Opening the
i401k

Make sure you look thoughtful like this
while you open your account.


Ok, I admit this part is a smallish pain in the ass, as no one likes paperwork, but it’s worth it.

Here are the steps:

  1. Get an EIN (Employer Identification Number) from the IRS.

  2. Have a business bank account. It’s easy to open one. Pick a low-cost one or one with your current bank so it’s easy to transfer money in and out. Remember, W-2 taxed wages and 1099 untaxed money should never go into the same account.

  3. Pick either a Deferred or Roth i401k (more below).

  4. Open the i401k with Schwab for the Three-Fund option. For the single fund option using a Vanguard mutual fund, use E*Trade or Ascensus.

The Business Bank Account

If you don’t already have one, open a business bank account. Any 1099 freelance money you earn should go in this account; it is untaxed. Your personal account is where any W-2 income or personal money lives, as that income has already been taxed.

Why a business account? It’s easier to track business income and expenses if they all flow in and out of one account. Also, if you ever get audited by the IRS, you don’t have to unscramble your personal/W-2 money vs. 1099 company money.

To make contributions to your i401k the funds need to come from your business, including if you’re a Sole Trader, LLC or S-Corp.

The Employer Identification Number (EIN)

It’s like a business's social security number. If you’re an LLC or S-Corp, you hopefully already have one. If you’re a Sole Trader, you can apply for one with the IRS on their website.

It’s very easy and takes a week or two to get one.

It’s needed so your i401k can be matched to you and your business by the IRS.

*Make sure you use the official IRS website; there are scam lookalikes on the web. Click the button below for the IRS.

Filling out the i401k application plan documents

Look at the plan documents, and then I suggest calling Schwab or E*Trade (or whomever you choose) and have them walk you through filling it out line-by-line. They are not the easiest documents to fill out. In general, the staff are very helpful and knowledgeable.

Traditional (Deferred) vs Roth i401k

Traditional (Tax-deferred)

  • Money goes into the i401k before tax and is a tax deduction. Example: If you make $150k and put $30k into the i401k, your taxable income is now $120k. Yes, a monster tax deduction!

  • When you start withdrawing it in retirement, it is taxed as income, most likely much lower than you are paying now. That’s why it’s called ‘deferred,’ as you pay the tax much later.

Roth

  • Money goes into the i401k after it has been taxed.

  • When you start to withdraw it in retirement you are not taxed at all.

  • You do not get a tax deduction yearly when the money goes in.

How do you choose?

There is always a debate over which one to use; it can be personal preference. In general, I suggested using a Traditional (deferred) i401k to get the deduction and avoid paying those higher tax rates on your income. The tax deduction will be on the highest-taxed part of your income.

In retirement, chances are you will be paying yourself less than your prime earning years and thus paying a lower tax rate. Example: You’re making $200,000/year now. In retirement, you will probably pay yourself $100,000/year so that you will pay a lower percentage rate of tax then.

All that untaxed money you get to keep in a deferred account means it’s growing for 10, 20, 30 years in your i401k instead of paying the tax before the money goes into a Roth. It’s making you money.

You can open two i401ks, a Traditional and a Roth, or open a second one later in life. However, if both i401ks are for your company, they must be under the same plan and have the same provider. You cannot have one with Schwab and one with E*Trade. Also, the contribution limits above still apply to both; you don’t get double!

Please chat with your accountant or advisor about opening any i401k plan.

Tax Brackets

Read The Knowledge post here on how your income is taxed at different rates; it’s like a layer cake of different tax rates. Putting money in your i401k cuts your tax bill in the best way.

What provider to open the i401k with?

Mutual Funds

If you want to use the Single Fund Option:

As of April 16th, 2024, Vanguard announced that it no longer manages i401k plans. It has transferred the plans to Ascensus, who will manage them.

The Vanguard mutual funds have not changed (they’re still amazing); they will no longer manage the i401k. Read The Knowledge post on why here.

Ascensus charges a $20 per year fee for i401k and $20 per year for each mutual fund you hold.

E*Trade does not charge anything to buy Vanguard funds, so they may be a better option. With E*Trade you can also buy stocks and ETFs.

Schwab charges a $74.95 fee each time you buy a Vanguard fund, so they are out. Schwab, get it together and stop charging fees for buying funds.

  • Schwab is great for a classic Three-Fund Portfolio

  • They do have Target Date mutual funds

  • You can buy other ETFs

  • You can also buy individual stocks like Apple and Microsoft.

  • The account is free.

  • There are no minimum initial investment amounts.

So, how do the providers make their money?

So, how do these guys make their money? Each ETF or fund you buy has a yearly fee called an ‘expense ratio.’ It’s the percentage you are charged of the amount you have in the ETF/Fund. Every ETF or Mutual Fund will publish its expense ratio.

  • We’re buying very low-cost Index Funds, and our costs will be around 0.03 - 0.11%. For example, $100,000 invested at 0.03% = $30 per year.

  • Ascensus also charges a fee of $20/year and $20 per fund.

In comparison, actively managed funds, where the manager tries to pick stocks and beat the market, can cost 0.5 - 2%, and they hardly ever perform better than index funds.

It’s always a good question to ask yourself in life with any transaction:

  • Who’s on the other side of this deal and why?

  • What’s their angle here?

I don’t get any payment from the providers if you open an i401k with them. Just a Christmas basket at the end of the year — I’m kidding, I don’t get a basket. Look me up in 20 years when you have $1.5mil in your i401k and say, ‘hi’.

Once the account is open, head to the next page, showing you how to buy the ETFs with Schwab.