Solo 401k vs. SEP-IRA

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NoshBader
Posts: 3
Joined: Tue Feb 13, 2018 9:48 am

Solo 401k vs. SEP-IRA

Post by NoshBader » Sat Apr 28, 2018 4:07 pm

Hey all,

I've been trying to understand the differences between these two plans, and I think I have a good idea of which account I need to open up, but I just wanted to submit my situation to see what opinions I get back. Thanks in advance!

Backstory: 29 yo with ~$10,000 in Roth IRA. Graduating medical residency and taking an IC job where yearly income will be ~$450,000. Wife is W2 making ~$80,000/yr with ~$50,000 in Roth/traditional IRA.

This will be my main source of income, and I'll have no employees. I'll only work this job for probably the next two years or so, and I was wondering if the increased paperwork of the SEP-IRA will be worth the supposed tax savings. I won't be able to max out this year, but definitely will for tax year 2019 and moving forward. I was reading you can contribute $16,000 in Roth contributions, but I thought the max contribution was $5500?

Happy to answer any clarifying questions, but was wondering had any idea which tax plan would be best if I'm looking at just long-term tax savings.

Thanks!

PFInterest
Posts: 1371
Joined: Sun Jan 08, 2017 12:25 pm

Re: Solo 401k vs. SEP-IRA

Post by PFInterest » Sat Apr 28, 2018 4:52 pm

Solo 401k. Otherwise no backdoor rIRA.

gclancer
Posts: 473
Joined: Sat Apr 27, 2013 10:34 am

Re: Solo 401k vs. SEP-IRA

Post by gclancer » Sat Apr 28, 2018 5:04 pm

PFInterest wrote:
Sat Apr 28, 2018 4:52 pm
Solo 401k. Otherwise no backdoor rIRA.
+1 Solo 401(k) is a no-brainer for you. Check that off the list and on to the next.

NoshBader
Posts: 3
Joined: Tue Feb 13, 2018 9:48 am

Re: Solo 401k vs. SEP-IRA

Post by NoshBader » Sat Apr 28, 2018 6:00 pm

Thank you!

Spirit Rider
Posts: 7973
Joined: Fri Mar 02, 2007 2:39 pm

Re: Solo 401k vs. SEP-IRA

Post by Spirit Rider » Sat Apr 28, 2018 7:00 pm

You are going to have ~= $450K in 1099 income and you can't max out all retirement plan contributions. There is something wrong there. After residency a physician should continue to live like a resident, max out their retirement plan contributions and use all available funds to pay off loans aggressively.

Only then should you engage in lifestyle creep. Even then you should probably continue to live live modestly until you can make a substantial down payment on a house. Even though it might seem like you have denied yourselves so much for so long. A little delayed gratification will go a long way towards future financial security.

As others have said, you should adopt a one-participant 401k and make the maximum contributions possible. This would be an employee elective deferral of $18.5K and an employer contribution of 20% of net self-employment earnings (business profit - 1/2 SE tax) or more likely given the high business profit, 25% of an S-Corp's W-2 wages. In both cases up to $36.5K ($55K - $18.5K). Some of this could be limited if you have already made employee elective contributions for the year during residency and/or contributed to a 403b.

Then as has been said, you should do a $5500 Backdoor Roth, rolling any pre-tax balances in any traditional, SEP and SIMPLE IRA accounts. Your wife should be maxing any employee elective deferrals at her W-2 employer if possible. If she has a 401k, 403b or 457b at work that accepts rollover contributions, she should rollover any pre-tax balances in any traditional, SEP and SIMPLE IRA accounts to that plan.

You should find a way to employ your wife in your business. If she doesn't have a plan that accepts rollover contributions, she can instead rollover to the one-participant 401k if you hire her. This will allow her to do a $5500 Backdoor Roth. If she doesn't have a plan where she can make $18.5K in employee elective contributions and it can be justified paying her about $25K for administrative, marketing, etc... in your business. She could make $18.5K in employee elective contributions to the one-participant 401k and receive $6.25K in employer contributions.'

If you can't find a way to make significant pre-tax retirement plan contributions. You are going to get killed with taxes. Physicians get a late start with investing although you look like you married a smart spouse with her IRA balance. If you think I am going overboard with the retirement plan contributions. Consider this, with a late start and the fact you will get a very small percentage of your retirement income from SS (< 10%), You need to start retirement savings of a minimum of 20% of your gross income after residency. With $500/year in gross income that is $100K/year in retirement savings. Now you can start and work your way up, but you should really start by maximizing your pre-tax employer retirement accounts. At you marginal tax rates the government(s) are going to give a big helping hand.

