New Sole Proprietorship Retirement Questions

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nukewerker
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New Sole Proprietorship Retirement Questions

Post by nukewerker » Sat Jul 12, 2014 5:03 pm

I just started a new business this year and due to the nature of the profession am required to be a PLLC. Since I have no employees, the tax status is a sole proprietor pass through.

I am just now starting to make some money with the company (started in April). I have roughly 25k in business checking. I have yet to pay myself anything and have been living off of savings (have about 10k left). Monthly expenses are about $3500 on the personal side and $500 or so on the business side.

I have yet to set anything up for retirement. After reviewing solo 401k and SEP ira I am leaning towards the S401k. I think its getting close to time to pay myself a distribution from the company and as a result I would like to set aside a portion for retirement everytime I make a distribution.

With the 401k I see I can contribute up to 52k/yr through a combination of employee/employer contributions. I am set to receive a small inheritance of about 40k that is not taxed. I expect the business to make at worst 60k although the past month I have made several multiples of that converted annually. But there is a realistic chance that if I fund expenses only through the business I won't be able to take full advantage of the 52k contribution space.

Should I use the inheritance to fund living expenses and use business profits to fund retirement so that at the end of the year I am at or close to the 52k limit?

Also any advice on SEP vs. S401k?

assumer
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Re: New Sole Proprietorship Retirement Questions

Post by assumer » Sat Jul 12, 2014 5:23 pm

I'm not quite that experienced at this yet, but I just started an LLC this year as well.

A few points:
  1. If you're sure you aren't going to do an s-corp election (I'm definitely not going to do the election), then feel free to take money out of your business checking anytime you want throughout the year.
  2. I chose a solo 401k through eTrade, investing in vanguard funds. Vanguard is cheaper to do this, but etrade allows self loans.
  3. The amount you can contribute to the various qualified retirement plans can be calculated here.
  4. It doesn't matter how much you take from the business checking to your personal. The retirement contribution limits are the same since you're paying taxes on all your revenue this year whether or not you keep it in your business checking.

Lafder
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Re: New Sole Proprietorship Retirement Questions

Post by Lafder » Sat Jul 12, 2014 5:37 pm

The maximum 401k or SEP contribution is also maxed at a percent of your adjusted income. So it may not be the full 52k.

Personally I have a SEP since the maximum allowable is higher. Though I have not made enough/year to hit the max yet.

The SEP is very easy to start and maintain.

lafder

assumer
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Re: New Sole Proprietorship Retirement Questions

Post by assumer » Sat Jul 12, 2014 5:43 pm

Lafder wrote:The maximum 401k or SEP contribution is also maxed at a percent of your adjusted income. So it may not be the full 52k.

Personally I have a SEP since the maximum allowable is higher. Though I have not made enough/year to hit the max yet.

The SEP is very easy to start and maintain.

lafder
Based on the link I gave, could you let me know some values where the SEP contribution limit is higher than a solo 401k? For almost all the numbers i've tried I haven't seen a SEP IRA give a higher result than the solo 401k. (I tried 40k, 100k, 200k).

They are equal once you type in 300k but the sep ira never seems to be higher.

DSInvestor
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Re: New Sole Proprietorship Retirement Questions

Post by DSInvestor » Sat Jul 12, 2014 6:33 pm

Lafder wrote:The maximum 401k or SEP contribution is also maxed at a percent of your adjusted income. So it may not be the full 52k.

Personally I have a SEP since the maximum allowable is higher. Though I have not made enough/year to hit the max yet.

The SEP is very easy to start and maintain.

lafder
IMO, SEP-IRA never has a higher allowable max than Solo 401k. Solo 401k's employer profit share max is calculated the same way as SEP-IRA max and then Solo 401k has the employee salary deferral contribution which is 17.5K or 23K if age 50+. Solo 401k requires much less income to hit the 52K max due to the employee salary deferral contribution.
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pteam
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Re: New Sole Proprietorship Retirement Questions

Post by pteam » Sat Jul 12, 2014 11:46 pm


nukewerker
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Re: New Sole Proprietorship Retirement Questions

Post by nukewerker » Sun Jul 13, 2014 7:28 am

OK thanks, Some good info here.

After reading everything I guess it does make sense that everything after the 17.5k will not be tax advantaged space? Since I already will pay 33% or so on profit? But the 17.5k is either pretax or roth eligible right? Also I worked at a company earning wages for the first 3 months of the year. Since my pay was over $5500, I assume I can contribute to a roth IRA as well?

nukewerker
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Re: New Sole Proprietorship Retirement Questions

Post by nukewerker » Sun Jul 13, 2014 7:47 am

I got this from Fidelity's site. Seems too good to be true. But as I read it with the 401k you can deduct the 17.5k and the 20-25% of profit from your taxable amount. If so this clearly seems to be the way to go for small business owners who are self employed. I don't see where it says SP though so maybe this is for a S-corp

"A Self-Employed 401(k) may substantially reduce your current income taxes because generally, you can deduct the entire amount of your plan contributions from your taxable income each year.

