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My Experience with Vanguard’s Individual 401k

by retirebyforty on January 15, 2014 · 42 comments

in investing, retirement

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This article is for the people who are thinking about self employment or are wondering about the retirement saving options for the self employed. The first part is about how much you can save and the second is about my experience with Vanguard.

Individual 401k – a great option for soloprenuers

2013 was the first full year that I was self employed and I did well enough to continue saving for full retirement. Before I left my corporate job, I calculated that we would need about $500/month from my online business to make ends meet without dipping into saving. If I make anything more than that, I can contribute a tax advantaged retirement account to reduce our tax liability. Taxes take such a big bite out of your income and you should try to reduce your tax as much as possible.

Here are the main options for the self employed.

  • SEP IRA. The employer (self) can contribute up to 25% of your income to this account.  The cap was $51,000 in 2013 and $52,000 for 2014.
  • SIMPLE IRA. The employee (self) can contribute up to $12,000 in 2013. The employer (self) can match up to 3% of the employee’s compensation.
  • Individual 401k aka solo 401k. This one is only for solopreneurs with no employee (or just the spouse.) The employee (self) can contribute up to $17,500, the standard 401(k) limit. In addition, the employer (self) can contribute up to 25% of the earned income. The total limit is $51,000 in 2013 and $52,000 in 2014. You can add another $5,500 if you’re at least 50.

In 2013, I made about $33,000 and I’m keen to avoid tax as much as possible. If we can reduce our tax liability enough, we can get into the 15% tax bracket and won’t have to pay tax on our dividend income. I plugged $33,000 into the calculator at solo401kcalculator.com and here is the result. The individual 401k enabled me to save more than the other accounts so I went with that.

vanguard individual 401k i401k solo 401k self employed

At first, this seems a little off to me. For the individual 401k, I thought I should be able to contribute $17,500 plus 25% of $33,000. Well, I should have known it wouldn’t be that simple when it comes to the IRS. Here is what I got from irs.gov.

When figuring the contribution, compensation is your “earned income,” which is defined as net earnings from self-employment after deducting both:

  • one-half of your self-employment tax, and
  • contributions for yourself.

You need to sit down with one of those crazy 21-step worksheets to figure out your maximum contribution.

Anyway, I already plugged my number into TurboTax and the result is the same. So for 2013, I will contribute $17,500 + $6,000 to make it $23,500. BTW, if you are self employed and have some contractors working for you, then you need to do part of your taxes in early January because you need to send out the 1099-MISC. Yes, it’s tax time already. Yuck!

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Vanguard i401k

I decided to go with Vanguard for my individual 401k. Vanguard is a great company and I like their index investing approach for my 401k.

I called Vanguard and set up an appointment with the small business service division. Later on, I talked to Vanguard’s representative for about 30 minutes. He went over what Vanguard is all about and their investing philosophy. They wanted to make sure we are the right fit for each other. For my i401k account, I will be buying and holding index funds, so it’s a good fit. If you trade often, then Vanguard probably isn’t the right choice for you.

Here are some details.

  • Cost – $20 per year for each Vanguard fund held in the i401k account.
  • Investment choices – More than 100 Vanguard mutual funds. I found out later that I couldn’t invest in Admiral Shares in the i401k account. Admiral Shares have lower expense ratio than the investor shares so they are less costly.
  • Roth option – Vanguard is one of the few companies to offer Roth 401k.
  • No Loan – You can’t borrow from your i401k account at Vanguard. This isn’t a big deal to me because I don’t plan to do this anyway.
  • Fee waiver – If you have more than $50,000 with Vanguard, then they will waive the $20/year fee.
  • IRS – You will have to file form 5500 with the IRS if the i401k plan asset is over $250,000. See the IRS’ instruction for form 5500.

The representative told me that this account probably isn’t the right place to build a complete portfolio because of the per fund fee. I agree and targeted only one midcap index fund in this i401k account. I didn’t have much midcap investment in my other accounts so this would be a good place for it. I use Personal Capital to keep track of our asset allocation and I added the new Vanguard account there. It’s quite helpful to see all your asset classes mapped out.

vanguard i401k asset allocation midcap

I like Vanguard’s customer service and would recommend them. There was a little problem with the account application paperwork and they helped me straighten out everything. I also feel like I could call them anytime. They are friendly and not intimidating or pushy.

All in all, I’m satisfied with Vanguard. The only problem I have is the inability to invest in their Admiral Shares. I wasn’t sure how much I could contribute in 2013 so I waited until November to open an account and contributed $17,500 in one shot. Normally, you need the minimum of $10,000 to start investing in Admiral Shares. I met that minimal qualification so I thought I should be able to invest in the Admiral Shares. For some reason, they won’t let you invest in Admiral Shares in the i401k account. That’s a bit baffling to me.

