Independent contract Income: SEP IRA? Individual 401k?

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Topic Author
SimpleFund
Posts: 22
Joined: Thu Feb 27, 2014 7:31 pm

Independent contract Income: SEP IRA? Individual 401k?

Post by SimpleFund »

Hello, I have read the Bogleheads book recently and am starting the road to investing. There is so much to learn and know and I know I've barely scratched the surface...Honestly I've felt very overwhelmed but this website has been an immense help!!

Right now, I need to make a decision soon (before April 15th) regarding some independent contract work income I received.

Emergency Funds: 6 months
Debt: Student Loans @ <2%
Status: Filing Jointly
Age: 33
Bracket: 33%; 6.37% State (NJ)
Eventual Desired Allocation: 70% stocks (total stock market index), 15% international index, 15% total bond market (3 fund simple?)<---hoping to do this in another thread.

Current Allocations:

Taxable: 80% (CDs @ approx 2.5% rate - 5 year terms mostly)

NonTaxable: 20%

Her 401k (inactive old one): 10%
Her 401k (inactive old one): 5%
Her 401k (currently active): 5%

His: No 401k or anything.

I plan on posting a complete list of the 401k plans and ratios and options and match #s in another thread. I am having troubling finding the tickers for some of them...My main concern right now is:

1. Last year I had additional income of about 30k from independent contract work, I receive only 1099 under my name. I want to know how I can deduct possibly 25% of this income into a SEP-IRA or individual 401k plan?? or simple IRA even??
2. From what I have researched, I cannot do 401k for 2013 tax season because I missed the deadline(12/31/13) but SEPIRA/SIMPLE IRA are April 15 right?
3. Thinking of going with Vanguard on this and doing 3 simple funds assuming I put in 25% of 30k and split them into appropriate %...good idea?

This is my first post, I hope I kept it simple and provided enough information...I want to do other investments because I have too much money in taxable CDs (Yes, I know...I cannot sleep at night with risk... :D ) and I will post a reallocation/mutual fund thread for that issue.

Thank you. :happy
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BolderBoy
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Location: Colorado

Re: Independent contract Income: SEP IRA? Individual 401k?

Post by BolderBoy »

SimpleFund wrote:1. Last year I had additional income of about 30k from independent contract work, I receive only 1099 under my name. I want to know how I can deduct possibly 25% of this income into a SEP-IRA or individual 401k plan?? or simple IRA even??
2. From what I have researched, I cannot do 401k for 2013 tax season because I missed the deadline(12/31/13) but SEPIRA/SIMPLE IRA are April 15 right?
3. Thinking of going with Vanguard on this and doing 3 simple funds assuming I put in 25% of 30k and split them into appropriate %...good idea?
Welcome. You are right that it is too late for 2013 to open an i401k, but you can open one NOW in anticipation of 2014 funding. VG allows empty i401k plans that are awaiting funding. i401k plans beat SEPIRAs when you can choose between them. Downside is public reporting is required when the total assets exceed some triple digit thousands amount.

Personally, I think that missing out on maximizing retirement contributions in any given year is WORSE than what kind of plan you put it into, so YES, by all means, open a SEPIRA (I don't know anything about SIMPLE plans but don't think you can fund them as much.) Contribute the max to the SEPIRA. If you can, also contribute the max to an IRA and your wife should as well.

3 Fund Approach is wonderful. I've been doing it for years now (40/60 split as I'm "retired"). Keep it simple!
Spirit Rider
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Joined: Fri Mar 02, 2007 1:39 pm

Re: Independent contract Income: SEP IRA? Individual 401k?

Post by Spirit Rider »

You are correct that a solo 401k must be created by 12/31 of the tax year you are making the contributions for. However, a SIMPLE IRA must actually be created even earlier, by 10/01 of the tax year you are making the contributions for. You have until 04/15 of the following year to create and fund a SEP IRA.