If your business is unincorporated, you can deduct contributions for yourself from your personal income.
If your business is incorporated, you can generally deduct contributions as a business expense.

No Plan Self-Employed 401(k)
Net Business Profits $100,000 $100,000
Less Deduction for ½ Self-Employment Tax -7,065 -7,065
Less Max. Contribution (25% of earned income) -0 -18,587
Less Salary Deferral -0 -17,000
= Taxable Income = $92,935 = $57,348
Taxes Due $19,937 $11,256
Taxes Saved $0 $8,681

How a Self-Employed 401(k) contribution can add up

As you can see from the example below, for 2012 a self-employed business owner who is age 50 with $100,000 in compensation may save up to $20,500 more with a Self-Employed 401(k) than with a SEP-IRA or Profit Sharing Plan.
2012 Example No Plan Self-Employed 401(k)
Employer's Tax Deductible Contribution Up to 25% of compensation (not to exceed $50,000) $18,587 $18,587
(25% x $74,348)
Employee's Deferral Option (not to exceed $17,000) Not applicable $17,000
Employee's Catch-Up Deferral Option if age 50 or older (not to exceed $5,500) Not applicable $5,500
Final Total Contribution $18,587 $41,087

assumer
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Re: New Sole Proprietorship Retirement Questions

Post by assumer » Sun Jul 13, 2014 10:29 am

nukewerker wrote:I got this from Fidelity's site. Seems too good to be true. But as I read it with the 401k you can deduct the 17.5k and the 20-25% of profit from your taxable amount. If so this clearly seems to be the way to go for small business owners who are self employed. I don't see where it says SP though so maybe this is for a S-corp
It's not too good to be true! It's an available tax shelter of up to $52k/year that only self employed individuals get to take advantage of. On the downside self employed individuals pay more social security and medicare tax ("Self Employment Tax"), but if you take full advantage of the solo 401k you will likely come out ahead over someone not self employed.

Oh and as an aside, after $117k of salary (well, net profits), the self employment tax is only 2.9%.

sologuy
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Re: New Sole Proprietorship Retirement Questions

Post by sologuy » Sun Jul 13, 2014 10:57 am

What if the total income from the self employment is insufficient to reach the $17,500 individual max and/or you wish to contribute less than that?

For example, for $5k of income

gross income: 5,000
adjusted income: $4,646 (gross - 1/2 SE tax, per fidelity calculator)
s401k contribution $4,646
profit sharing $930

Since there is only $5k of income, is the max contribution between employer and profit sharing
$4,646 + $930 = $5,576 (business would be net negative)
$4,070 + $930 =$5,000
$3,716 + $930 = $4,646 which would occupy $3,716 of the $17,500 allowed for all personal contributions to retirement accounts, leaving $13,784 available to put into a 401k or SIMPLE IRA (max 12k) at another job?

*edited for math*
Last edited by sologuy on Sun Jul 13, 2014 7:32 pm, edited 1 time in total.

Lafder
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Re: New Sole Proprietorship Retirement Questions

Post by Lafder » Sun Jul 13, 2014 11:14 am

I stand corrected. But, now I wonder why my accountant recommended a SEP and never mentioned a solo 401k for me.

The max SEP contribution is 25% of adjusted income up to 52,0000$ for 2014

Here is the reference http://www.irs.gov/Retirement-Plans/Pla ... d-SARSEPs)

And the max solo 401k is $17,500 employee contribution, PLUS 25% of income contribution from employer, up to 52,000$ for 2014. So potentially a higher max with lower income.

Here is the reference http://www.irs.gov/Retirement-Plans/One ... 1(k)-Plans

Note that once solo 401k assets pass 250k you have to file a form "A one-participant 401(k) plan is generally required to file an annual report on Form 5500-SF if it has $250,000 or more in assets at the end of the year. A one-participant plan with fewer assets may be exempt from the annual filing requirement."

Both change if you ever have employees.

Here is more info on comparing the two:
http://www.getrichslowly.org/blog/2013/ ... oyed-401k/
https://www.fidelity.com/retirement-ira ... pare-plans

Why would my accountant have recommended the SEP? I will ask her. I was incorrect and thought the solo 401k max was $17500. Just when I think I have things figured out, I figure out I am wrong.

lafder

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

Re: New Sole Proprietorship Retirement Questions

Post by Spirit Rider » Sun Jul 13, 2014 5:17 pm

Lafder wrote:I stand corrected. But, now I wonder why my accountant recommended a SEP and never mentioned a solo
401k for me.

