Author Topic: Sole Proprietorship and Individual 401k  (Read 25850 times)

iamlindoro

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Sole Proprietorship and Individual 401k
« on: October 21, 2013, 10:38:22 AM »
Hi all,

I'll keep it short-- Early this year my company went under and I have spent most of the year unemployed.  I have a decent emergency fund and other investments, and sources of passive income, as well as sporadic but very well paid consulting.  For most of the year, funding my retirement accounts hasn't been realistic because I was just keeping pace with bills and other costs.  However, recently I have had a number of lucrative consulting gigs come my way and I have at least the rest of the year funded, with more work coming in in the past couple of weeks.  So, now I'm considering funding an individual 401k to tax-advantage the remaining income for the year.  I already have Vanguard investments so I'm likely to use them:

https://investor.vanguard.com/what-we-offer/small-business/individual-401k

To those who administer their own 401k, I have a few questions:

* Obviously I simply fund the account myself, and keep records and take it into account in my quarterly tax filings.  I can't recall if the 1040ES worksheet has a spot in the calculation for tax-advantaged accounts, but I'd assume it does, and that it simply lops whatever contribution right off the top of the taxable earnings.  Right?

* Though not a certainty, there's a decent chance I could put away more than 17.5K in the remainder of the year, so I was interested in the "Employer Contribution" element of the Individual 401k.  The thought of supercharging my 401k by making "employer" contributions to myself is very appealing!  That said, I am sure this is an area to tread lightly... if you are a sole proprietor who has "matched" your individual 401k contributions, can you give some advice or links on how best to keep records and not run afoul of the IRS?  To date, I have been depositing my consulting checks in my personal account and keeping records in my accounting software about which are consulting earnings.  It's not ideal and I suspect if I start handling 401k contributions that I ought to separate out my consulting earnings into a different account and paying myself a paycheck-- something I should probably have been doing all along, anyway.

Any insight or advice from those in the know or those having done this would be very appreciated!  If the "contribution" bit holds true, I'm surprised I've managed not to read about it to date!

iamlindoro

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Re: Sole Proprietorship and Individual 401k
« Reply #1 on: October 21, 2013, 10:47:05 AM »
I guess I'll add one more statement and one more question:

Since the "employer contribution" is also a deductible business expense, though it's not 100% tax free, it also seems like a nice way to get the extra tax advantage.... right?

The question is about going back to non-self-employed work but keeping the consulting going.  What are the rules on the individual 401k contribution max, and employer contribution, when also offered and participating in another business' 401k?  I am fairly certain that I understand 17.5K is the maximum contribution across all accounts, but in the case of having both the individual and a corporate sponsored 401k, what is the optimal tax/saving strategy to put in the max amount and derive the greatest benefit?  ie, can I put in 17.5k with an employers 401k, take their matching, and then simply do employer contribution only from consulting income on my individual account?

brewer12345

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Re: Sole Proprietorship and Individual 401k
« Reply #2 on: October 21, 2013, 10:50:03 AM »
Can't help you on issue one since we have yet to do quarterly estimated.  As for the second issue, it is completely non-controversial.  As a sole proprietor you can contribute up to 20% of earnings as the employer match.  IIRC that means you can shelter up to the first 23 or 24k of income if you wish.  Easy peasy and the IRS does not care, just follow the rules.  We use Fido and it is very easy, but I am sure the other brokers are easy too.

You might want to check ASAP because I believe there is a deadline to set up your solok and IIRC it is in October of the tax year  you want to contribute for.  Call VG today!

iamlindoro

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Re: Sole Proprietorship and Individual 401k
« Reply #3 on: October 21, 2013, 10:55:25 AM »
Can't help you on issue one since we have yet to do quarterly estimated.  As for the second issue, it is completely non-controversial.  As a sole proprietor you can contribute up to 20% of earnings as the employer match.  IIRC that means you can shelter up to the first 23 or 24k of income if you wish.  Easy peasy and the IRS does not care, just follow the rules.  We use Fido and it is very easy, but I am sure the other brokers are easy too.

You might want to check ASAP because I believe there is a deadline to set up your solok and IIRC it is in October of the tax year  you want to contribute for.  Call VG today!

Thanks, Brewer-- I'll probably get set up this week.  It's funny how in the dark I feel in spite of long time participation in corporate sponsored retirement.

It occurs to me that the above being true, we probably ought to be pushing folks with a side hustle to contribute + match themselves for extra tax advantagey goodness.

iamlindoro

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Re: Sole Proprietorship and Individual 401k
« Reply #4 on: October 21, 2013, 10:59:26 AM »
Just for the sake of making the post information-rich for anyone who comes later, looks like the deadline in 12/31 of the year:

http://newdirectionira.com/401k-contribution.html

"Individual 401(k) and Roth Individual 401(k) accounts must be established by December 31."

All the better!

iamlindoro

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Re: Sole Proprietorship and Individual 401k
« Reply #5 on: October 21, 2013, 06:46:20 PM »
Just continuing to bring back information as I learn it:

* The employer contribution (to yourself) in a Schedule C/1099 scenario is not a Schedule C deduction, but rather is lumped in to your regular contributions on IRS form 1040 line 28.  The IRS doesn't want to let you deduct it in the Schedule C because then you're also reducing your self employment taxes, and they don't want that.

References:

http://www.accountantforums.com/solo-401k-and-1040-a-t15528.html
http://www.taxalmanac.org/index.php/Discussion:Self_Employed_401K_contributions

Good calculator here:

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

See the calculator for the assumptions, but on a 70K theoretical business income, the maximum yearly amount for a self employed individual 401k is $30,510.  17.5$ in elective deferral (Employee contribution) and $13,010 in "employer" contribution... to yourself!  On 150K in self employment income, you can get over $45K into your 401k in a year!

