Similarly, if the Roth IRA limits were raised for high cost-of-living areas, that would allow people living there to sock away more ABSOLUTE dollars. The leveraged retirement income provided by the tax-free growth and retrieval of these would then be exponentially higher than that of folks in cheaper areas. At retirement, people are more or less free to live wherever they want (personal considerations aside, which are pure choice anyway), so at this point where they lived during their working years probably shouldn’t be much of a factor.

I wouldn’t necessarily be opposed to simply eliminating the limits entirely for everyone, except that it would have to involve a significant restructuring of the tax code, I would imagine, to maintain “balance” (like we have one now), and while the tax code is in dire need of significant restructuring, I can’t say I’ve typically seen such efforts result in anything terribly positive…

Also as Brip Blap says, we are penalized because we pay a fortune in state income and property taxes. So far I only managed to avoid AMT because I am single. Had I had a husband earning about as much as I do and a couple of kids, I’d probably be hit with it because you loose exemption for kids for AMT. If I sell some stock, I might be hit with it as well. OK, so I earn slightly over 100K. But it doesn’t go nearly as far around here as everywhere else.

I think Shadox hit the nail on the head. The tax code in the US penalizes people on the coasts. I am teetering on the edge of the AMT due to (ironically) my massive deductions for the horrific property taxes in Jersey. Something will have to change with the US tax code in the next decade. The run up in home prices here in Jersey is having an additional unintended consequence – the linked increase in property taxes. It has gotten to the point for me that even if I save the max in my 401k and IRAs each year AND pay off my mortgage, my property taxes alone cost me $700 per month today. Imagine what they’ll be in ten years. No matter how much I’ve piled in a 401k it wouldn’t be enough to pay for that AND my other expenses.

A 401k becomes pretty much an afterthought for coasters, as opposed to the 100% of retirement needs it is for friends of mine who still live in small towns down South.

You are right that for the wealthy this tax break isn’t going to mean a lot. For people of middle class net income like myself, it is a valuable savings tool.

I’m not a tax specialist, but I’ve read that the conversion process has a huge problem if you convert an older 401K to an IRA. I would like to do this to increase my investment options with low expenses.

LazyMan: The flipside is that you have been riding a hellacious real estate market, and you could easily choose to sell your overpriced real state at retirement and move elsewhere, thereby pocketing a hug windfall. In that case, re-indexing the income limits based on cost of living would provide an unfair advantage to people like you. It’s not perfect, but if there are going to be limits, then they should be the same all around.

With regard to abolishing the limits, it’s not like giving the wealthy access to a $4k tax break is really skewing the playing field. That’s such a small (proportional) amount to the truly wealthy that I can’t imagine that it gives them a meaningful advantage above and beyond their high income and already substantial investment holdings.

For what it’s worth, we’re also over the limits this year, and it sucks. Then again, it’s great, as it means we’re in a great position income-wise. But let me ask you this… Why not just do a non-deductible contribution and then convert it to Roth in 2010 when the income limits are slated to go away?

It’s like the tax on real estate sales. Most people aren’t affected by that tax, because the majority of the realty sales in the country aren’t having 6 figure profits. I don’t think a change would be considered because there are more low cost areas then high cost areas and the creation of pretax deductions already lowered what the government collects in tax.

What do you need to do to make it happen? Well you’ll have to pay a corporate lawyer about $250 to write a trust document for the entity that’ll hold the investment money. And you’ll have to write up some basic plan documentation that define all the rules of the plan. (A corp attorney might have boilerplate for that also.) After that, open up a Vanguard Small Business Investment-Only FBO account.

I guess what I’m saying is, knowing now about the SE401K and the differences between it and a SEP-IRA, I feel that the SE401K has no advantage large enough to make me consider switching, or even opening one. The added paperwork and, in my situation, unimportant contribution limit differences just aren’t compelling enough to get me to consider the SE401K as a viable vehicle for my self-employed retirement funds.

Lastly, I’m no financial planner, but your wife may want to ask one about incorporating or otherwise becoming a separate business entity for tax purposes. She may find that she can save herself the Self Employment taxes which would have the effect of raising her take home by at least 15%.

However, the whole retirement savings system in this country makes no sense. Why is it that individuals whose companies offer a ROTH 401K should enjoy the tax advantages of that option, while employees whose companies don’t should be stuck with the alternative?

Why is it that employees should be tied to investment options or retirement options offered by their companies to begin with?

