Reply #9 on: September 01, 2015, 07:16:46 AM »
Thanks for the responses! Here's what I'm hearing:
  • I can open an individual 401k without taking any other steps first, like forming an LLC or anything like that.
  • I can contribute up to $18k on my own plus some employer percentage (it doesn't matter because I won't even hit $10k, most likely). This means I can put in everything I make!
  • I still have to pay self employment taxes, but contributions I make are pre-income tax, so deductable.

Is this correct?

Does this mean I can't put in every cent I make, because I have to calculate self employment tax first? That shouldn't be hard, but I don't want to over-contribute and get hit with some kind of penalty.
Pretty much, but keep in mind that $18K is for ALL 401ks so if you may want to make sure there is some employee space left for when you get another full time job jic they have a match.

eyePod

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Re: Self-employed mustachians: is a self-funded 401k worth it?
« Reply #10 on: September 01, 2015, 07:46:39 AM »
You might also look into a SEP IRA, which would allow you to contribute up to 20% of net earnings as a sole-proprietor (you will want to look up the current limits as it's been a few years since I checked). They are relatively simple to use; I set up mine online through Vanguard.

I don't think SEP IRAs have the same limits (they should be higher). Here's an example of someone putting in over 20k in 2012. http://www.budgetsaresexy.com/2012/03/maxing-out-sep-ira-investments/

wenchsenior

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Re: Self-employed mustachians: is a self-funded 401k worth it?
« Reply #11 on: September 01, 2015, 08:12:13 AM »
Thanks for the responses! Here's what I'm hearing:
  • I can open an individual 401k without taking any other steps first, like forming an LLC or anything like that.
  • I can contribute up to $18k on my own plus some employer percentage (it doesn't matter because I won't even hit $10k, most likely). This means I can put in everything I make!
  • I still have to pay self employment taxes, but contributions I make are pre-income tax, so deductable.

Is this correct?

This sounds correct to me, but I've just started setting my own individual 401K up this very week. I have a side gig that brings in about 10-15k/year. I first considered a SEP IRA (much easier to set up) but decided there would definitely be some years I could contribute more than the ~2K SEP IRA limit (note, that is the % limit on MY income...if my income where higher, I could contribute more).

Whereas, the 401K will allow me to contribute nearly all my side income in the years I am able because the percent limits don't apply. There are online calculators that will figure out how much you can contribute in each case.

Re: over-contributing, I haven't looked into it in detail yet, but I THINK you have until April 15th of the following year to make contributions once the plan is place. So my current plan is to slightly under-contribute, and (if possible...again not sure exactly how this works) make a catch-up payment once I do taxes in Feb/March of the following year.

wenchsenior

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Re: Self-employed mustachians: is a self-funded 401k worth it?
« Reply #12 on: September 01, 2015, 08:15:39 AM »
You might also look into a SEP IRA, which would allow you to contribute up to 20% of net earnings as a sole-proprietor (you will want to look up the current limits as it's been a few years since I checked). They are relatively simple to use; I set up mine online through Vanguard.

I don't think SEP IRAs have the same limits (they should be higher). Here's an example of someone putting in over 20k in 2012. http://www.budgetsaresexy.com/2012/03/maxing-out-sep-ira-investments/

My understanding is that SEP IRA limits are ~20% (slighly less) of your self-employed income, with no employer match. I just ran numbers recently and could contribute about 1800$ of my typical 10K income to a SEP, whereas I could contribute about 9K of 10K to an individual 401K.


terran

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Re: Self-employed mustachians: is a self-funded 401k worth it?
« Reply #13 on: September 01, 2015, 09:51:34 AM »
Thanks for the responses! Here's what I'm hearing:
  • I can open an individual 401k without taking any other steps first, like forming an LLC or anything like that.
  • I can contribute up to $18k on my own plus some employer percentage (it doesn't matter because I won't even hit $10k, most likely). This means I can put in everything I make!
  • I still have to pay self employment taxes, but contributions I make are pre-income tax, so deductable.

Is this correct?

Does this mean I can't put in every cent I make, because I have to calculate self employment tax first? That shouldn't be hard, but I don't want to over-contribute and get hit with some kind of penalty.

Close. You need to deduct 1/2 of the self employment taxes and any business expenses you're planning to deduct. Here's something that might help: http://www.irs.gov/Retirement-Plans/Self-Employed-Individuals-Calculating-Your-Own-Retirement-Plan-Contribution-and-Deduction. Your tax software or tax preparer should be able to handle the calculations, but do make sure you open the plan before the end of the year and set the effective date of the plan to the 1st of this year.

I don't think SEP IRAs have the same limits (they should be higher). Here's an example of someone putting in over 20k in 2012. http://www.budgetsaresexy.com/2012/03/maxing-out-sep-ira-investments/

This is incorrect. Both plans have an absolute limit of 53k, but you can can hit that limit at much lower income levels with a solo 401k (about $185k vs $265k) and for all income levels below that you will be able to contribute more with a solo 401k.