solo 401k or solo roth 401k???

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whitecliff
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solo 401k or solo roth 401k???

Post by whitecliff » Sun Jul 07, 2013 8:53 pm

Ok so I have posted a few times asking questions of how to get my financial house in order and have learned a ton from you guys. I have a business right now in which I am the only employee. This year I should be paid about 250k of which I have basically no overhead. I really should be an employee but that is not the issue. I currently have a SEP IRA of which I am currently maxing out. I am currently in the process of starting an individual 401k to take advantage of employEE contributions and not just employER in the SEP. I will probably be changing jobs in the next few months and may be and employee for a few years until I purchase this other business and can again contribute to the solo 401k.

My questions is, should I create a roth solo 401k instead of just solo 401k to take advantage of after tax savings? (I am sure this question alone could have a thousand answers)

Or is the advantage of lowering my gross income for tax purposes worth skipping ROTH contributions? If I open a solo 401k now can I add/convert to ROTH conversions later?

Also my CPA advised me that if I change jobs and become employee I can continue to fund the SEP and solo 401k and not pay myself salary as long as all contributions are pre tax, IF I do roth contributions I will have to pay taxes and continue to pay salary out of the account.

I appreciate all advise and if you need more info please ask. Thanks

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JamesSFO
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Re: solo 401k or solo roth 401k???

Post by JamesSFO » Sun Jul 07, 2013 9:19 pm

I'm not sure I followed all of the gyrations you outlined, but let me say this if you go with the Vanguard (VG) individual 401K product you get to pick whether the contribution is Roth (EE contributions only) or traditional (EE or ER contribution) at the time of contribution.

Thus start by getting the new 401K plan open for your business.

whitecliff
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Re: solo 401k or solo roth 401k???

Post by whitecliff » Sun Jul 07, 2013 9:43 pm

JamesSFO wrote:I'm not sure I followed all of the gyrations you outlined, but let me say this if you go with the Vanguard (VG) individual 401K product you get to pick whether the contribution is Roth (EE contributions only) or traditional (EE or ER contribution) at the time of contribution.


I understand this part of the solo 401k. The main question I have is determining whether to add ROTH contribution ability to the solo 401k. Also if I open a solo 401k without the ROTH part can I add the ability to do Roth contributions on the employEE portions at a later date?

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JamesSFO
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Re: solo 401k or solo roth 401k???

Post by JamesSFO » Sun Jul 07, 2013 10:40 pm

whitecliff wrote:
JamesSFO wrote:I'm not sure I followed all of the gyrations you outlined, but let me say this if you go with the Vanguard (VG) individual 401K product you get to pick whether the contribution is Roth (EE contributions only) or traditional (EE or ER contribution) at the time of contribution.


I understand this part of the solo 401k. The main question I have is determining whether to add ROTH contribution ability to the solo 401k. Also if I open a solo 401k without the ROTH part can I add the ability to do Roth contributions on the employEE portions at a later date?


Again, the Vanguard form plan of the solo 401K products will support both and you make the contribution type choice AT TIME OF CONTRIBUTION. So say you set up the plan today, then you go to make an EE contribution on 8/1/2013, on 8/1/2013 when you make the contribution you code whether it is roth/traditional. Same again when you make a contribution on say 2/1/2014 for the 2013 tax year... There shouldn't be any mandatory decision now.

I still don't quite understand your first post to provide more suggestions.

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White Coat Investor
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Re: solo 401k or solo roth 401k???

Post by White Coat Investor » Sun Jul 07, 2013 10:46 pm

Yes, you can add it later. The question in some ways is more complex than you think, and in some ways less complex. This is simply the eternal traditional vs Roth question rephrased.

It really comes down to your marginal tax rate now vs your effective tax rate on the IRA withdrawals later. So you're making $250K and putting $50K of it into a 401K. Let's assume you're married, so your tax bracket is probably 28%. Add in 5% for state and your marginal is probably 33%.