I know this may be old news for some, but it's had me grinning all day.  This is a HUGE tax advantage if you're an aggressive saver!

Jwesleym

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Re: Sole Proprietorship and Individual 401k
« Reply #6 on: October 21, 2013, 09:01:54 PM »
Small world, I was just researching this today.  My wife is starting a side hustle / business (stay at home mom), and I was checking to see if we could start a 401k and figure out how to put all of her income in. This would be a great way to shelter her income and small business from taxes.

Side note, the spouse of a sole proprietorship can also contribute to the 401k as long as you "assist" with the business.

I think this will be useful when we FIRE in 7 years, because we can contribute to the 401k anything we get from side hustles up to the max for both of us. I'm not well versed with tax law, but it seems like I could shelter all of our income in a 401k as long as we made less than the combined contribution limit and "company" match. Is this feasible, or should I just work on maxing IRAs instead.

I understand once you claim your business for tax purposes, it is no longer considered a side hustle. Maybe I should call it hobby.

brewer12345

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Re: Sole Proprietorship and Individual 401k
« Reply #7 on: October 21, 2013, 09:16:23 PM »
The solo has been a boon to us with dw's business.  The sole proprietor's spouse can contribute, but only if the spouse does not contribute to their employer's plan.  You still have to pay self employment taxes on income you shelter in the solo.  However, if you are managing your income for an obamacare subsidy, the solo is a great tool.

Justin234

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Re: Sole Proprietorship and Individual 401k
« Reply #8 on: October 23, 2013, 11:17:06 PM »
I am in the process of figuring out this very question, just like another person who responded, and I've also been quite pleased with the idea of maxing out our contribution and using the employee side of the contribution as a business expense. I run a small business with my wife (having recently quit the office world for "semi-independence"). I'm about to open a solo 401k with Vanguard.

Everything I've read here meshes with my research. One thing I'll point out is that I don't believe you can put 401k contributions in Vanguard Admiral shares, even if you go over $10k. So you'll always be paying a slightly higher fee.

I do wonder about a few things that have been hard to figure out. I've even been considering consulting an accountant since I don't want to make a mistake (either under-contributing or over contributing). Since there's a discussion going here, I thought I'd post my questions (at the risk of hi-jacking the thread).

1) I believe that for my $17.5k personal contribution limit, I have to subtract the couple thousand dollars I already contributed to my 401k at my old job work. But I DON'T have to subtract my $5500 put into my IRA. Does this sound correct?
2) I can't figure out whether my wife can be considered an "employee" - we basically do the exact same thing and earn about the same amount of money. Could each of us potentially put in $17.5k? Would I have to make her an employee? Not sure what the ramifications are of that (financial and marital :).
3) Having difficulty deciding about ROTH versus traditional. That is a big question and depends on a lot of factors so not going to try to figure it out here.

Whether or not anyone has answers, I'd be curious to hear updates on what you do, and I'll try to do the same when I move forward.

iamlindoro

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Re: Sole Proprietorship and Individual 401k
« Reply #9 on: October 24, 2013, 12:03:50 AM »
1) I believe that for my $17.5k personal contribution limit, I have to subtract the couple thousand dollars I already contributed to my 401k at my old job work. But I DON'T have to subtract my $5500 put into my IRA. Does this sound correct?

Yes, that's correct as I understand it.

2) I can't figure out whether my wife can be considered an "employee" - we basically do the exact same thing and earn about the same amount of money. Could each of us potentially put in $17.5k? Would I have to make her an employee? Not sure what the ramifications are of that (financial and marital :).

Per the IRS, the spouse is specifically covered by the Indiviual 401K:

http://www.irs.gov/Retirement-Plans/One-Participant-401(k)-Plans

And here, it's stated that it's $17.5K per individual, and the total contribution in a participant + spouse scenario is $102K per year as of the writing:

http://www.solo401kexperts.com/contributionlimits.php

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The sum of both contributions can be a maximum of $51,000 per year (for 2013) or $55,500 for persons over age 50.

If the business owner's spouse elects to participate in the Solo 401(k) and earns compensation from the business, the spouse is allowed to make separate and equal contributions increasing the couples' annual total contribution to $102,000 for 2013 or $113,000 if both spouses over age 50.

So... all told, a pretty badass setup!  I'm waiting on a consulting check to come in (Net 30, yuck!) and then I'm going to get set up for this year.

Justin234

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Re: Sole Proprietorship and Individual 401k
« Reply #10 on: October 24, 2013, 01:01:10 AM »
Per the IRS, the spouse is specifically covered by the Indiviual 401K:

http://www.irs.gov/Retirement-Plans/One-Participant-401(k)-Plans

And here, it's stated that it's $17.5K per individual, and the total contribution in a participant + spouse scenario is $102K per year as of the writing:

http://www.solo401kexperts.com/contributionlimits.php

Quote
The sum of both contributions can be a maximum of $51,000 per year (for 2013) or $55,500 for persons over age 50.

If the business owner's spouse elects to participate in the Solo 401(k) and earns compensation from the business, the spouse is allowed to make separate and equal contributions increasing the couples' annual total contribution to $102,000 for 2013 or $113,000 if both spouses over age 50.

So... all told, a pretty badass setup!  I'm waiting on a consulting check to come in (Net 30, yuck!) and then I'm going to get set up for this year.

Indeed - holy crap, $102,000?? That is just crazy. Not that I'll make it up to that point this year, but my business projections indicate that $130K is a possibility in a few years, and our annual cost of living is about $34k, so, along with IRA contributions of $11k, that is a potentially HUGE tax write off AND deferral - the solo 401K option seems almost MMM-posting-worthy, considering how he's so into self-employment. Maybe he's reading this?