The maximum SEP IRA contribution is actually 20% of net self-employment earnings (net profit - 1/2 SE tax). The 25% is the percentage of actual compensation, but the contribution itself reduces the compensation (0.2 = 0.25 / (1.0 + 0.25)).
Topic Author
SimpleFund
Posts: 22
Joined: Thu Feb 27, 2014 7:31 pm

Re: Independent contract Income: SEP IRA? Individual 401k?

Post by SimpleFund »

BolderBoy wrote:Welcome. You are right that it is too late for 2013 to open an i401k, but you can open one NOW in anticipation of 2014 funding. VG allows empty i401k plans that are awaiting funding. i401k plans beat SEPIRAs when you can choose between them. Downside is public reporting is required when the total assets exceed some triple digit thousands amount.
Thank you for the advice. I spoke with Vanguard and they mentioned that I could not do a i401k unless I was incorporated or something but with a SEP IRA i could just use my SSN. I do have a LLC that I registered years ago that I maintain and keep but I dont get paid under it; I get paid under my name. Does the Individual 401k require some business form filing?? Does it require a EIN #?
Spirit Rider wrote: The maximum SEP IRA contribution is actually 20% of net self-employment earnings (net profit - 1/2 SE tax). The 25% is the percentage of actual compensation, but the contribution itself reduces the compensation (0.2 = 0.25 / (1.0 + 0.25)).
Thank you confirming this. I read it on a website and at the time it didn't make sense to me in how the contribution itself affects the contribution itself :oops: Those IRS guys, they sure are tricky. :D But hey, 20% is better than 0 for me.
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PaddyMac
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Re: Independent contract Income: SEP IRA? Individual 401k?

Post by PaddyMac »

"Thank you for the advice. I spoke with Vanguard and they mentioned that I could not do a i401k unless I was incorporated or something but with a SEP IRA i could just use my SSN."

I think they gave you fuzzy info. You can absolutely open their Individual 401k as a sole proprietor, you just need a free EIN number from the IRS. You don't need to incorporate!
You can apply online and get it in a few minutes:
http://www.irs.gov/Businesses/Small-Bus ... %29-Online

Use this for the 401k or whenever you don't want to give a client your SSN (for W-9 form used for 1099 MISC income etc).
Spirit Rider
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Re: Independent contract Income: SEP IRA? Individual 401k?

Post by Spirit Rider »

An example can probably help visualize how the maximum profit sharing contribution is both 20% of net self-employment earnings and 25% of compensation.

$10K(net SE earnings) - $2K(SEP IRA contribution) = $8K(compensation)

NOTE: The SEP IRA contribution is both 25% of compensation and 20% of net SE earnings. The 20% is a direct calculation, whereas the 25% is not, because the contribution changes the compensation.
huntertheory
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Re: Independent contract Income: SEP IRA? Individual 401k?

Post by huntertheory »

The sites from Vanguard and Fidelity on this are both helpful and pretty straightforward:

https://investor.vanguard.com/what-we-o ... pare-plans

https://www.fidelity.com/retirement-ira ... s/overview

I max out my employer 401k and am very happy with my SEP-IRA for small business income. Given the flexibility around timing, I determine the amount of my contribution around February when I am calculating my taxes for the year; TurboTax even helps with the calculation. It's been a tremendous savings and (particularly tax savings) vehicle for us.

I also just recently switched jobs, and I rolled my old 401k into my SEP-IRA at Vanguard (I spent awhile reading IRS materials and talking to Vanguard to make sure this was OK).

Also, keep in mind that -- at least according to my understanding -- you can contribute to a SEP-IRA one year, an individual 401k the next, and switch back and forth, etc without any issues (other than a growing number of accounts).
mah001
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Joined: Fri Sep 28, 2012 9:30 am

Re: Independent contract Income: SEP IRA? Individual 401k?

