Individual 401k as a sole proprietor and your spouse

[dpmd]

Advertisement - Members don't see this ad

I just started private practice and my income comes mostly from paid call and whatever reimbursement I get for stuff I do. I am leasing office space and management (including billing/collections, etc) for a fixed percentage of my collections and they are letting me pay the full premium for the group health insurance the employees of the office get (about half of what I could get if I got an individual plan with much better coverage). I was employed for most of the year and will only bring in about 20-30K this year (minus the management percentage, minus expenses-not really much besides some one time costs but I will be sure to milk anything I can claim, minus taxes). I was thinking of starting a solo 401k since it would let me put the most away this year (and possibly next year depending on how busy I get and what my reimbursement is like), and I was reading that it would also let my spouse put stuff away. I have done a bunch of reading about it but I am confused about what I would need to do in order to let him put some money away as well (more important this year I guess since I already maxed my employee contributions for the year in my prior job). Right now he doesn't do much with regards to my work but I could have him do some administrative stuff (aside from the office manager) and he is a nurse so I guess I could even have him answer some calls or whatever (maybe ask him to keep my home office clean and wash my lab coats). The question is do I have to actually make him a W2 employee or 1099 contractor or is it enough to say we are in a community property state so we will share the profit/loss equally? He is currently going to school to transition from a LVN to RN and is not otherwise employed so figuring out a way for more money from my job to go towards retirement seems like a good plan (since our actual living expenses low enough that I don't need the money now). Anybody doing this now, or have any knowledge about it?

 

[krl7044]

I just started private practice and my income comes mostly from paid call and whatever reimbursement I get for stuff I do. I am leasing office space and management (including billing/collections, etc) for a fixed percentage of my collections and they are letting me pay the full premium for the group health insurance the employees of the office get (about half of what I could get if I got an individual plan with much better coverage). I was employed for most of the year and will only bring in about 20-30K this year (minus the management percentage, minus expenses-not really much besides some one time costs but I will be sure to milk anything I can claim, minus taxes). I was thinking of starting a solo 401k since it would let me put the most away this year (and possibly next year depending on how busy I get and what my reimbursement is like), and I was reading that it would also let my spouse put stuff away. I have done a bunch of reading about it but I am confused about what I would need to do in order to let him put some money away as well (more important this year I guess since I already maxed my employee contributions for the year in my prior job). Right now he doesn't do much with regards to my work but I could have him do some administrative stuff (aside from the office manager) and he is a nurse so I guess I could even have him answer some calls or whatever (maybe ask him to keep my home office clean and wash my lab coats). The question is do I have to actually make him a W2 employee or 1099 contractor or is it enough to say we are in a community property state so we will share the profit/loss equally? He is currently going to school to transition from a LVN to RN and is not otherwise employed so figuring out a way for more money from my job to go towards retirement seems like a good plan (since our actual living expenses low enough that I don't need the money now). Anybody doing this now, or have any knowledge about it?

You are on the right track and have the right idea. I do exactly this for my clients (with spouse employees) who try to maximize their retirement plan contributions. Yes, you do want to pay your spouse a salary (W2), because presumably your spouse is an employee of your business (and you can save more on taxes this way vs. if you put the entire amount into your own 401k account). You might want to have a CPA or a fee-only financial planner work with you on this one because it can get a bit tricky. I typically optimize/maximize tax savings by assigning an appropriate salary to the spouse. In a nutshell, you can pay your spouse towards the very end of the year with a single check depending on how the year has been for you. You will have to make salary deferral contribution for your spouse by December 31st. However, the profit-sharing part of your solo-401k contribution can be made (to your and your spouse accounts) by your tax filing date the following year, so you have total flexibility to wait and see. You can open a solo-401k account directly at Vanguard for both you and your spouse.

 

[Stroganoff]

Have you also maxed out spousal IRA? (Even if it has to be Traditional and not Roth). My gut says for the Individual 401k he would most likely have to be a W2 and not 1099. I'm personally leaning towards a Vanguard SEP-IRA since I don't have any employees. I could then ease my way into an Individual 401k. Since you seem to have actual staff a Individual 401k would be way better for your practice since I believe you wouldn't have to make all employer contributions equal for everyone...