At this level of income, you really should consider engaging some professionals. A Lawyer and CPA who can help you navigate the choices of business entity and tax planning. Be careful of anyone who tries to steer you to expensive insurance and/or investment options. You definitely need term (not whole, fixed index, etc...), just plain term life insurance. Just as importantly you need own occupation disability insurance.

I strongly suggest you go to WhiteCoatInvestor.com A web site by doctors for doctors. They have some of the best vetted professionals I have seen. They simply do not tolerate people taking advantage of physicians. Which as a group a very often exploited by professionals looking to get rich off of them instead of helping them get rich. If you have already made some mistakes along the way. Don't worry many of the have also been there. Start off by posting an introductory question in the forums.

I have no vested interest in the site, but have been greatly impressed with what WCI has accomplished and continues to provide for the White Coat community.

Lafder
Posts: 3718
Joined: Sat Aug 03, 2013 7:56 pm
Location: East of the Rio Grande

Re: Solo 401k vs. SEP-IRA

Post by Lafder » Sun Apr 29, 2018 10:35 am

solo401k is a little more paperwork to set up. But it allows more money to be put away pretax for the same income since you get to contribute as employer and employee. The max contribution is the same for a solo401k or SEP IRA so at your income level you may be able to max either.

However, as mentioned, you have an opportunity to do back door Roths for you and your spouse. But you can not do so easily if you have a SEP IRA due to the pro rata rules.

Fidelity allows you to roll any existing IRAs or rollover IRAs into them, in case you happen to have any. They need to be moved for the back door Roths. This is an example of Vanguard not being best as they do not allow you to roll in other retirement accounts. Also, Fidelity has lower expense funds for their solo401k than Vanguard does.

So all things considered, indeed a solo401k has advantages over a SEP IRA in most cases, including yours.

lafder

NoshBader
Posts: 3
Joined: Tue Feb 13, 2018 9:48 am

Re: Solo 401k vs. SEP-IRA

Post by NoshBader » Sun Apr 29, 2018 12:42 pm

Spirit Rider wrote:
Sat Apr 28, 2018 7:00 pm
You are going to have ~= $450K in 1099 income and you can't max out all retirement plan contributions. There is something wrong there. After residency a physician should continue to live like a resident, max out their retirement plan contributions and use all available funds to pay off loans aggressively.
I really appreciate your thoughts and comments. It's a complex world I've only gotten into in the past couple years.

Debt is a very scary thing for my wife (I believe irrationally, but that's another topic) so as a compromise for letting me control most of the finances I agreed to focus most aggressively on the ~$300,000 loans when I graduate. The $450,000 is pre-tax so if I can max out retirement and knock my loans in half or so before the years end I'm all in. I'm just not sure it's reasonable. Debt should be gone and retirement maxed out though for FY2019.

I like your suggestion about the tax attorney or CPA because as much as I try to educate myself (and I do use WCI) some of the plans and strategies you were throwing out are a bit above my head currently. I will look into that.

Spirit Rider
Posts: 7973
Joined: Fri Mar 02, 2007 2:39 pm

Re: Solo 401k vs. SEP-IRA

Post by Spirit Rider » Sun Apr 29, 2018 2:42 pm

NoshBader wrote:
Sun Apr 29, 2018 12:42 pm
Spirit Rider wrote:
Sat Apr 28, 2018 7:00 pm
You are going to have ~= $450K in 1099 income and you can't max out all retirement plan contributions. There is something wrong there. After residency a physician should continue to live like a resident, max out their retirement plan contributions and use all available funds to pay off loans aggressively.
I really appreciate your thoughts and comments. It's a complex world I've only gotten into in the past couple years.

Debt is a very scary thing for my wife (I believe irrationally, but that's another topic) so as a compromise for letting me control most of the finances I agreed to focus most aggressively on the ~$300,000 loans when I graduate. The $450,000 is pre-tax so if I can max out retirement and knock my loans in half or so before the years end I'm all in. I'm just not sure it's reasonable. Debt should be gone and retirement maxed out though for FY2019.

I like your suggestion about the tax attorney or CPA because as much as I try to educate myself (and I do use WCI) some of the plans and strategies you were throwing out are a bit above my head currently. I will look into tmn hat.
One point you might try to raise with your wife. Most if not all of any pre-tax retirement contributions would be at a marginal federal income tax rate of 35%. Throw in some state taxes and each $1 of pre-tax contributions probably only costs you a net of $0.60. Each year's available contribution space is use it or lose it.

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