Post by mah001 »

As far as switching back and forth between 401(k) and SEP, if either plan document (see Form 5305-SEP for example) indicates it's not ok, then technically it's not. It's not like the standard for a SIMPLE Ira, whose exclusive plan rule requires merely that only one plan be actively maintained ( i.e. you can't contribute to another plan for the same year). But as a practical matter, it's probably ok to maintain a SEP plus another plan if there are no issues in operation, even if the written plan says you can't do it.

Regarding the EIN, last time I checked the Form SS-4, it continues to be confusing regarding applying; there's a box that says 'started a pension plan' as your reason for needing a EIN. But you really should be applying for a number for the business, in this case a sole proprietorship. When you apply for a number for a plan, what you get is a trust EIN. Virtually all 401 plans hold the funds in trust.

The IRS does not need a business ID when you have a plan until such time as you file for a determination letter, if ever, or when you eventually file a Form 5500 series information return.
Spirit Rider
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Re: Independent contract Income: SEP IRA? Individual 401k?

Post by Spirit Rider »

huntertheory wrote:Also, keep in mind that -- at least according to my understanding -- you can contribute to a SEP-IRA one year, an individual 401k the next, and switch back and forth, etc without any issues (other than a growing number of accounts).
In most cases this is not correct.

1. You cannot create a SEP IRA if you already have a solo 401k. You would have to terminate the solo 401k. This is not a trivial process and the IRS would take a dim view of doing this repeatedly(401k plans are intended to be long term).

2. You cannot create a 401k if you currently have IRS model(5305-SEP) SEP plan. Most large plan providers (Fidelity, T. Rowe Price, Vanguard, etc...) are 5305-SEP plans. You would either have to find a plan provider with their own prototype plan or pay to have your own drafted(not cheap).

3. If you have a 5305-SEP model SEP IRA, you can terminate this plan at any time and create a solo 401k. However, you are now in item 1 state from above. So practically speaking there is only a single SEP-IRA -> solo 401k change available. However, that should not be a problem, since the solo 401k gives the option of employee deferral and/or/neither employer profit sharing.

So feel free to start with a SEP IRA while you only need profit sharing contributions and switch to a solo 401k when you need to add employee deferrals. Once you have a solo 401k, you can choose each year which contributions to make, so there is no need to switch back to a SEP IRA.

There are other advantages(other than employee deferral) to a solo 401k for a future discussion
Topic Author
SimpleFund
Posts: 22
Joined: Thu Feb 27, 2014 7:31 pm

Re: Independent contract Income: SEP IRA? Individual 401k?

Post by SimpleFund »

mah001 wrote: Regarding the EIN, last time I checked the Form SS-4, it continues to be confusing regarding applying; there's a box that says 'started a pension plan' as your reason for needing a EIN. But you really should be applying for a number for the business, in this case a sole proprietorship. When you apply for a number for a plan, what you get is a trust EIN. Virtually all 401 plans hold the funds in trust.
The IRS does not need a business ID when you have a plan until such time as you file for a determination letter, if ever, or when you eventually file a Form 5500 series information return.
I think for 2013, I should just contribute to a SEP-IRA. It seems like it will be easier to move from SEP-IRA to----->i401k in the future years if need be. If I apply for a EIN this year, when I receive my 1099 checks, do they still write it out to me individually? -- I guess what I am asking is that if I need a "company name" associated with the EIN?
huntertheory wrote:TurboTax even helps with the calculation..
Good to know, I'll probably need it in a week or 2...
Spirit Rider wrote: There are other advantages(other than employee deferral) to a solo 401k for a future discussion
This is excellent, thank you, and in my situation right now, the best thing to do is do the SEP-IRA, contribute 20% for 2013 tax year since I have until April 15th...

The only other advantages that I see with the i401k is using it as a loan and allowing catch up contributions if I am over 50 y/o. Both of which shouldn't be an issue for me. Is there anything else that you can think of?
Spirit Rider
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Re: Independent contract Income: SEP IRA? Individual 401k?