Why shouldn’t there be just ONE type of retirement vehicle that would be open to everyone, regardless of employment status, marital status or income? This vehicle would not be managed by employers, but employers could offer matches to these accounts if they so chose (just like in the 401K system today).

This would make life much simpler for everyone. Individuals would be able to manage their own retirement accounts and reduce the atrocious costs that are typical in most 401K plans; employers would eliminate the cost and liability of managing retirement vehicles; and complexity overall would be reduced.

The big losers? Accountants and full-service (i.e. high cost) brokerage houses.

So, for us, it’s all about the taxes – we pay much more in taxes than we pay in total living expenses. My wife either pays nearly $40K out of her $70K to Uncle Sam and Uncle Schwarzenegger, and probably quits since it isn’t worth it to get out of bed in the morning, or we try to use every tax sheltering device available and get her taxes down to a less evil $15-$20K.

It isn’t so much about “retirement” – it’s about how much of our savings is tax-deferred or not. Also, we’re old enough that the “withdrawal age” isn’t that far away.

Alright, I’m beginning to understand what everyone’s talking about when it comes to the differences in contributions. However, could someone please explain to me _why_ that actually matters to the self employed individual running a business? The only real benefit that I can see is if someone wanted to contribute a very large amount of money each year for their retirement, in excess of 20% of their earnings. But I fail to see the _reasoning_ behind contributions that large. In fact, isn’t contributing more than 20% of your income towards your retirement contrary to almost all the financial advice out there? If you have a $100,000 income and start at $0 in your retirement accounts and contribute 15% a year for just 25 years you wind up with over $1.6 million. If you do the $15K and then 20%, making the contribution roughly $35K, yes you wind up with over $3.6 million for retirement, but you’re removing over 1/3 of your income BEFORE taxes. I’m all for looking ahead, but doesn’t over a third of your current income seem just a little extreme?

But since a self-employed person should be doing this anyway, it isn’t much extra work. I found the biggest pain with SE401Ks is that “basic versions” of tax software isn’t set up to handle it – you have to use the “premium biz/LLC edition” of Turbotax to handle a SE401K.

The big advantage for SEP is if you have both W2 income and SE income (like a blog, extra consulting work, etc). In this case, you can have both a work 401K _and_ a SEP funded with 20% of your SE income. And you can still fund a Roth if you qualify income-wise. Note that a SEP is called an “IRA”, but it doesn’t count against IRA funding limits – it is a separate vehicle from Roth or Trad. IRAs.

Disclaimer: please read up on this stuff before making decisions; I’m not a tax guy…

A Self-Employed 401K (or sometimes called Solo 401K) is simply a 401K for a self-employed individual. Because it’s a 401K, it follows 401K rules. It can be pre-tax contributions or after-tax Roth contributions. Totally up to you. It also follows the same rules for withdrawals. 10% penalty before 59.5 — although if you rolled over Solo Roth 401K money to a Roth IRA, you could then withdraw the contributions without penalty.

Besides the Roth option, Solo 401Ks follow different contribution percentage formulas. SEP-IRAs are 20% of salary while Solo 401Ks are 14K + 20% of income. If you’re making 225K, doesn’t matter which you pick since you’ll be capped at the total 45K limit. But any amounts lesser, Solo 401K lets you contribute more.

The disadvantage is that this is a 401K and requires much more paperwork filing. As such, Vanguard does not offer Solo 401Ks nor do many brokerages. The cheapest Solo 401K option seems to be a brokerage account from Charles Schwab.

Perhaps I’m missing something (very possible, I’m a moron afterall) but it seems to me that the SE401K is not as good as a SEP-IRA because you make your contributions to the SE401K AFTER takes, while with a SEP it’s before. And the contributions are tax writeoffs. So, since the maximum contribution to EITHER is $45,000/year (for 2007), I don’t understand how putting money into the SE401K is easier/better than the SEP.

Also with a SEP, and this is directly from Fidelity’s website; “You can withdraw at any time, but a 10% penalty may apply if you are under 59½.” Whereas with the SE401K you can’t touch the money until at the earliest 59½.

And lastly, just to satisfy my own curiosity (because I’m a moron, remember?) could you please elaborate on what you meant when you said, “SEPs are good for setting aside SE income if you already have a W2 job and a 401K at work?” I’m incorporated so that statement doesn’t apply to me, but I’m really curious as to what you meant and how that can affect someone’s decision on which retirement vehicle to choose.