...

Why would my accountant have recommended the SEP? I will ask her. I was incorrect and thought the solo 401k max was $17500. Just when I think I have things figured out, I figure out I am wrong.

lafder
Unfortunately, a significant percentage of accountants are woefully ignorant when it comes to retirement plan issues. She is not the first nor will she be the last accountant to give bad advice on these issues.

Spirit Rider
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Re: New Sole Proprietorship Retirement Questions

Post by Spirit Rider » Sun Jul 13, 2014 5:46 pm

sologuy wrote:What if the total income from the self employment is insufficient to reach the $17,500 individual max and/or you wish to contribute less than that?

For example, for $5k of income

gross income: 5,000
adjusted income: $4,646 (gross - 1/2 SE tax, per fidelity calculator)
s401k contribution $4,646
profit sharing $930

Since there is only $5k of income, is the max contribution between employer and profit sharing
$4,646 + $930 = $5,576 (business would be net negative)
$4,070 + $930 =$5,000
$3,743 + $930 = $4,646 which would occupy $3,743 of the $17,500 allowed for all personal contributions to retirement accounts, leaving $13,757 available to put into a 401k or SIMPLE IRA (max 12k) at another job?
The max deductible 401k contribution (both employee deferral and employer profit sharing) is 100% of self - employment income (net profit - 1/2 SE tax).

So if you wish to max out the profit sharing of $930, your deductible deferral would be $4646 - $930 = $3716 traditional 401k contribution.

However, according to Alan S. if you chose to make a Roth deferral, then you could make both a Roth 401k $4646 employee deferral and a $930 employer profit sharing (always pre-tax) contribution.

ERISA Stone
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Re: New Sole Proprietorship Retirement Questions

Post by ERISA Stone » Sun Jul 13, 2014 9:10 pm

Spirit Rider wrote:
sologuy wrote:What if the total income from the self employment is insufficient to reach the $17,500 individual max and/or you wish to contribute less than that?

For example, for $5k of income

gross income: 5,000
adjusted income: $4,646 (gross - 1/2 SE tax, per fidelity calculator)
s401k contribution $4,646
profit sharing $930

Since there is only $5k of income, is the max contribution between employer and profit sharing
$4,646 + $930 = $5,576 (business would be net negative)
$4,070 + $930 =$5,000
$3,743 + $930 = $4,646 which would occupy $3,743 of the $17,500 allowed for all personal contributions to retirement accounts, leaving $13,757 available to put into a 401k or SIMPLE IRA (max 12k) at another job?
The max deductible 401k contribution (both employee deferral and employer profit sharing) is 100% of self - employment income (net profit - 1/2 SE tax).

So if you wish to max out the profit sharing of $930, your deductible deferral would be $4646 - $930 = $3716 traditional 401k contribution.

However, according to Alan S. if you chose to make a Roth deferral, then you could make both a Roth 401k $4646 employee deferral and a $930 employer profit sharing (always pre-tax) contribution.
Do you have the math on this? The 415 maximum annual addition amount is limited to 100% of eligible compensation up to $52k. This limit includes 401(k), Roth, and profit sharing amounts. $5576 ($4646+$930) exceeds this limit. It is irrelevant if the employee (EE) contribution is a pre-tax or Roth. They count against all limits just the same. I'm not an accountant but my understanding is the 401k contribution (pre-tax or Roth) are both reported on the personal side so they would not affect the business schedule.

I am speculating obviously about your accountant but 401(k) plans are qualified retirement plans and they have a ton of special requirements that you don't have to worry about when you have a SEP. When you are a solo(k), there is much less to worry about but there are still requirements, such as the 5500 when you have assets over $250k. Also, there are some timing limits for 401(k) contributions that cause employers a lot of problems. However, they are much less restrictive for sole proprietors. For someone that doesn't yet understand the mechanics of a qualified retirement plan, I can understand why a 401(k) wouldn't be recommended.

If you start a 401(k) plan, the limits you need to be aware of are:
  • 415 Maximum Annual Additions Limit: maximum amount you can put in total contributions for they plan year (excluding rollover contribution amounts): 100% of compensation up to 52K. This can be made up of any combination of EE or ER funds. There is also a limit below (404) that further limits ER contributions.
    402(g) Limit: maximum 401(k) or Roth Contribution Total Amount: 100% of compensation up to $17,500
    404 maximum deductible contribution limit: ER contributions (profit sharing/match) are limited to 25% of eligible compensation. Note that it would be 20% of earned income because the contribution would actually reduce your earned income amount.
    Catch-up Contribution: $5500 - if you have met the 402(g) limit above, you can contribute an additional amount if you are at least age 50. This does not count against any of the limits above.

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