Thanks for the link - my confusion was about whether the spouse needs to receive a W-2 (thought I read that somewhere, but couldn't find where). So far it seems like was can just be two separate contributors and pay ourselves 50/50.

By the way, I switched over to a business savings/checking earlier this year, and got a business credit card. I just pay myself at the end of each month, into my personal account. It really simplifies things, and allows me to demonstrate income in a more clear way, since I get paid for a service and don't receive 1099s (or the represent only about 10% of my income). It also helps with my accounting to put all business expenses on the business card or checking account, and deposit all income there, rather than having it mixed in with my grocery purchases, etc. It's much cleaner and simpler.

iamlindoro

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Re: Sole Proprietorship and Individual 401k
« Reply #11 on: November 06, 2013, 04:46:16 PM »
Got an Individual 401k started with Vanguard (where I have my taxable accounts as well) today.  You get a 108 page PDF full of paperwork to fill out, but there are really only 20 or so pages to fill out and return, and 15 or so to print total for your files.  Off it went to PA for setup!  I'm excited to get started and already trying to scheme to see how much more I can cram in before the year ends.

iamlindoro

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Re: Sole Proprietorship and Individual 401k
« Reply #12 on: November 06, 2013, 04:47:50 PM »
Quasi-related, this link was really helpful in setting up an EIN for Sole Proprietor 401k purposes:

http://www.mysolo401k.net/ein-number.html

Loud Noises

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Re: Sole Proprietorship and Individual 401k
« Reply #13 on: November 07, 2013, 07:41:48 AM »
Thanks for all the great info in this thread.  I've been debating between a solo 401k and an SEP IRA to supplement my Roth IRA, currently my only retirement account.  All my income comes from self employment.  I talked with the folks at TD Ameritrade (where I have my IRA) and they tried to steer me clear of the solo 401k because of the complications and costs.  Would you mind elaborating more on why you went with that instead of an SEP IRA?

iamlindoro

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Re: Sole Proprietorship and Individual 401k
« Reply #14 on: November 07, 2013, 08:30:22 AM »
Thanks for all the great info in this thread.  I've been debating between a solo 401k and an SEP IRA to supplement my Roth IRA, currently my only retirement account.  All my income comes from self employment.  I talked with the folks at TD Ameritrade (where I have my IRA) and they tried to steer me clear of the solo 401k because of the complications and costs.  Would you mind elaborating more on why you went with that instead of an SEP IRA?

Acknowledging that I'm not a expert, I think it's true that there's a slightly higher barrier to entry in setting up the Individual 401k, though having now done the paper (and gotten really, really good phone support from Vanguard's Solo 401k guys, who talked me through each page via phone) it wasn't too painful. The thing that made the difference for me was that the calculation of the Individual 401k allows you to contribute more at identical income levels versus the SEP IRA-- both allow up to 51K this year, but with the Individual 401k, you can contribute 100% of the first 17,500 and 25% of profits after self employment taxes, versus the 25% of profits w/ the SEP IRA.  Though both allow up to the same contribution, you reach it at a somewhat smaller income with the 401k.

There's a good chart on this article:

http://money.cnn.com/2013/08/20/pf/expert/small-business-401k.moneymag/

Basically, it shows that at 125K income, you can contribute $23,300 to the SEP IRA, and $40,800 to the Individual 401k.

There are other advantages like a higher contribution to the 401k after 55, but hopefully I shouldn't need to take advantage of that!

Justin234

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Re: Sole Proprietorship and Individual 401k
« Reply #15 on: November 07, 2013, 03:25:03 PM »
Thanks for all the great info in this thread.  I've been debating between a solo 401k and an SEP IRA to supplement my Roth IRA, currently my only retirement account.  All my income comes from self employment.  I talked with the folks at TD Ameritrade (where I have my IRA) and they tried to steer me clear of the solo 401k because of the complications and costs.  Would you mind elaborating more on why you went with that instead of an SEP IRA?

Just as a follow up to what iamlindoro wrote, this calculator gives you an estimate of what you can withhold for 401(k), SEP IRA, and SIMPLE IRA.

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

Basically, the more frugal you are, the more the 401(k) - you can potentially put 2-4x more in your tax sheltered account.

I filled out my paperwork yesterday and will be sending it in today. Set up plan, and individual accounts for both myself and my wife. The paperwork wasn't very complicated - I'm not sure how it could be that hard. We'll see how the investment portion goes. The only thing I still have to figure out is how to actually manage the "matching".

As I said before, I think this is a pretty awesome  benefit of being my own boss (well, in partnership with my wife)!

iamlindoro, do you know if you have to pay the annual account fee for all the investments you list on the form, even if they have $0? I listed more than I planning on using so as to avoid paperwork, but it would be too bad if I got charged for each one I wasn't using.

Glad you had good luck with the people at Vanguard - I found them less helpful, they kept directing me to the info on the website. And that was supposed to be the small business specialist. Maybe I just got the wrong person...

I will also update this thread when I get things set up and find out the process for investing.

iamlindoro

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Re: Sole Proprietorship and Individual 401k
« Reply #16 on: November 07, 2013, 04:01:57 PM »
Thanks for all the great info in this thread.  I've been debating between a solo 401k and an SEP IRA to supplement my Roth IRA, currently my only retirement account.  All my income comes from self employment.  I talked with the folks at TD Ameritrade (where I have my IRA) and they tried to steer me clear of the solo 401k because of the complications and costs.  Would you mind elaborating more on why you went with that instead of an SEP IRA?