For 2014, I will contribute $1,450/month so I can take advantage of dollar cost averaging. The good thing about Vanguard is you won’t have to pay a transaction fee each time you invest. At Firstrade, I have to pay $10 for each trade. At Etrade, it is $20 each.  I know, I have accounts in too many brokerages. I’ll consolidate them one of these days. If we have extra money at the end of the year, then I’ll add the employer contribution again.

Let me know if you have any questions and I will try to answer them. As for the 401k from my previous employer, I rolled it over to an IRA and that worked out very well last year.

Are you self employed? If so, are you saving for retirement? I know it can be difficult to save when you’re struggling day to day, but you need to plan for the future as well.

Disclaimer: I’m not a financial adviser and the information here might not be 100% accurate. You need to do your own research before investing.

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{ 42 comments… read them below or add one }

theFIREstarter January 15, 2014 at 2:17 am

Interesting stuff as always. I’ll have to see if we have a similar option in the UK for when my self employed income is more than a few pennies a month :)

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Dividend Growth Investor January 15, 2014 at 6:38 am

Thanks for writing this article. I set-up a SEP IRA last year, since I already have a 401 (k) plan at work.

I was wondering however, do you have to pay $20/year per fund with Vanguard if your total assets exceed $50K, or was the $20/year a mere annual administrative charge? Are there any other charges with Vanguard?

I was also wondering what are the reporting requirements for individual 401 (k) plans? At what stage do you need to submit form 5500 annually? Is there any other paperwork one needs to be aware of?

And last but not least, did you research other solo 401 (k) providers, before you selected Vanguard? What were your criteria for provider selection?

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retirebyforty January 15, 2014 at 9:29 am

From what I understand, the $20/year per fund fee is waived if you have more than $50K invested. That’s the only fee other than the regular expense ratio.

I did a little research and I don’t need to file the 5500 form until the plan’s value is over $250,000. I will update the article.

I only checked with Etrade. From my conversation, it’s just like a regular IRA and you pay the same fee. For this account, I wanted to invest in Vanguard funds so that was the main reason I went with Vanguard. I also looked at Fidelity briefly and they were my 2nd choice.

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Maverick January 15, 2014 at 4:32 am

I’ve got to get a website started…and bring in a solo income first to make this work. :)

As a Vanguard Voyager customer, I agree they are a great low cost fund provider. I’ve been with them for over two decades now. Founder John Bogle spoke at my graduation.

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Financial Samurai January 15, 2014 at 6:29 am

I’m digging the solo 401(k)!

Just thought of something though. If you only make $33,000 a year, would it not be better to pay taxes on that income as you can hopefully assume that your net worth/withdrawals will be greater than $33,000 a year at 59.5?

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Dividend Growth Investor January 15, 2014 at 6:45 am

He can probably do solo Roth 401K, but he probably doesn’t want to pay taxes today. My taxes for example are so high, I can live on that amount actually ( Fed, State, Local, FICA)

If he pays taxes today, and invests in a regular account, he would pay taxes for 20 – 30 years on cap gains and dividends. And in retirement also.

But with a regular 401K, his money compounds tax deferred until he has to make distributions at age 70.5 years. Plus he can put the tax savings to work in taxable investment accounts. Then he would have to pay ordinary income taxes on withdrawals (RMD).

It is a trade-off of whether you pay taxes today, or you pay them in the future. I

If at some point his taxable income is low, he can roll over portions of the 401K into a Roth and pay lower or no taxes.

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retirebyforty January 15, 2014 at 9:36 am

Thanks for answering. Yes, Mrs. RB40 is still working. When she quit work, we’ll have the opportunity to rollover some of the retirement account to Roth IRA.
We also want to be in the low tax bracket for dividend income and possible rental sales. I need to talk to a tax account about the rentals…

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Financial Samurai January 16, 2014 at 1:17 pm

Cool. I forgot about Mrs. RB40. Makes sense.

I have a feeling you’re going to make much more this year than last year!

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retirebyforty January 17, 2014 at 7:02 am

I hope so, but I’m not sure how much more I can make. I’m aiming for a 30% raise this year.

Anon E. Mouse January 15, 2014 at 7:09 am

His spouse is still working, so their joint income is more than his $33,000. Also of course he has Oregon income tax to deal with, which is high (9% – 11%-ish).

In general, though, you’re right of course. Tax deferral may not be the best approach for someone in a low tax bracket.