 

[dpmd]

No actual staff. Everyone who actually does stuff for my practice is covered in a lease payment to a guy rather than me actually employing anyone. So it would be stretching the truth to make my husband into an employee (since I will have to make up duties for him). Already maxed out spousal IRA. The individual IRA is for people with no employees (besides maybe a spouse). The benefit is that if you don't make enough to max out the sep-IRA you can put more into the 401K (based on how much is considered salary versus business profit, it got a little confusing when I read it, but that was the benefit pushed by every site I looked at)

 

[krl7044]

Stroganoff: A solo-k is basically a SEP-IRA with salary deferral. The key here is that you can defer a lot more with a solo-401k with a smaller salary. So for example, assuming you pay yourself $134k. With that you can contribute $33k into the SEP and you can max out the solo-k with a $51k contribution. To max out the SEP you'd need to make over $200k. Another way to look at 401k vs. SEP: you only need to earn 62k to put away $33k in your solo-k. So that's a big difference.

dpmd: There is no law that says that you can not employ your spouse in your business/practice. You do what's right for you and make sure your accountant is on board. When you set up solo-k for you and your spouse, you get to decide the salary deferral amount (can be different every year), and the profit sharing amount - this you always set at maximum (25% for a W2). So when your spouse gets paid a W2, you can contribute any amount (up to $17,500) as salary deferral, and 25% of the salary as profit sharing. You need to make sure that your calculations are correct because you'll be moving the money yourself (it won't be automatic). The amount of profit sharing contribution will be around 20% if you are paid with a 1099, that's why you want your accountant to calculate the amount of your contribution. The great thing about the solo-k is that it is flexible, that's why it may be a bit tricky deciding how to allocate your contributions. Once you do it once, you'll see how it is done. If you have specific numbers I can show you how this might work.

 

[Stroganoff]

Stroganoff: A solo-k is basically a SEP-IRA with salary deferral. The key here is that you can defer a lot more with a solo-401k with a smaller salary. So for example, assuming you pay yourself $134k. With that you can contribute $33k into the SEP and you can max out the solo-k with a $51k contribution. To max out the SEP you'd need to make over $200k. Another way to look at 401k vs. SEP: you only need to earn 62k to put away $33k in your solo-k. So that's a big difference.

I was more referring to the differences on the employer contribution side. It might be more the difference between SIMPLE and SEP IRA, but I could have sworn a solo-401k offered the employer to "reward" employees differently whereas with the IRA types, the employer match has to be the exact same for all employees.

But since you bring that up, from what I've read so far, even the solo 401k employer contribution is limited to 25%, the same as SEP IRA. I did the comparison on Vanguard for $134K in your example, and $33,500 was the max employer contribution for both solo-401k and SEP-IRA since it maxed at 25%.

(And sorry dpmd for introducing business IRAs into the mix... slight side topic)

 

[krl7044]

I was more referring to the differences on the employer contribution side. It might be more the difference between SIMPLE and SEP IRA, but I could have sworn a solo-401k offered the employer to "reward" employees differently whereas with the IRA types, the employer match has to be the exact same for all employees.

But since you bring that up, from what I've read so far, even the solo 401k employer contribution is limited to 25%, the same as SEP IRA. I did the comparison on Vanguard for $134K in your example, and $33,500 was the max employer contribution for both solo-401k and SEP-IRA since it maxed at 25%.

(And sorry dpmd for introducing business IRAs into the mix... slight side topic)

For solo 401k - the same match for all employees, same as for SEP. You can't dial in different matches, but you can alter the match year to year.

Good for you, never trust anyone, try to replicate the calculations yourself. Vanguard does not provide a number for solo 401k contribution for an employee only for an independent contractor - so if you put the numbers (and select independent contractor), you'll get a number less than $51k but more than $33.5k. Try it! The number will be less because salary deferral is still $17,500, but the profit sharing is now around 20%, or $26,800 or $44,300. If you use $17,500 + 25% of $134k you'll get $51k.

 

[dpmd]

I was more referring to the differences on the employer contribution side. It might be more the difference between SIMPLE and SEP IRA, but I could have sworn a solo-401k offered the employer to "reward" employees differently whereas with the IRA types, the employer match has to be the exact same for all employees.

But since you bring that up, from what I've read so far, even the solo 401k employer contribution is limited to 25%, the same as SEP IRA. I did the comparison on Vanguard for $134K in your example, and $33,500 was the max employer contribution for both solo-401k and SEP-IRA since it maxed at 25%.