Just as a follow up to what iamlindoro wrote, this calculator gives you an estimate of what you can withhold for 401(k), SEP IRA, and SIMPLE IRA.

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

Basically, the more frugal you are, the more the 401(k) - you can potentially put 2-4x more in your tax sheltered account.

I filled out my paperwork yesterday and will be sending it in today. Set up plan, and individual accounts for both myself and my wife. The paperwork wasn't very complicated - I'm not sure how it could be that hard. We'll see how the investment portion goes. The only thing I still have to figure out is how to actually manage the "matching".

As I said before, I think this is a pretty awesome  benefit of being my own boss (well, in partnership with my wife)!

iamlindoro, do you know if you have to pay the annual account fee for all the investments you list on the form, even if they have $0? I listed more than I planning on using so as to avoid paperwork, but it would be too bad if I got charged for each one I wasn't using.

Glad you had good luck with the people at Vanguard - I found them less helpful, they kept directing me to the info on the website. And that was supposed to be the small business specialist. Maybe I just got the wrong person...

I will also update this thread when I get things set up and find out the process for investing.

Hey Andrew,

I am not certain about the account fee for all the investments you list.  The guy I spoke to seemed to indicate that this signup was not your last chance to add funds to the account, and that you would have the ability to add or remove items once the account was set up-- it wasn't explicitly stated but it seemed to indicate it was just a "hint" to get started versus a commitment to paying fees on them all.  I note that they say $20/year for each fund *held*, so I would think as long as you don't have any holdings in the fund, you're OK.  I also know that if any one member of the plan has assets over $50K, you qualify for Voyager Select, and your fees are all waived.  Don't know what amount you're starting with/rolling in, but at least with this level of contribution, it should be reachable quickly.  I am personally curious if you qualify for the waiver on the 401k if you also hold a taxable account with assets > $50K.

I found this blog entry interesting and informative, too:

http://www.mypersonalfinancejourney.com/2011/12/opening-and-managing-self-employed.html

I also asked about the designation of "employee" versus "employer" contributions and was told that there is a separate employer site for small business, with a separate interface, and that transferring funds in is easy (a simple bank transfer) and allows for designation by employee/employer.  I haven't seen it yet, but will be interested to see once everything is set up.

On a personal note, it's cool to see that others find this as interesting an approach as I do-- like I've said before, I'm sure it's old news to some, but I've taken it on face for years that $17.5K is the best one can do (barring employer contributions), and as someone who was very lax on getting started in his 20s, I feel like I have a nice opportunity to make up for lost time.
« Last Edit: November 07, 2013, 04:35:11 PM by iamlindoro »

iamlindoro

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Re: Sole Proprietorship and Individual 401k
« Reply #17 on: November 07, 2013, 04:39:06 PM »
PS: Antimustachian alert- I express mailed my paperwork.  :P

Justin234

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Re: Sole Proprietorship and Individual 401k
« Reply #18 on: November 07, 2013, 11:50:42 PM »
PS: Antimustachian alert- I express mailed my paperwork.  :P

Ha ha - maybe you'll pay for the extra express mail postage in the profit you make by investing a few days earlier...

CB

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Re: Sole Proprietorship and Individual 401k
« Reply #19 on: November 08, 2013, 08:16:58 AM »
Since the "employer contribution" is also a deductible business expense, though it's not 100% tax free, it also seems like a nice way to get the extra tax advantage.... right?

If this is true, would it mean that the "employer" contribution portion also avoids self-employment taxes?

iamlindoro

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Re: Sole Proprietorship and Individual 401k
« Reply #20 on: November 08, 2013, 08:27:55 AM »
Since the "employer contribution" is also a deductible business expense, though it's not 100% tax free, it also seems like a nice way to get the extra tax advantage.... right?

If this is true, would it mean that the "employer" contribution portion also avoids self-employment taxes?

Not the case unfortunately-- you still report the full income on the schedule C, and the self employment taxes are based on that amount-- there's no deduction for the employer contribution on the schedule C.  The employer and employee contributions are totaled and entered on line 28 of the 1040.  One of the links above goes into some detail on this, but it's my understanding so far.

http://www.taxalmanac.org/index.php/Discussion:Self_Employed_401K_contributions  (third from last response from a CPA)

Quote
I would agree with Dhtax, neither the Sch C owner's "employee deferral" portion nor the employer contribution is deductible directly on Sch C, both are deductible on line 28 of Form 1040. Neither portion will reduce his SE taxable income. The advantage of an individual 401K over a SEP is that it allows the taxpayer with no employees to arrive at the maximum deduction at a lower Sch C net profit than will a SEP.

iamlindoro

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Re: Sole Proprietorship and Individual 401k
« Reply #21 on: November 11, 2013, 05:15:13 PM »
Vanguard processed my individual 401k setup paperwork today and sent me my small business login.  As they reported to me, it is familiar but different.  More barebones than the personal investor site, with functionality to view the status of contributions, make them, and admin the plan details.  There's not much here, but then, not much is needed.  I see where you set up banking, and the contributions appear to be a simple 2-3 step process.  I can't do one yet since I'm still waiting for them to set up the "participant" portion.  All told, I can't see too much fuss in the "extra overhead" of the Solo 401k.  It's largely just log in to a second account, contribute your money, and then go back to your own personal account to track performance.