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Riley King January 15, 2014 at 6:34 am

Thanks for the post! I am right in the middle of figuring this out on my taxes. I am struggling to find the answers to a couple of questions:
1. Can you contribute more than the revenue for your business in one year? e.g. Online store had gross revenue of $15K, but I want to make max contribution of $17500.
2. Since you have several different income streams, is the 25% based on the aggregate or on one business? I have a series LLC with numerous sub-companies, but no single companies is >$17500.
3. Similar to a group 401k, does a solo401k forfeit the Trad. IRA tax deduction?

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retirebyforty January 15, 2014 at 9:41 am

I’m not a tax accountant and you might have to consult a real one.
1. I don’t think you can contribute more than your income. I plugged $15,000 in the calculator and it said you can contribute about $14,000 with the i401k.
2. I don’t know. Try a tax software like Turbotax and see what it says. It makes sense if you can look at the total income from all your LLCs.
3. Yes, it’s the same $17,500 from what I understand.

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Sandy January 15, 2014 at 8:08 am

I kept calling Fidelity to set up a Solo 401K and gave up after being on hold three times for over 30 minutes each. I want to roll a 401K from my former employer into the solo 401K. I also wanted to now about fees associated with the account and any compliance reporting requirements. Do you know who files the 5500 form? Does Vanguard do that for you?

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retirebyforty January 15, 2014 at 9:42 am

You have to file it yourself if the i401k plan has over $250,000 in it. I just updated the article with this info. Thanks.

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Done by Forty January 15, 2014 at 9:16 am

Joe, I am starting a side business and didn’t know if any of these options are available to me with that income, even if I’m already maxing out a 401k through my current employer. Any possibility of double-dipping?

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retirebyforty January 15, 2014 at 9:43 am

From my research, you can contribute up to 25% of your income from your side business as employer contribution. You can’t double dip on the employee defer compensation side.

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Wilson January 15, 2014 at 10:43 am

Thanks for the article; I’ve been looking forward to this one. I had started a SEP IRA over 3 years ago and didn’t really investigate the solo 401k option. I max it out yearly and could benefit from the higher contribution limits of the solo 401k, but I’ve been depositing the excess savings into a pre-existing ROTH IRA and a taxable account. I think this year I may focus on dividend and similar stocks/ funds in the taxable account to build those up and generate the holy grail of passive income. I should have started a 401k a few years ago, I may be too late to the party as per my goals.

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retirebyforty January 15, 2014 at 4:51 pm

Good luck with the dividend stocks. I like our taxable accounts too, but I’m trying to minimize our taxable income for now.

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Sharon January 15, 2014 at 10:51 am

I rolled all of my work 401K to Vanguard and got Admiral Shares – Wellington when I took early retirement buyout. Great service, inexpensive fees, terrific Mutual Fund results. Highly recommend them.

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retirebyforty January 15, 2014 at 4:52 pm

I really like Vanguard too. They are very trustworthy and it’s a great company to work with.

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Kevin January 15, 2014 at 12:54 pm

I’ve had a Vanguard 401k for a couple years now, but you definitely did more research than I did. I didn’t realize the 25% was on earned minus contributions. I’ve just been doing a flat 25%, I wonder who polices that, lol. This also explains why I couldn’t upgrade my fund to an Admiral (> $10k) like I could in my other Vanguard accounts. I just assumed the fund didn’t have a corresponding Admiral. I like the ease of the account administration, I can transfer money into any of my accounts (Roth, Trad, 401k) at any time with no extra charge. One regret I have is I rolled my old 401k into Vanguard prior to setting up my business i401k. Vanguard doesn’t allow you to combine the accounts after the fact.

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retirebyforty January 15, 2014 at 4:55 pm

If you over contributed, you probably need to talk to a tax adviser. I don’t know how you would go about fixing that kind of issue. I’m sure the IRS would be very unhappy. You can use Turbotax or the online calculator at solo401k.com to see your limit.
Is there any disadvantage to having your old 401k in an IRA? Seems pretty similar to me.

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Kevin January 15, 2014 at 5:58 pm

I just wanted to combine those buckets of money for easier asset allocation. After using Personal Capital I wanted to adjust our allocation a little bit and wanted to simplify with one less account.

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Bryce @ Save and Conquer January 15, 2014 at 9:59 pm

I’ve never been a business owner, but I have read about the i401(k). I probably would have gone with either Fidelity or Schwab once I found out that you can only get investor shares in the Vanguard i401(k). I don’t specifically know if you can get Fido Advantage Class fund shares in their i401(k), but it would be worth checking on. If you had gone with Schwab, you could have used their Schwab index ETFs which have lower expense ratios than Vanguard for similar funds, such as Total US Market Schwab SCHB ER=0.04%, Vanguard Admiral Total US Market ER=0.05%, and Investor Class Total US Market ER=0.17%

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retirebyforty January 17, 2014 at 7:00 am

I will check with Fidelity. I think most i401k plan discourage ETFs because it’s traded like stocks.

