Author Topic: Is a Solo 401(k) a good choice for me?  (Read 1986 times)

Dollar Slice

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Is a Solo 401(k) a good choice for me?
« on: August 16, 2015, 09:56:09 PM »
My current retirement scenario: I have about 50/50 invested in Roth and traditional IRAs - the Roth I started myself, the trad. is a rollover from a previous 401(k). I am currently in a HCOL/high-tax area and my marginal rate between fed/state/city is around 35%. ETA: I forgot to say I don't have a 401(k) available right now at work.

I'm anticipating some freelance income to the tune of a couple/few thousand dollars a year... nothing major. It was irking me that I'd be looking at paying nearly half of it in taxes, and someone in another thread suggested that I get an EIN and start a solo 401(k) with Vanguard which would shelter almost all of the freelance income. My investments are all with Vanguard already and I believe I'd qualify for a fee-free plan. Sounds good so far.

So... questions.

How much paperwork are we talking about between getting an EIN and the 401(k)? To set it up, plus annually?

If I get paid under my SS#, can I still contribute that money to the 401(k)? Or do I have to get paid with the EIN? How about if I got paid with cash from a person that wouldn't be filing any 1099 forms (e.g., babysitting)? How much paperwork do I have to keep in terms of my income?

Am I screwing myself in re: the IRA - I read that if I have a 401(k) available from my employer I can no longer contribute to a traditional IRA if my income is over $71k/yr (and it is, just barely). Does that include this plan? So if I made $3k in freelance money, I could contribute/tax-shelter $2500+ but would lose my ability to contribute $5500 to a traditional IRA, therefore having LESS tax deferral space available to me? This seems like a potential deal-killer...

Thanks in advance for any help/advice... I've done quite a bit of reading this weekend but none of it seems tailored to a situation like mine and I'm not clear on what I can do.
« Last Edit: August 16, 2015, 10:04:18 PM by Vee »

Able was I ERE

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Re: Is a Solo 401(k) a good choice for me?
« Reply #1 on: August 17, 2015, 03:56:01 AM »
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How much paperwork are we talking about between getting an EIN and the 401(k)? To set it up, plus annually?

Getting an EIN is trivial online from the IRS.  Vanguard will walk you through the steps to opening a solo 401k.  The form is 100+ pages, but most is legalese boilerplate.  Here is Retire By 40's Experience with Vanguard’s Individual 401k.  Yearly, the paperwork is small---just a line at tax time indicating contributios (unless you have $250k in the account, then there is a 2 page form).

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If I get paid under my SS#, can I still contribute that money to the 401(k)? Or do I have to get paid with the EIN? How about if I got paid with cash from a person that wouldn't be filing any 1099 forms (e.g., babysitting)? How much paperwork do I have to keep in terms of my income?

You can contribute based on your reported business income.  Cash, things paid under your own SSN, etc.  For tax records, you should be keeping track of all income---just a spreadsheet or log book should be sufficient.

Quote
Am I screwing myself in re: the IRA - I read that if I have a 401(k) available from my employer I can no longer contribute to a traditional IRA if my income is over $71k/yr (and it is, just barely). Does that include this plan? So if I made $3k in freelance money, I could contribute/tax-shelter $2500+ but would lose my ability to contribute $5500 to a traditional IRA, therefore having LESS tax deferral space available to me? This seems like a potential deal-killer...

You start to lose the deduction for your IRA contributions at $61k Modified AGI.   If you lose any of your deduction for a Traditional IRA, then I'd suggest contributing to a Roth IRA instead. 

Run the numbers yourself.  You should try to run the numbers to see how it would affect your ability to deduct your IRA contributions.  The Taxcastor could be enough, otherwise create an account at TurboTax, TaxAct or HR Block to run the numbers.

Dollar Slice

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Re: Is a Solo 401(k) a good choice for me?
« Reply #2 on: August 17, 2015, 08:24:09 AM »
Thanks for the answers!

Run the numbers yourself.  You should try to run the numbers to see how it would affect your ability to deduct your IRA contributions.  The Taxcastor could be enough, otherwise create an account at TurboTax, TaxAct or HR Block to run the numbers.
I would lose all of my ability to contribute to a Trad. IRA if I had a solo 401(k), it looks like. So... unless I make $6000+ freelancing per year, it seems like my attempt to avoid paying so much tax would result in me paying MORE tax. (I'd skip the tax on three or four grand, but pay the tax on $5500 that would have to go Roth instead of trad. IRA.) The upside is that I'd have more money in retirement accounts. The downside is that I'd have less money total.

Rough guesstimate:
$3500 freelance w/solo 401k:
15% SE tax on freelance: $525
35% tax on IRA contribution: $1925
Total tax paid: $2450

$3500 freelance w/o solo 401k:
45% tax on freelance: $1575
0% tax on trad. IRA contribution: $0
Total tax paid: $1575

So I'm basically paying $875 to tax-shelter an additional ~$3000. I'm not exactly sure how to factor in the tax implications of Roth vs. traditional though...

wenchsenior

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Re: Is a Solo 401(k) a good choice for me?
« Reply #3 on: August 18, 2015, 08:35:43 AM »
I'm facing a very similar situation, except I'm currently making about 10K of freelance Sole Proprietorship income per year, give or take a few thousand, and I have no current IRAs or retirement vehicles. I was leaning toward a SEP Ira for ease, but it sounds like maybe 401k through Vanguard is the way to go for me as well, because I certainly could contribute more than the ~ 18% of net income limit of the SEP in at least some years.