Justin234

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Re: Sole Proprietorship and Individual 401k
« Reply #22 on: November 14, 2013, 06:15:52 PM »
Vanguard processed my individual 401k setup paperwork today and sent me my small business login.  As they reported to me, it is familiar but different.  More barebones than the personal investor site, with functionality to view the status of contributions, make them, and admin the plan details.  There's not much here, but then, not much is needed.  I see where you set up banking, and the contributions appear to be a simple 2-3 step process.  I can't do one yet since I'm still waiting for them to set up the "participant" portion.  All told, I can't see too much fuss in the "extra overhead" of the Solo 401k.  It's largely just log in to a second account, contribute your money, and then go back to your own personal account to track performance.

I got mine set up today too (sent it snail mail so I'm a little behind... :) And, my "participant" (that is, me and wife) individual 401k accounts have magically appeared on our my personal investor accounts, which was a pleasant surprise. I was mistakenly expecting that I'd need a new personal login for that, but it's just listed under my taxed investments and my IRAs, and I guess I make purchases right there just like any other investment.

It seems pretty simple to me, too. You're right that the business interface is a lot more basic than the personal account. As far as I can tell, all I have to do is:

1) calculate the maximum "matching" contribution I can make (which I think I will only know at the end of the year when I know my net business income)
2) Log in to the smallbiz website (which, note to others, is not the "log in" button at that top of the page - that goes to personal accounts - but the link to the right that says, "Invest now - Log on to Vanguard Small Business Online®")
3) Purchase stocks on behalf of my business, for myself or my wife up to total allowable

then

4) calculate the maxumum personal contributions for me and my wife, which I think will be ($17,500 each minus any 401k contributions we've already made for the year)
5) Log in to my personal account
6) Purchase stocks for myself

Am I missing something or is it really that simple???

Out of curiosity, iamlindoro, from an investment strategy standpoint, are you going to start making regular investments similar to what one might do with an employer, or just put it all in at once? I have a relatively large amount in cash (large for me, that is), and no where else tax-free to put it, so I'm thinking of just doing the whole 2013 investment now or in the next month, and then doing the whole 2014 investment in January, so I have to whole year to grow it. Not sure what I'll do for the business match...

Anyone know if there is any tax advantage to favoring personal or matching contributions? I.e., if I have limited net profit and have to choose, is there any difference tax-wise whether I put it towards a personal or a matching contribution? As far as I can tell the answer is 'no', especially based on iamlindoro's comment that matching contributions can't be considered business expenses (which is really a shame). Does this apply to all 401(k) plans? It really surprises me.

Justin234

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Re: Sole Proprietorship and Individual 401k
« Reply #23 on: November 14, 2013, 07:06:29 PM »
Regarding my last question,

Anyone know if there is any tax advantage to favoring personal or matching contributions? I.e., if I have limited net profit and have to choose, is there any difference tax-wise whether I put it towards a personal or a matching contribution? As far as I can tell the answer is 'no', especially based on iamlindoro's comment that matching contributions can't be considered business expenses (which is really a shame). Does this apply to all 401(k) plans? It really surprises me.

I read the discussion you linked to, iamlindoro, and now it makes sense about the Schedule C issue. I suppose that's another benefit of incorporating - any employer contribution would then avoid the SE tax of 15%.

Also, from what I could tell from that discussion, there is no tax benefit for one type of contribution over another. I think I'll double check that though, because it wasn't definitively addressed and I don't know my tax forms very well.

iamlindoro

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Re: Sole Proprietorship and Individual 401k
« Reply #24 on: November 14, 2013, 08:00:15 PM »
I read the discussion you linked to, iamlindoro, and now it makes sense about the Schedule C issue. I suppose that's another benefit of incorporating - any employer contribution would then avoid the SE tax of 15%.

Also, from what I could tell from that discussion, there is no tax benefit for one type of contribution over another. I think I'll double check that though, because it wasn't definitively addressed and I don't know my tax forms very well.

Yeah, I understand it on both counts exactly as you say above.  There does not appear to be a tax benefit of one of the other-- With that in mind I think it's worth making the first 17.5K as "employee" contribution as you don't have to worry about the calculation until you hit that threshold (and at that point you probably have a healthy margin of employer dollars too).

This year, my income has varied wildly from month to month-- there have been months where I was just covering costs, and others (like this month) where there's a fair amount of excess.  I like the idea of making a percentage contribution after some amount I consider "safe," but to be honest I haven't thought that far ahead yet-- I know what I can put in for this year, and I'm going to have to figure out the ongoing plan in January.
« Last Edit: November 14, 2013, 09:33:13 PM by iamlindoro »

iamlindoro

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Re: Sole Proprietorship and Individual 401k
« Reply #25 on: November 15, 2013, 01:22:08 PM »
Just thought I would throw out a screenshot of the contribution interface for those interested-- No second step in the personal account required, the contributions go straight in on the small business side.

deltaecho

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Re: Sole Proprietorship and Individual 401k
« Reply #26 on: November 16, 2013, 07:13:55 AM »
are you able to buy admiral shares for the 401k at vanguard?

brewer12345

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Re: Sole Proprietorship and Individual 401k
« Reply #27 on: November 16, 2013, 07:50:59 AM »
We just pile up the cash in a bank accout and wait until we file our taxes to make the contribution.  No worries that way.

deltaecho

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Re: Sole Proprietorship and Individual 401k
« Reply #28 on: November 16, 2013, 04:16:49 PM »
Actually, I'm just wondering if admiral shares are available at all in the vanguard solo 401k.

iamlindoro

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Re: Sole Proprietorship and Individual 401k
« Reply #29 on: November 16, 2013, 04:21:01 PM »
Actually, I'm just wondering if admiral shares are available at all in the vanguard solo 401k.

No, they are not.

the fixer

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Re: Sole Proprietorship and Individual 401k
« Reply #30 on: November 16, 2013, 04:30:33 PM »
I was under the impression there was some ongoing paperwork with administering the plan. Like, some kind of plan document you have to file with the IRS and one or two other things you have to "distribute" to participants (i.e. keep on file in case you're audited).