I don't know how much retirement income you expect, but keep in mind that (ignoring SS and other sources of income) your first $11K out of that 401K isn't taxed, the next $18K is taxed at 10%, the next $55K is taxed at 15%, and the next $70K is taxed at 25%, it seems a pretty good bet to me that your effective tax rate in retirement will be less than 28% federal. So save money now at 28%, and withdraw it later at 15% or so. You'll have to run the numbers for your own situation, but as a general rule, most high earners in their peak earning years should be using the tax-deferred portion of their 401K instead of the Roth. If you want to hedge your bets a bit, you can put 1/4-1/2 of your contributions into the Roth side. I prefer doing my Roth outside the 401K, by doing personal and spousal backdoor Roths every year in addition to the tax-deferred 401K (and defined benefit plan, and solo 401K, and HSA etc). The finance buff did a nice write-up on the subject:

http://thefinancebuff.com/case-against-roth-401k.html

P.S. If you want to start doing backdoor Roth IRAs, you need to get rid of the SEP-IRA. Vanguard's solo 401K does not let you roll a SEP-IRA into it but other solo 401Ks may.

http://whitecoatinvestor.com/retirement ... -roth-ira/

P.P.S.
Also my CPA advised me that if I change jobs and become employee I can continue to fund the SEP and solo 401k and not pay myself salary as long as all contributions are pre tax, IF I do roth contributions I will have to pay taxes and continue to pay salary out of the account.


Either your CPA is a wacko or more likely you misunderstood each other. If you become an employee you can no longer make contributions to a SEP-IRA or a Solo 401K, no matter whether you are making Roth or traditional contributions. Only self-employment income can go into those. Also keep in mind that some Solo 401Ks may not let you do in-service conversions.
1) Invest you must 2) Time is your friend 3) Impulse is your enemy | 4) Basic arithmetic works 5) Stick to simplicity 6) Stay the course

whitecliff
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Re: solo 401k or solo roth 401k???

Post by whitecliff » Mon Jul 08, 2013 7:54 am

EmergDoc wrote: Vanguard's solo 401K does not let you roll a SEP-IRA into it but other solo 401Ks may.


Yes I have looked into this on these forums and it looks like if I am hardcore vanguard then you can roll the current SEP into fidelity (which will accept this kind of transfer), and then move it right back to vanguard. Others said they have done this.

EmergDoc wrote:If you become an employee you can no longer make contributions to a SEP-IRA or a Solo 401K, no matter whether you are making Roth or traditional contributions


Is this true if my business is still generating income due to services provided and money is still coming in and using that money from the business account to fund the pre tax contributions?

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PaddyMac
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Re: solo 401k or solo roth 401k???

Post by PaddyMac » Mon Jul 08, 2013 10:43 am

If your business is still generating income, you can still save that money into your SEP or solo 401k. Check with your CPA though; the SEP is separate, but not sure about the 401k (they may be merged with any 401k your employer might offer).

If you can save enough tax deferred, then add in other expenses, you may be able to drop your MAGI low enough to qualify for a Roth IRA.

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JamesSFO
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Re: solo 401k or solo roth 401k???

Post by JamesSFO » Mon Jul 08, 2013 10:58 am

PaddyMac wrote:If your business is still generating income, you can still save that money into your SEP or solo 401k. Check with your CPA though; the SEP is separate, but not sure about the 401k (they may be merged with any 401k your employer might offer).

If you can save enough tax deferred, then add in other expenses, you may be able to drop your MAGI low enough to qualify for a Roth IRA.


EE amount is capped ($17,500 + over 50 catch up contributions) across all ERs

ER amount is capped per ER control group, so ER#1 the small business can contribute the ~30K differences and ER#2 the new BigCo you work for can contribute.

The SEP/401K amounts are capped in combination as well.

whitecliff
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Re: solo 401k or solo roth 401k???

Post by whitecliff » Mon Jul 08, 2013 11:16 am

EmergDoc wrote:It really comes down to your marginal tax rate now vs your effective tax rate on the IRA withdrawals later. So you're making $250K and putting $50K of it into a 401K. Let's assume you're married, so your tax bracket is probably 28%. Add in 5% for state and your marginal is probably 33%.

I don't know how much retirement income you expect, but keep in mind that (ignoring SS and other sources of income) your first $11K out of that 401K isn't taxed, the next $18K is taxed at 10%, the next $55K is taxed at 15%, and the next $70K is taxed at 25%, it seems a pretty good bet to me that your effective tax rate in retirement will be less than 28% federal. So save money now at 28%, and withdraw it later at 15% or so. You'll have to run the numbers for your own situation, but as a general rule, most high earners in their peak earning years should be using the tax-deferred portion of their 401K instead of the Roth. If you want to hedge your bets a bit, you can put 1/4-1/2 of your contributions into the Roth side. I prefer doing my Roth outside the 401K, by doing personal and spousal backdoor Roths every year in addition to the tax-deferred 401K (and defined benefit plan, and solo 401K, and HSA etc). The finance buff did a nice write-up on the subject:

http://thefinancebuff.com/case-against-roth-401k.html


This was basically the info I was looking for, thanks ERdoc

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