Which raises another point… with a corporation you can hire your spouse to run some small aspect of your business and use the strategy mentioned previously to double your retirement savings with all the same tax advantages. This is a no-brainer if your spouse has no other employer or has an employer with no retirement plan. If they do have another retirement plan you’d need to look into whether it’s permissible to contribute to both.

First set up a corporation. An S Corp or LLC most likely, but it depends on your situation. Have a lawyer do it, it cost me $800 but was well worth it.

Make yourself an employee of your own corporation and pay yourself a modest salary, something the IRS would consider reasonable. For a part-time job, $1000 a month might be reasonable.

Then set up a SIMPLE IRA which allows you to contribute up to 100% of your salary, up to a limit of something like $12K.

With a $12K salary and a SIMPLE-IRA, you can put your entire year’s salary into your retirement plan, easily maxing out the contribution limit. To do that with a SEP-IRA you’d have to pay yourself a huge salary. A huge salary is bad because you’ll pay an extra 15% in Social Security taxes on it.

The corporation’s profits over and above your salary would come to you in the form of dividend distributions. You do not pay Social Security taxes on this and it’s taxed as dividends rather than earned income (i.e. at a lower tax rate, and exempt from things like local taxes which are based on earned imcome).

Oh, and even for the $12K salary you do earn, you pay no federal tax on that because you’re putting it all into your retirement plan on a pre-tax basis. Not only that, but the corporation can match your SIMPLE IRA contributions up to 100% on a pre-tax basis as well, because the match is an expense to the corporation, and all of the corporation’s expenses are tax deductible.

Aren’t mutual funds already diversified? And don’t you preach index funds? How much more diversity can you get? Isn’t there such a thing as TOO much diversity?

A friend of mine has a seven year old with $200 in a ROTH. He helps her put in about $20 a month now.

Contributing to an IRA or Roth IRA before the SEP is an interesting approach since you avoid the self employment tax on that amount of money also. I fill my IRA each year, and plan to open my SEP-IRA soon.

Trent – For your young age, you should be in higher risk investments. Small Cap growth (No. American, and Intl.). Adjusted for inflation, your Vanguard fund is only going to return 3-4% per year in real terms. Success to you.

Thanks for the bump in the right direction.

Clint Lawton

http://www.a-debt-free-life.com

I think !wanda is right, if it is not earned income (i.e. you do not get a w-2 for the stipend/fellowship), you cannot invest in a Roth IRA. Like Credit, I thought since I self-reported and paid taxes on the stipend, I could contribute to a Roth IRA. I found out (using TurboTax this year) this is not the case.

I am also surprised Trent can contribute to a Roth IRA while he is self-employed. Trent – you may be OK because you are married, but if you don’t get a w-2 for your self-employment, can you really contribute to a Roth IRA? (Or do you get a w-2 for some of your income?)

Just curious, I am still trying to understand the system. Since I thought I could no longer contribute to a Roth IRA, I decided to invest in mutual funds.

According to the accountant I use, the portion of the fellowship used for tuition, fees and required books, supplies and equipment is not taxable. However, the amount used for other expenses such as room, board and travel is taxable and this portion is considered earned income. Most of those on fellowships ignore this rule and just don’t pay the taxes. So if you want to follow the rules and pay the taxes, then you can contribute to a Roth IRA. However, please don’t make Trent’s mistake of putting your money into an S&P 500 index fund unless you like losing money and paying the opportunity cost to not have to think about your investments.