Hi guys,
It’s Finance Fridays, and this is kind of confusing because I promised I would talk about Backdoor Roth IRAs last week. However, on Monday I promised I would talk about SEP-IRA, SIMPLE IRA and Solo 401k. Then I said I would talk a little about Spousal IRAs in a comment to Fred.
Just to keep things in some semblance of order, I’m going to talk about SEP-IRA, SIMPLE IRA- and Solo 410k this week, so that it is in the same week as Locums, Moonlighting and the Second Job. I will then talk about Backdoor Roth IRAs next week and Spousal IRAs the following week.
Stock Photo from: Pixabay
For physicians working a second job, you should be considered self-employed. Additionally, you shouldn’t have any other employees working for you because it makes the taxes much more complex, and way outside the scope of this post. If you don’t have any employees, then things are a little easier, and the main difference is how much you can contribute.
All that said, let’s move on:
What is a SEP-IRA?
A SEP-IRA is an acronym that stands for Simplified Employee Pension. It works for similar to a traditional IRA, but the contribution limits are different:
How much can I contribute to my SEP-IRA?
The contributions you make to each employee’s SEP-IRA each year cannot exceed the lesser of:
25% of compensation, or
$54,000 for 2017 ($53,000 for 2015 and 2016 and subject to annual cost-of-living adjustments for later years).
So, to give you an idea, if you make an additional $50,000 from locums, moonlighting, or some other secondary job, you can contribute $12,500 to your SEP-IRA.
However, if you somehow had a monster income year and made an additional $250,000, you would be over the 25% cap, at $62,500 and only be able to contribute $54,000. I would imagine for most physicians, making this amount moonlighting or doing a second job would be difficult. However, for those who do locums as a primary job, then you should definitely use a SEP-IRA to try to contribute as much toward your retirement as possible.
There is one other small snag, your contributions are subject to a “net earnings from self-employment”.
“If you are self-employed, base your contribution on net profit – minus one-half of the self-employment tax – minus your SEP contribution. See IRS Publication 560 on determining the contribution amount.”
This can be complex if you have multiple employees, but since it’s just you, the long and short of that sheet is that you contribute 20% of your gross compensation (which is 25% of your net). So for the example above, if you made an additional $50,000, you can contribute $10,000. However, if you made $250,000, you would not hit the cap and could contribute $50,000. For those who are are, you would need to make a gross of $270,00 in order to put away the maximum of $54,000 for 2017.
What is a SIMPLE IRA?
SIMPLE IRA is an acronym that stands for Savings Incentive Match PLan for Employees. Once again, the contribution limits are different.
How much can I contribute to a SIMPLE IRA?
If you have a SIMPLE IRA, you can make:
An employee contribution equal to 100% of your net earnings from self-employment, up to $12,500 for 2016 ($15,500 if you are 50 or over), plus
An employer contribution equal to 3% of your net earnings from self-employment.
For SIMPLE IRA purposes, “net earnings from self-employment” is your revenues, minus your expenses, times 92.35% (to account for your deduction for one-half of your self-employment tax).
For example, let’s say you make $100,000 net, after subtracting your deduction for one half of your self-employment.
If you are under 50, you can put away $12,500 and then match yourself for an additional 3% of net which is $3,000. So you put away $15,500.
If you are over 50, you can put away $15,500, and then match yourself for an additional 3% of net which is $3,000. So you put away $18,500.
What is a Solo 401k?
A Solo 401k (aka Individual 401k) is very similar to a 401k you would have with your employer.
How much can I contribute to a solo 401k?
You are allowed to make:
An employee contribution of $18,000 for 2016 ($24,000 if you are 50 or over), plus
An employer contribution of 20% x (your business’s profit, minus the deduction for one-half of your self-employment tax).
For example, let’s say you make $100,000 net, after subtracting your deduction for one half of your self-employment.
