i401K vs Simple IRA for side business spousal contribution

[monstermonster]

Hi Folks- I need a gut check on this and I figured this is the best place to ask.

I have a day job at which I make $51,800 per year, and I just qualified for the work 401K and am maxing that out at $19,500 per year.

I also have a business that grosses $25K - $35K per year, net ends up being around $16K after COGS and op expenses.

I got married in 2021 and our combined income means I no longer qualify for contributions to a traditional IRA or roth IRA. Previously I used the Traditional IRA for my business retirement savings.

My spouse currently makes an absolutely ridiculous amount of money at their day job and maxes out their 401K ($19,500).  They also have side businesses that total about $50K per year. We each participate materially in one another's businesses.

So, it looks like we can each set up SEP IRA's our side businesses and contribute up to 25% of net income for each of us on EACH business to reduce taxable income since SEP's allow you to contribute for spouses.

It seems like since we both max out our day job 401Ks, the individual 401K and the SEP IRA have the EXACT SAME LIMITS, only the SEP IRA is way less work to administer.  Only downsides is we have to contribute the same percentage for both of us in the SEP IRA, vs the individual 401K has more flexibility.

So this would reduce taxable income by up to $33,000:

• My Business ($16K net) - $8K total - $4K contribution for me (25%) and $4K contribution for them (25%)
• Their business ($50K net) - $25,000 total - $12,500 contribution for me (25%) and $12,500 contribution for them

Am I reading this right? Anything I'm missing?

[terran]

I don't think there's any advantage contributing based on your work in the other's business here. That might be the case if 1) one of you wasn't already maxing out your workplace plan and didn't have enough self employment income to max out the self employed plan or 2) one of your businesses made so much that it maxed out a single overall max ($58k in 2021). Since neither of those is the case I'd just keep in separate so you contribute to your self employed plan for your business and she contributes to her self employed plan for her business.

I think you might be confused about a couple of things with the contribution limits. First, the contribution is based on net income (line 31 of schedule C for a sole proprietor) minus 1/2 of self employment tax, not gross income. Second, for a sole proprietor the limit is 20% to make it so you aren't contributing on the contribution. For an S-corp the limit is 25% of your W2 compensation (not net profit). Either way, you don't get to double count things, so if you have income from her business on which you contribute then she can't contribute based on that income and vice versa, which is why I say I don't see the advantage of both of you contributing based on income from both businesses. Here's a good calculator you can use -- as long as you answer the questions about your other job these limits will apply to either SEP or solo 401(k) even though the calculator is designed for solo 401(k)s.

My next recommendation would be that consider a solo 401(k). You're right that the limit is the same since you're both already maxing out workplace plans. The solo 401(k) really isn't hard to administer, and if you go that route it would open the option for both of you to start making backdoor Roth IRA contributions since (unlike the SEP) the plan itself won't cause issues, and if you open it at the right place (I would suggest E*Trade) you can roll you current traditional IRA into the plan which removes that obstacle as well.

Another option, though it does add some complexity and some additional cost, would be to start custom solo 401(k) plans that would allow so called mega-backdoor Roth contributions. Here's a good thread from someone who took on this endeavor: https://forum.mrmoneymustache.com/taxes/anyone-execute-a-mega-backdoor-roth-in-solo-401k/. The advantage of this is that you could contribute just about all of your net self employment income to Roth solo 401(k) (after jumping through some hoops). This would also avoid the reduction in Qualified Business Income, which might increase your QBI deduction depending on other circumstances.

[LifeHappens]

First, congrats on your marriage! Glad to see you pop in here.

I use a SEP IRA from Vanguard for my business and it is very easy to administer, but a solo 401k didn't look any more difficult. If you have a Vanguard account, I suggest calling them and talking through your scenario.

In terms of each of your companies contributing to each other's IRA/401k, I would make doubly or triply sure you can document your participation in each business. If you don't have formal sub-contracts with each other, this may be the time.

[monstermonster]

I don't think there's any advantage contributing based on your work in the other's business here. That might be the case if 1) one of you wasn't already maxing out your workplace plan and didn't have enough self employment income to max out the self employed plan or 2) one of your businesses made so much that it maxed out a single overall max ($58k in 2021). Since neither of those is the case I'd just keep in separate so you contribute to your self employed plan for your business and she contributes to her self employed plan for her business.