I've been using a SEP-IRA for simplicity and have been intimidated to get into the solo 401(k) thing. If the ongoing paperwork's not so bad I might consider it.

Also, seeing Vanguard's process is interesting, but if I were to set one up I'd do it with Fidelity so I could roll over my traditional IRAs into it, thus opening me up for the potential to do backdoor Roth contributions.

Justin234

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Re: Sole Proprietorship and Individual 401k
« Reply #31 on: January 14, 2014, 11:55:15 AM »
I just thought I'd post an update about my experience with the 401k at Vanguard. Over the course of November and December I maxed out the "Employee contribution" for both myself and my wife (we each earn about 50% of the income from out business). It was quite simple - just logged on to the smallbiz side of the Vanguard site, selected the contribution amount, then designated whether the money would go into my account or my wife's, and which fund, and whether it was an employer or employee contribution. Ended up putting $34000 in between the two of us (I already had $1000 in from my former employer.) I do nothing on my personal Vanguard account - the balance just gets updated there.

I do all my withdrawals from my business account, as it is the business that is paying it's employees. Then I transfer the remaining revenue into my personal account as our profit.

I received year-end statements from Vanguard from both out plans. So far, no sign of the paperwork that seems to scare people away from these plans. I do my taxes on TurboTax so I'll be interested in seeing how they have solo 401ks integrated into their system. If anything comes up, I'll post another update.

I still have to decide how much "employer contribution" to put in - haven't quite done a final balance of the expenses for 2013 to know exactly how much I'm allowed to contribute.

I might not do any from the employer side, and just put money into the 2014 account, since, having maxed out both of our 2014 IRAs, I don't have a lot of cash lying around. It will depend on how business goes in the next few months. I'll probably start doing monthly contributions like a "real" employer.

headachemustache

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Re: Sole Proprietorship and Individual 401k
« Reply #32 on: January 19, 2014, 02:28:30 PM »
Hello,  I'm a new member and this is my first post.  I have been reading this thread on individual/solo 401k with interest, as I am self-employed, a sole proprietor, and just opened a solo401k at Vanguard before the close of 2013.  I found it (much) easier to set up than expected.  As I start to figure out my total income from 2013, I'm also trying to calculate the 2013 maximum contributions to the solo401k before April.  I have been contributing to a Roth IRA (2013 no exception) and SEP-IRA for years, and only recently learned of the supreme advantages of the solo401k, particularly as I've just passed the age 50 mark.  Now that I have the solo401k, I won't be contributing to the SEP any longer. 

I'm gradually gaining understanding about the employee/employer split in the solo401K contributions, but I'm confused by the further split into Roth/nonRoth for the employee contribution.  How does one decide how much, if any, of the employee contribution should be Roth?   And if I've already contributed to my Roth IRA for 2013, does that amount matter in the solo401k Roth calculation?  Sorry for the newbie questions, don't mean to hijack… just very curious about how best to think this through.

iamlindoro

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Re: Sole Proprietorship and Individual 401k
« Reply #33 on: January 19, 2014, 08:06:38 PM »
I'm gradually gaining understanding about the employee/employer split in the solo401K contributions, but I'm confused by the further split into Roth/nonRoth for the employee contribution.  How does one decide how much, if any, of the employee contribution should be Roth?   And if I've already contributed to my Roth IRA for 2013, does that amount matter in the solo401k Roth calculation?  Sorry for the newbie questions, don't mean to hijack… just very curious about how best to think this through.

I don't think I understand what you're getting at with your question.  A Roth IRA and a Solo 401k are different entities-- You can contribute to your 401k, max out all employer and employee contributions, and if your MAGI is below the threshold, you can contribute to your Roth IRA as well-- No part of the 401k contribution should be or is to a Roth-- they're totally separate.

Also not sure what you mean by "solo 401k Roth" calculation.

headachemustache

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Re: Sole Proprietorship and Individual 401k
« Reply #34 on: January 19, 2014, 08:40:10 PM »
Sorry I was not clear.  I do realize that a Roth IRA and a Solo 401k are completely separate entities. 

My (first) question refers to the Solo/Individual 401k and the choice within that account for employee contributions to go either to the Individual 401k OR to the Individual Roth 401k.    Vanguard and eTrade both offer the Roth option within their Individual 401k accounts.  I'm with Vanguard and I can split my employee contributions between the two, as long as I stay within the maximum for EE contribution.  The employER contribution cannot go to the Roth "side".

As described on the Vanguard SBS site:
"Employee contributions   :   Either pre-tax or Roth employee deferral contributions can be made up to $17,500 for both 2013 and 2014. Individuals age 50 or older can make an additional $5,500 catch-up contribution. Contributions can't exceed 100% of compensation."

and as described on the e*Trade site:
"Individual and Roth Individual 401(k) plans offer the maximum retirement savings for self-employed individuals and spouses. The Individual 401(k) offers tax-deferred growth potential. The Roth Individual 401(k) account offers tax-free growth potential. Use either plan or both plans together to maximize your retirement savings."

My second question was about whether any contribution to my (entirely separate) ROTH IRA would count against the ROTH space within my Individual 401K.

Justin234

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Re: Sole Proprietorship and Individual 401k
« Reply #35 on: January 19, 2014, 10:51:38 PM »
My (first) question refers to the Solo/Individual 401k and the choice within that account for employee contributions to go either to the Individual 401k OR to the Individual Roth 401k.