If you are under 50, you can put away $18,000 and then match yourself for an additional 20% of net which is $20,000. So you put away $42,500.
If you are over 50, you can put away $18,000, and then match yourself for an additional 20% of net which is $20,000. So you put away $45,500.
Overall, a Solo 401k is this is the best overall option to maximize your retirement income.
However, it’s not as easy to set up as a SEP-IRA, which may deter some.
So a solo 401k is the best… but wait, don’t I already have a 401k through my primary job?
Yes, you probably do. However, you can have multiple 401ks as long as the employers are different and separate.
However, you need to understand that your employee contribution limit is still capped at $18k for the year.
What does this mean?
You need to spread your $18k over the two different 401ks in order to maximize your employer match, and maximize your retirement contribution.
“Normal Example”
You make $200k as an employed physician, you put away your $18k and your employer matches 100%. So $18k and $18k for $36k.
“A Common Multiple 401k Example”
You make $200k as an employed physician, but then you make an additional $50k (net) doing moonlighting.
Your moonlighting money has access to your Solo 401k. So now where should you put the money to maximize it?
In this situation, you still put $18k into your primary job, which is matched for $18k, for the $36k.
Then in your solo 401k, you contribute nothing, but your employer (you) contributes 20% of your net, which is an additional $10,000.
So, overall you were able to put away an additional $10,000, for a total of $46k.
“Another Common Multiple 401k Example”
You make $200k as an employed physician, but then you make an additional $50k (net) doing moonlighting.
Your primary employer makes an employer contribution of $20k – NOT MATCHED. (lucky you!)
Then in your solo 401k, if you contribute nothing, but your employer (you) contributes 20% of your net, which is an additional $10,000.
In this situation, you can make your own choice, contribute your $18k to your employer or to your own solo 401k?
Most likely, since you created your own 401k, you have set it up to have the funds you like… and in general, many employer plan options are not optimal. For this reason, you would most likely make the contribution to your Solo 401k choosing the funds you like. So then $20k + $18k + $10k = total of $48k
On the flip side, if your primary employer gives a contribution of $20k and also does a 100% match, then in that situation you would contribute to their 401k.
$18k + $18k match + $20k contribution = $56k + additional $10k from Solo 401k = $66k
but wait….did you catch the error?
Wait a second… you can’t contribute > $53k to one 401k plan!
You’re right! You can’t, most likely if you tried, your employer would just prevent it from happening. However, if they didn’t, you would have a tax headache when you do your taxes.
The cap for 2016 for a 401k is $53k. So, in order to really optimize things you would:
You make $200k as an employed physician, but then you make an additional $50k (net) doing moonlighting.
Contribute $16.5k to your primary employer, get a $20k contribution and $16.5k match… for a total of $53k (maximum) through that 401k.
Then you contribute $4500 to your Solo 401k, and get your additional $10k match.
$53k (primary employer) + $1.5k & $10k (solo 401k) = total of $64.5k
Wait a second, $64.5k in 401ks? That’s over the the limit!
Yup. It’s over the 401k limit. However, because you have two different employers, it’s not over the individual limit of $18k.
However, please pay attention. This is related to multiple 401ks ONLY. For tax purposes, if your primary job uses a 403b, then there are limitations in place (separate from 401ks) then prevent you from putting away more money into a Solo 401k. For some reason, 403b considers you as an employer/employee which messes with the ability to have “multiple employers”.
So having a 403b basically restricts you to the $53k rule across your 403b + Solo 401k.
TL;DR
In general, a Solo 401k > SEP-IRA or SIMPLE IRA.
However, it’s not as easy to set up as a SEP-IRA, which may deter some.
You can have multiple 401ks, but your employee contribution (across all accounts) is still $18k, see examples.
Having multiple 401ks can help you get above the normal $53k cap.
However, a 401k is not a 403b. Having a 403b essentially restricts you to this cap.
-Sensei
Agree? Disagree? Questions, Comments and Suggestions are welcome.
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