Hold on, quick question. It seems like the employer side of either type of account can contribute up to 20% for each of us as spouses of one another's company who materially participate in the business and it isn't tied to how much actual compensation I receive from the business. So if I make $500 from my SO's business, but am a member of their 401K/SEP IRA as a spouse, doesn't that mean they can contribute 20% of the net income (minus .5 * self employment)  to *each* of our accounts?

Doesn't that effectively double the limit for each business from 20% to 40%?

I may have gotten myself confused.

(I am not used to rich people problems with taxes, I know way more about how to max out the saver's credit).

I use a SEP IRA from Vanguard for my business and it is very easy to administer, but a solo 401k didn't look any more difficult. If you have a Vanguard account, I suggest calling them and talking through your scenario.

Yea, I called and talked with Vanguard and they said the contribution limit would be the same either way in my scenario, but you don't have to do quite as complicated calculations on the i401K. Having been a 401K admin before, the SEP IRA is definitely a smidge easier as it's not linked to your EIN just your SSN. it doesn't seem to offer me any advantage in this situation to do have the i401k so I was tempted to do the SEP.

[terran]

Yes, I'm pretty sure you're confused unless you can find something saying you can double contribute. Probably the simplest way to look at it is that regardless of how you split the income between the two businesses each of your incomes will end up on your separate Schedule C's such that they add up to the total business income, and that's what the contribution will will be calculated on.

As I said, there are a couple of possible advantages to the solo 401(k) if you want to be able to contribute more to Roth (either through backdoor IRA and the easy end or mega backdoor Roth on the complicated end), but if that's not something you're interested in then SEP is a fine option.

[seattlecyclone]

I had a SEP for a while because, as you note, the pre-tax contribution limits are the same as the 401(k) when you're already maxing out your 401(k) at your main employer, and the SEP is easier to set up. Then I left my main gig and found that I actually wanted to use the full 401(k) contribution space, so I set up the individual 401(k) at that time. Would have been slightly less work to do the 401(k) from the start. No big deal though.

Also be aware that if you want to do backdoor Roth IRA contributions, the SEP balance will mess with that (see also: pro rata rule), while an individual 401(k) balance will not.

[monstermonster]

Probably the simplest way to look at it is that regardless of how you split the income between the two businesses each of your incomes will end up on your separate Schedule C's such that they add up to the total business income, and that's what the contribution will will be calculated on.

So, reading through the IRS documentation, for a i401K on the employeR side, I can contribute up to 25% of net self-employment earnings or the maximum of $57,000 in 2020 and $58,000 in 2021.

"If you have a spouse who is employed by and earns income from this business in some capacity, you can make the same contributions for each of you."

Since two different business are employing us, it seems like we can do 25% of earnings for each of us in each business. For me this would be 25% of net profit for my business, plus 25% of whatever money my SO's pays me. For my SO, it would be opposite.

Sorry I know I'm being thick. I MAY want to ask the CPA about this, I thought it would be simpler than this.

Also be aware that if you want to do backdoor Roth IRA contributions, the SEP balance will mess with that (see also: pro rata rule), while an individual 401(k) balance will not.

Yea, unfortunately, I already have basis in a Roth as it was my primary investment vehicle for years so I'm kinda screwed anyway on pro-rata rules. No plan for a backdoor roth right now, my income doesn't really justify it (my SO's does but we're financially separate from one another, despite this current mess).


Not the IRS, but a blog post on doubling up:

https://www.myubiquity.com/business/can-my-spouse-participate-in-my-solo-401k/

[bacchi]

The title mentions SIMPLE and the first post mentions SEP. Different vehicles.

----
The spouse will need to be an employee. The spouse's SEP contribution is based on the W2 and is paid by the company, matching the % the owner contributes.


Ah, I see that the link above ^^ describes the W2, K1, or QJV paths.

[terran]

Sorry I know I'm being thick. I MAY want to ask the CPA about this, I thought it would be simpler than this.

I think you're just making it more complicated than it needs to be. You can split the income however you want (as long as you can justify it based on the work you each do) and contribute 25% (reduced to 20%) of that income for each of you, but at the end of the day you're still contributing the same amount in total, you're just changing how it's split up between the two of you depending on how you split the income.

As far as the pro-rata issue with your traditional IRA, see my comments about rolling your traditional IRA into a solo 401(k). That would let you make backdoor Roth IRA contributions if you want.