Post by Spirit Rider »

SimpleFund wrote:
Spirit Rider wrote: There are other advantages(other than employee deferral) to a solo 401k for a future discussion
This is excellent, thank you, and in my situation right now, the best thing to do is do the SEP-IRA, contribute 20% for 2013 tax year since I have until April 15th...

The only other advantages that I see with the i401k is using it as a loan and allowing catch up contributions if I am over 50 y/o. Both of which shouldn't be an issue for me. Is there anything else that you can think of?
You mentioned two of the major 401k advantages. The other two major advantages are:
1. For early retirement, you can start 401k qualified withdrawals when you separate from an employer at 55.
2. SEP IRA accounts are fundamentally IRA accounts. Their balances must be prorated with any non-deductible IRA basis. This could make back-door Roth IRA conversions cost prohibitive.
Topic Author
SimpleFund
Posts: 22
Joined: Thu Feb 27, 2014 7:31 pm

Re: Independent contract Income: SEP IRA? Individual 401k?

Post by SimpleFund »

what do I fill in here under "percentage" for sep-ira?

20% or 25%? here:

https://personal.vanguard.com/us/SbsCal ... Controller

thanks
Topic Author
SimpleFund
Posts: 22
Joined: Thu Feb 27, 2014 7:31 pm

Re: Independent contract Income: SEP IRA? Individual 401k?

Post by SimpleFund »

SimpleFund wrote:what do I fill in here under "percentage" for sep-ira?

20% or 25%? here:

https://personal.vanguard.com/us/SbsCal ... Controller

thanks
I actually found it. It's 25% and automatically calculates for you the contribution amount. Nice little calculator.
Spirit Rider
Posts: 13977
Joined: Fri Mar 02, 2007 1:39 pm

Re: Independent contract Income: SEP IRA? Individual 401k?

Post by Spirit Rider »

SimpleFund wrote:
SimpleFund wrote:what do I fill in here under "percentage" for sep-ira?

20% or 25%? here:

https://personal.vanguard.com/us/SbsCal ... Controller

thanks
I actually found it. It's 25% and automatically calculates for you the contribution amount. Nice little calculator.
Yes, this calculator is calculating the 1/2 SE tax deduction, subtracting it from the net business profit to get the net self-employment income. The input percentage is the contribution percentage of compensation.

In the case of a sole proprietor, they are calculating to reflect the fact that the contribution is deducted from the net self-employment income to get the compensation.

Note: This calculator assumes that all of your net business profits when combined with W2 income subject to SS are less than or equal the SS max wage base. If this is not true, do not use this calculation to determine your actual maximum contribution. If you use tax preparation software it will determine the actual amount. If you do your taxes manually, you will need to use Schedule SE and the Self-Employment Deduction Worksheet in Publication 560.
Topic Author
SimpleFund
Posts: 22
Joined: Thu Feb 27, 2014 7:31 pm

Re: Independent contract Income: SEP IRA? Individual 401k?

Post by SimpleFund »

Spirit Rider wrote:
SimpleFund wrote:
SimpleFund wrote:what do I fill in here under "percentage" for sep-ira?

20% or 25%? here:

https://personal.vanguard.com/us/SbsCal ... Controller

thanks
I actually found it. It's 25% and automatically calculates for you the contribution amount. Nice little calculator.
Note: This calculator assumes that all of your net business profits when combined with W2 income subject to SS are less than or equal the SS max wage base. If this is not true, do not use this calculation to determine your actual maximum contribution. If you use tax preparation software it will determine the actual amount. If you do your taxes manually, you will need to use Schedule SE and the Self-Employment Deduction Worksheet in Publication 560.
Good to know, I plan on using turbo tax (it should calculate it right?)...I am going to do most of the taxes first so I know what my "net" business income is before I open the account, so I know about how much to contribute...
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