(And sorry dpmd for introducing business IRAs into the mix... slight side topic)

Well the Sep-IRA was what was originally looking at getting, but the fact that you could put away more with a 401k was what intrigued me. For example, this year I anticipate that I will end the year having brought in about 30K with maybe 10K of expenses. If I split the remaining 20K between my spouse and I, then in theory we can each put the entire 10K in to our 401k as part of our salary deferral (but do I then need to do W2s or 1099s for each of our "salaries"?) and the business has no net profit so no employer contribution (or the profit is the 20k after expenses that I have, in which case the sep IRA only lets me put in 20% of that or 5K)?

 

[krl7044]

Well the Sep-IRA was what was originally looking at getting, but the fact that you could put away more with a 401k was what intrigued me. For example, this year I anticipate that I will end the year having brought in about 30K with maybe 10K of expenses. If I split the remaining 20K between my spouse and I, then in theory we can each put the entire 10K in to our 401k as part of our salary deferral (but do I then need to do W2s or 1099s for each of our "salaries"?) and the business has no net profit so no employer contribution (or the profit is the 20k after expenses that I have, in which case the sep IRA only lets me put in 20% of that or 5K)?

Right, with SEP you can do 20% max. With Solo 401k you can put away $18.5k if your net is $20k (if you are a contractor/self-employed), so forget doing W2s, etc. You can do that when your income is large and you can benefit from actually paying your husband.

 

[Stroganoff]

I'm still confused, and it looks like apples and oranges if you mix in the salary deferral. Let's say someone has already maxed out their $17,500 401k salary deferral through a regular job, so salary deferral is out of the picture. They have a side business that has income. So, to do apples-to-apples, we only look at the employer (profit sharing) side:

SEP: "up to 25% of their W-2 earnings or 20% of net self employment income up to the SEP IRA contribution limit"
Individual 401k: "up to 25% of W-2 wages or 20% of net self employment income."

So that part looks identical to me. 25% of W-2 (meaning your tax structure is corporate) or 20% of net income (meaning probably Schedule C pass-through taxation). Both maximum limits are $51,000.

So I see the solo 401k as only good if one does not already have a 401k through another job. If they do, and the $17,500 is maxed out, then SEP looks better to me.
---------
Also, I've always wondered if one could have both a solo 401k and a SEP IRA to have $51,000 + $51,000 buckets.

 

[dpmd]

You can have both but the 51k is a max for the combo

 

[krl7044]

I'm still confused, and it looks like apples and oranges if you mix in the salary deferral. Let's say someone has already maxed out their $17,500 401k salary deferral through a regular job, so salary deferral is out of the picture. They have a side business that has income. So, to do apples-to-apples, we only look at the employer (profit sharing) side:

SEP: "up to 25% of their W-2 earnings or 20% of net self employment income up to the SEP IRA contribution limit"
Individual 401k: "up to 25% of W-2 wages or 20% of net self employment income."

So that part looks identical to me. 25% of W-2 (meaning your tax structure is corporate) or 20% of net income (meaning probably Schedule C pass-through taxation). Both maximum limits are $51,000.

So I see the solo 401k as only good if one does not already have a 401k through another job. If they do, and the $17,500 is maxed out, then SEP looks better to me.
---------
Also, I've always wondered if one could have both a solo 401k and a SEP IRA to have $51,000 + $51,000 buckets.

The question is, which 401k to max out. You might be better maxing out the Solo 401k because presumably you will pay higher taxes as a contractor vs. being an employee for someone else. In the case of being a contractor, you want to max out your solo 401k, while contributing a match at work. Also, the 401k at work might be very poor quality with high fees, while a solo 401k at Vanguard will have some of the best investments available.

One big difference between a SEP and a solo 401k (at Vanguard) is that a SEP can have a brokerage, so you can use ETFs (and that's what I typically use to build ultra-low cost portfolios). However, Vanguard fees have come down so much that it is a tossup. Also, there are several asset classes that are not yet available as Vanguard mutual funds, so that's another reason to use ETFs. The main reason why I haven't used SEP since solo 401k came out is because of the flexibility of the solo 401k - you can decide to max out the salary deferral when it is convenient for you, while a SEP is always a SEP. One advantage of having a SEP is that you can convert a part of it to Roth, while solo 401k (at least the one at Vanguard) does not have that option. However you can close the solo 401k and move the money into an IRA and then re-open it if you wish.

You can not contribute to a SEP and to a solo 401k at the same time for a single business. You can have either one or the other (unless both are offered by two different businesses, similar to having two 401k plans). If you have a SEP and a solo 401k, as dpmd said, the maximum you can contribute to both is $51k.