I think "Individual 401k" implies "traditional (pre-tax) 401k". You are basically deciding whether you want to be taxed before you put the money in (Roth) or upon withdrawal (traditional). You would decide between Roth 401k or traditional 401k in the same way as you would decide on Roth IRA or traditional IRA: what tax bracket are you in now, compared to where you will be when retired/withdrawing? If you expect to be in a lower tax bracket when you retire, traditional is preferable because you'll pay less. I am in the same bracket as I will be when I retire, so it is a wash - I do Roth IRA and traditional 401k.

My second question was about whether any contribution to my (entirely separate) ROTH IRA would count against the ROTH space within my Individual 401K.

No - the limits are unrelated. For 2013/14 the total max contribution to ANY IRA (Traditional, Roth, or a combo) is $5500 per year. The total max contribution to ANY 401k (Traditional, Roth, or a combo) is $17500 per year. Just because they are both Roth does not mean they count into the same pot. "Roth" describes how they are taxed; they are separate, unrelated entities.

headachemustache

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Re: Sole Proprietorship and Individual 401k
« Reply #36 on: January 19, 2014, 10:59:17 PM »
Thank you for your response.  Now if I could only know for sure what my retirement tax bracket will be, I could get all of this lined up optimally!

kkbmustang

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Re: Sole Proprietorship and Individual 401k
« Reply #37 on: January 20, 2014, 06:45:16 PM »
The annual paperwork for the 401k would be the Form 5500 Information Return for Employee Benefit Plan that needs to be filed with the DOL. (It's an IRS form but it gets submitted to the DOL - long story as to why.) Also, the Summary Annual Report that goes to plan participant. Check www.dol.gov. IIRC medical plans with fewer than 100 participants are exempt from the 5500 requirement. I don't think 401k plans get the same exemption, but you'd have to double check.

iamlindoro

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Re: Sole Proprietorship and Individual 401k
« Reply #38 on: January 20, 2014, 09:40:10 PM »
The annual paperwork for the 401k would be the Form 5500 Information Return for Employee Benefit Plan that needs to be filed with the DOL. (It's an IRS form but it gets submitted to the DOL - long story as to why.) Also, the Summary Annual Report that goes to plan participant. Check www.dol.gov. IIRC medical plans with fewer than 100 participants are exempt from the 5500 requirement. I don't think 401k plans get the same exemption, but you'd have to double check.

I believe that if the total assets are < $250K, a solo 401k is exempt from the Form 5500 requirement-- ideally everyone here will need to file the form :)

kkbmustang

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Re: Sole Proprietorship and Individual 401k
« Reply #39 on: January 21, 2014, 10:47:00 AM »
The annual paperwork for the 401k would be the Form 5500 Information Return for Employee Benefit Plan that needs to be filed with the DOL. (It's an IRS form but it gets submitted to the DOL - long story as to why.) Also, the Summary Annual Report that goes to plan participant. Check www.dol.gov. IIRC medical plans with fewer than 100 participants are exempt from the 5500 requirement. I don't think 401k plans get the same exemption, but you'd have to double check.

I believe that if the total assets are < $250K, a solo 401k is exempt from the Form 5500 requirement-- ideally everyone here will need to file the form :)

Good to know. Also, there will likely be plan amendments to comply with the law, but Vanguard should provide those to you.

Redfive20

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Re: Sole Proprietorship and Individual 401k
« Reply #40 on: February 17, 2014, 03:57:32 PM »
Does anyone know the contribution limit for a person who has already had a 401K plan from the full time job?

iamlindoro

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Re: Sole Proprietorship and Individual 401k
« Reply #41 on: February 17, 2014, 04:05:35 PM »
Does anyone know the contribution limit for a person who has already had a 401K plan from the full time job?

The total employee contribution amount across all 401(k)s, be they traditional or solo, in a given year is $17,500 (as of 2014).  So you could do $8750 in each, 17.5K in one and none in the other, etc., so long as it totals $17.5K.  The *employer* portions are independent-- so if you can max out the $33.5K employer portion of your solo 401(k), you can ALSO max out your traditional 401(k) match without reducing the solo 401(k) match.

In short, it may be wise to at least contribute to the traditional 401(k) to maximize employer match, complete the $17.5K total in whichever account you like, and also maximize the employer contribution of the solo 401(k) as well. 

Redfive20

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Re: Sole Proprietorship and Individual 401k
« Reply #42 on: February 17, 2014, 07:06:45 PM »
Thank you, iamlindoro. It is great news! It means that the total ER and EE contributions across all 401(k)s could be more than 51K:

Max EE portion contributions across all 401(k)s will be 17.5K
Try to get all the match from the full time position through ER match
Max ER portion contributions of the solo 401(k) will be 33.5K


GetSmart

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Re: Sole Proprietorship and Individual 401k
« Reply #43 on: March 04, 2014, 10:29:06 AM »
Thanks for this thread - finally found the answer to several questions. I've been searching the forums for a week now and this is really good news!

I have both an incorporated business (no employees) and a partnership business with my SO.

So what seems to be the best scenario would be to maximize my 401k from the S-corp thus avoiding the SE taxes.  Then maximize the SO's 401k from the partnership business (won't avoid the SE taxes there).  Ultimately if this business does well we would incorporate it. 
We are both over 50 so this would be quite a savings and might allow us to catch up.

The bankrate calculators are helpful although I see in one calc they allow a 100% employer contribution match and on another calc it's limited to a 25% match.  I do believe it's 100% up to the allowable limit.

Well, I thought I had questions, but now I think I've just answered them all while typing and un-typing!  And I really should get back to work...thanks again for all the info.

