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March 17, 2011

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The idea for the SEP IRA is a good one since that allows you to contribute up to $49,000 into it. However, as a sole proprietor, you can only contribute up to 20% of your net adjusted self employment income (or net adjusted business profits) although contributions are typically 100% tax deductible. So even though you make $5K or so each year you can only contribute about $1K. I don't know what the nuances are for the combination of the 401K that you contribute to in your job and having a SEP IRA. Good luck.

I am not an expert in the rules for retirement accounts and others can better answer those questions. My one thought: If you want to retire "early", you wont be able to access the funds behind the retirement wall. It might make sense to keep the funds accessible. I know someone who is in this bind- a few million in retirement accounts, wants to retire, but wont because they dont have enough to get them to the age where those accounts are accessible.

@ Sandy - Is the 20% limitation because of the sole proprietor status?

My understanding was that with a solo 401(k) or solo Roth 401(k), one can put 100% of the first $16,500 in income from the business into the plan, plus 20% of net profit, up to a max out at $49,000.

Is that for another scenario that's different than a sole proprietor?

@Tyler,

Most people believe as you have stated that you cannot access retirement funds until 59.5 years of age without triggering the 10% early withdrawal penalty. However if you set up a proper SEPP (Substantially equal periodic payments) plan at the time of early withdrawal, you can get access to those funds at any age with no penalty. Very few people are aware of this and if this is holding your friend back he should definitely be looking into this. If he has a few million in retirement accounts it is unfortunate that he does not have anyone in the know who could have made him aware of this option.

See here for some basic details:

http://www.bogleheads.org/wiki/SEPP:Substantially_Equal_Periodic_Payments

I'd like to echo what Tyler said. I have a good amount in retirement funds and am now focusing on savings outside (not neglecting 401k contributions, of course) in case I want to retire early.

That said, I'll check into Apex's comment. Might be a good way of dealing with "too much saved in retirement funds."

What Apex said. The SEPP option (also referred to as the 72(t) option) allows you to withdraw funds from your IRA before reaching 59 1/2 without penalty. Have your friend check out early retirement websites and forums (like www.early-retirement.org) to get more information. There are plenty of people who have gone this route.

He's talking about a solo 401k, not a SEP IRA. Sandy is talking about a SEP IRA. Solo 401k and SEP IRA are different.

As far as I can gather what hes trying to do should work fine with a Solo 401k. He should be eligible as long as he has self employment income. The 1099 counts as self employment income and you can only put that 1099 money into the solo 401k.

Whether you want to do regular solo 401k or a Roth solo 401k depends more on your total income level, tax bracket and expected income / tax bracket in retirement.

Congrats on taking the initiative to find creative vehicles for retirement savings. You've inspired me to think about if I can make money from my own blog (which right now is mostly just an online money journal), in order to be able to contribute to a previous SEP IRA that I have. Lots more deductions available to those with 1099 income as well, I believe.

Apex- Thank you for the information. I will check it out.

Apex - thanks for the info on the SEPP. The link says it is for Traditional IRA's. Anyone know if it is available for Roth IRA's?

Jim is correct on the Solo 401K. Forgot about that one. You can put 100% of the first $16.5K from the business (more if older than 50), PLUS plus 20% of net profit, to a max of 49K (more if over 50) in a Solo 401K. This looks like the best route for this reader. There is also a Solo Roth too.

Yes, CoolMouseLuke, it is available for Roth IRAs.

And I agree with the others - solo 401(k) should work for what he wants to do. And yes, only income from self-employment would qualify for the contributions. Perhaps he could talk to his current employer about doing part of his compensation as a consultant (up to the 401(k) limit) and the rest as an employee...worth asking about.

@CoolRodent ;)

Yes it's available for the Roth. However the 5 year holding period rules of the Roth still apply and the SEPP rules will not over-ride them. The 5 year holding period applies to recent conversions as well so keep that in mind. So you have to meet all other Roth rules first and then you can use the SEPP rule to get it out early.

It's not available for a 401-k but a 401-k can be rolled to an IRA so that is a bit of a moot point.

You shouldn't tie up all your money in these stupid 401Ks and IRAs. You'll be spending a lot on maintenance fees and limiting your ability to access funds. You should consider buying tax free high yield municipal bonds in lieu of questionable 401 and IRAs.

Solo 401k and the contribution limits:

For the salary deferral portion, you can contribute the regular 401(k) maximum of $16,500 (with an an additional $5,500 if over the age of 50 at year end). And, you can add up to 25% of compensation for the profit-sharing portion. The combined maximum of these contributions can’t exceed $49,000, plus catch-up additions, if applicable.

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