Stick with my current 401k or open an Individual 401k?

[OmahaFella]

Hello!

I'm a 31-year-old freelance developer with two jobs; a steady W2 job, working 1000+ hrs/yr, and I also own an S-corp where I'm the sole employee. I'm trying to choose between two 401k options for 2014:

Option 1: Continue participating in the W2 employer's traditional 401k plan (what I've been doing for the past few years). Comes with about $3500 in employer contributions, and I can shield (in 2013) $17,500 by way of pre-tax contributions.

Option 2: Stop participating in option 1, and open an individual 401k with a max pretax contribution of $51,000: $17,500 as an employee, and $33,500 as the employer. Because the max employer contribution has to be 25% of the employee's salary, I'd need to increase my salary from $50k, to $134k.

At an average tax rate of 28%, the latter option would allow me to defer tax on $33,500, for a (momentary) savings of $9,380. Though, this scenario comes with the added burden of paying more taxes due to the higher salary. I'm not sure how to precisely calculate that part; my CPA's explained that the withholding on Social Security is basically all covered by my W2 job, leaving just the additional tax on Medicare (as both the employee and employer). There's also the less tangible concern about locking up that much more money in an account that has limited access (until age 59.5).

Anyone ever been in a similar situation? Thanks in advance for the guidance!

[brewer12345]

I think the best way to do this is spreadsheet it out.  Personally, I would have a hard time passing up on the free $3500 while building up some after tax assets for flexibility via the S corp.

[beltim]

My biggest issue is the ability of your S-corp to nearly triple your salary.  If you can do that, the difference between the two 401(k)s is almost trivial.

Brewer is right, though, a spreadsheet is a good idea.  The only reason you wouldn't have to pay Social Security tax (both the employer and employee parts) is if your regular job pays you more than the cap on Social Security. 

[willn]

I am curious. Don't you pay income taxes on the net income of the S corp anyway?  I thought S corp profit flows to your personal return.

[OmahaFella]

Thanks for the responses! My S-corp grosses about 180k each year, so there's room for me to up my salary, but it comes with the added tax burden of paying more Medicare tax (the W2 job maxes out my SS tax), rather than taking the money as shareholder distribution.

I too am struggling with refusing the $3500. And if I needed further incentive keep me away from the Individual 401k, I've been considering hiring an employee, which I think, would disqualify me. Thanks again for the input.