Redfive20

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Re: Sole Proprietorship and Individual 401k
« Reply #44 on: March 04, 2014, 08:30:08 PM »
Modify, I am not sure whether you need to concern the rule on Controlled Group. You own the significant potion of two businesses you described. If they belong to the same controlled group, I would think that IRS would treat them as one business that only can offer one plan.

GetSmart

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Re: Sole Proprietorship and Individual 401k
« Reply #45 on: March 05, 2014, 12:33:53 PM »
Redfive20 - thanks - I will have my accountant look into it - I figured there might be a catch.  Although at this point it's all speculation, I haven't done anything about it - haven't even opened an account yet.  Just planning for what I hope is a much better year than 2013.

Justin234

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Re: Sole Proprietorship and Individual 401k
« Reply #46 on: April 25, 2014, 12:01:12 AM »
Having filed my first set of taxes after setting up a Solo-401k, I thought I'd share some things I learned (for the record, I filed my taxes through Turbotax, and, against the recommendation of various people, never consulted a CPA around tax law - so I basically DIYed it, and hope I didn't screw anything up!):

1) First of all, I accidentally contributed $85 too much as an employee contribution (turns out my old job contributed an unexpected extra payment to the 401k I had through them); I thought I'd hit $17500 on the nose (job 401K + solo 401k), but ended up at $17,585. (Lesson learned: don't max out your solo-401k until you are totally sure what any other 401ks contributions will be!) You have to do this by April 15.

I thought this would be a huge hassle to address, but Vanguard has a special form for "Mistake of fact" (Form s573, FYI). Note that this form is specifically for simple arithmetic errors; there is another form that Vanguard originally sent me that was for larger administrative errors, but that was the wrong one, and I had to do some snooping to get the s573). I sent that form in, and got a check for $85 a few weeks later. Didn't have to note this on my tax return, either, according to the instructions.

2) Something I discovered when preparing the tax return: for those planning on including your spouse as part of the plan (that is, contributing $17,500 x 2): it was NOT as simple as I expected. The IRS requires that for filing purposes (and only for filing purposes) you split your business into two - so two Schedule Cs, with separate income/expenses for your own and your spouses' portion of the business. Besides being an unexpected step because I never divided expenses between us and had to retroactively assign them based), this also became an issue because you or your spouse can't contribute more than the net income for each "business" (i.e., half-business) to your respective 401k. So, if your business nets $50,000, and your spouse accounts for $10,000 in net profit, he/she can't max out a 401k at $17,500. The max would be ~$10,000. So you have to be careful if you think you can just add on your spouse as a secretary or bookkeeper or something, and max out their 401k. You will have to account for how he or she "made" $17,500 on the business, and how you "made" $17,500.

In my case, my wife and I bring in about 50% of the revenue; however, I had never thought to split up expenses between us. Doing so is inherently imprecise and somewhat arbitrary since we share expenses; but I had to make sure that it evened out so that we both netted over $17,500.

3) The calculation of max Employer contribution could only be made after I'd done most of my taxes, because you need to factor in your expenses, employee contributions, and SE taxes. There is a worksheet to do this called the "Deduction Worksheet for Self-Employeed", in Chapter 5 of IRS Publication 560. Once I calculated this, I made my employer contribution in the same way I made my employee contribution, and that was that. Turbotax for small-business also calculates this, but I found it's presentation confusing so I completed the worksheet myself to double check the maximum allowable.

4) Finally, the solo-401k manager of a "One participant plan" (this includes individual and spouse) have to complete and send in IRS form 5500-EZ - I think the deadline is end of summer for the year before. However, Vanguard tells me (via their handy Guidelines for completing Form 5500, which they sent) that I only have to file this if my plan holds more than $250,000, which is not currently the case, and won't be for another few years at least.

I hope this is helpful to anyone, and if I'm wrong about anything, feel free to correct me!

kpd905

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Re: Sole Proprietorship and Individual 401k
« Reply #47 on: April 25, 2014, 06:16:15 AM »
Does anyone know the contribution limit for a person who has already had a 401K plan from the full time job?

The total employee contribution amount across all 401(k)s, be they traditional or solo, in a given year is $17,500 (as of 2014).  So you could do $8750 in each, 17.5K in one and none in the other, etc., so long as it totals $17.5K.  The *employer* portions are independent-- so if you can max out the $33.5K employer portion of your solo 401(k), you can ALSO max out your traditional 401(k) match without reducing the solo 401(k) match.

In short, it may be wise to at least contribute to the traditional 401(k) to maximize employer match, complete the $17.5K total in whichever account you like, and also maximize the employer contribution of the solo 401(k) as well.

I currently max out my 401k at my employer.  I have a side hustle starting up that I could see making $5000-10,000 a year as 1099 income (books on Amazon).  Would I be able to start this 401k and put in any money as an employer portion?

bacchi

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Re: Sole Proprietorship and Individual 401k
« Reply #48 on: April 25, 2014, 09:28:26 PM »
I currently max out my 401k at my employer.  I have a side hustle starting up that I could see making $5000-10,000 a year as 1099 income (books on Amazon).  Would I be able to start this 401k and put in any money as an employer portion?

Yes but only up to 20%/25% depending on business set-up (solo vs C-corp). It's also on the profits and after 1/2 of the medicare/aid/ss taxes.

In other words, be careful when approaching the maximum. I wait to top up when the 1099s roll in after the tax year has passed.

iamlindoro

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Re: Sole Proprietorship and Individual 401k
« Reply #49 on: April 25, 2014, 10:18:38 PM »
Yep, Bacchi beat me to it-- also remember that to get the Solo 401k open, you'll need to furnish the investment company with proof that the business is actually registered, which can vary dependent on structure, but can be as simple as the fictitious business name filing for a sole proprietor.