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JJ April 11, 2014 at 8:04 pm

Hi whats difference between Solo 401K or i401k?

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retirebyforty April 12, 2014 at 9:36 pm

From what I understand, it’s just the same thing.

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[email protected] January 15, 2014 at 10:38 pm

Joe,
This is a major reason why I want to earn side income so I can use a SEP in addition to my 401K. Informative post.

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Holly@ClubThrifty January 16, 2014 at 6:58 am

I am self-employed and have a SEP IRA and Roth IRA with Vanguard. I rolled my old 401K into my SEP IRA as well.

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John S @ Frugal Rules January 16, 2014 at 8:36 am

Nice work Joe! I’m a bit surprised as well that they wouldn’t allow you in to the Admiral Shares. We were between the Solo and a SEP and decided to go the SEP route as our tax guy said it would work best for us. Last year was our first full year as well having us both being self-employed and we did put money aside each month but kept it in cash. I’m still kicking myself over that, but hindsight is 20/20. We’ve scheduled monthly contributions starting with this month so we’re good to go now moving forward.

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retirebyforty January 17, 2014 at 7:02 am

We kept cash for most of the year too. We missed out on the gain, but I don’t think it’s a huge deal. I didn’t know how much money I’d make so it was better to be more conservative.

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Jack @ Enwealthen January 18, 2014 at 6:33 am

Thanks for the detailed writeup of the process and fees with Vanguard.

I first heard of the solo 401k a few years back when I was looking at starting a consulting business. As far as I’m concerned it’s one of the primary reasons to be self-employed. Most people complain about all the extra taxes you have to pay, but being able to put $51K a year into a tax sheltered retirement account more than makes up for it.

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retirebyforty January 18, 2014 at 10:43 pm

You’d have to make around $180k to put $51k into an i401k account. That’s a great goal!

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Evan January 21, 2014 at 5:55 pm

Those are awesome options for most! I think the best thing is that you are able to use vanguard for it. I hate my 401K which fund has a fee of 1%+

There are other options under the defined benefit world (but you have to be putting in that 75K+ to make it worthwhile).

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Novice March 17, 2014 at 5:19 pm

If my self employed work is really up and down…ie one year I might make nothing, the next 100K, and I have a second job where I am the employee but there is no 401k offered, can I and is it smart to start a individual 401k?

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retirebyforty March 19, 2014 at 9:24 am

Yes, I think you really should open an i401k. On the year that you make a lot of money, you can contribute more. On those slow years, you don’t have to contribute. It’s very flexible.

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Thien March 27, 2014 at 12:32 pm

I recently opened the individual 401k at Fidelity but looking to transfer to Vanguard. I have yet to make deposits for 2013 but wondering when I transfer to Vanguard will this trigger capital gains tax? My funds when deposited into Fidelity will most likely just sit in the money market fund until I transfer. I was also wondering how re-allocation works in the Vanguard individual 401k, does reallocation trigger capital gains tax in these self-employed 401k accounts?

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retirebyforty March 27, 2014 at 3:04 pm

It shouldn’t be a tax event. You just need to make sure Vanguard roll it over correctly. Don’t tell Fidelity to send a check to you. Vanguard should be able to help you with this process. They have a very good customer support team. Just give them a call.

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JJ April 13, 2014 at 9:11 am

Need help deciding retirement!!

Hi everyone, My wife & I are both self employed, we have retail small business, we both file joint return.

Net Income 2013 was $56000
no state tax
my age 44 and wife 45

can we both have separate retirement plan?

whats the best plan for us, currently we do not have any retirement plan.

Thanks

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Derek Olsen June 17, 2014 at 8:47 pm

Thanks for this.

I was just looking into a 401k for myself.

-Derek

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Chris Clark July 10, 2014 at 12:57 pm

I’ve been thinking about a solo 401k myself. My situation is a little different. I am a full time police officer and pay regular employment taxes on that income. However, as most police officers I have side jobs where I earn income. Some issue a 1099 and some take out taxes and issue a W2. Would I still be able to count my side job earnings where a W2 is issued even though I pay taxes throughout the year? When I file my taxes at the end of the year it’s joint with my wife who also works.

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retirebyforty July 12, 2014 at 12:17 am

I’m sorry, but I don’t know the answer to your question. It sounds tricky because you already have a full time job and I assume you contributed to your retirement plan there. You should call Vanguard small business plan and see what they say. They were very helpful when I talked to them.

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