Solo 401K with a Solo Roth 401K and MEGA Backdoor Roth

kp79 · ‎October 10, 2020

In 2020, I have worked as both a sole proprietor / individual contractor with no employees and as a W2 part-time employee. I am 41 yrs old (under 50) and will have multiple streams of income in 2020:

$100K from 1099 contract work as a sole proprietor / individual contractor (from Jan 1-Apr 31)
$60K from a W2 as a part-time employee (projected through the entire year from Jan 1-Dec 31)
$85K in taxable short-term gains from stocks, dividends, and other investment income (projected through the entire year from Jan 1-Dec 31)
Projected Total Income for 2020: $245K from all income streams

I currently have 4 retirement accounts open:

a Solo (Individual) 401K (new account, balance: $0)
a Solo (Individual) Roth 401K (new account, balance: $0)
a Traditional IRA (existing account, balance: $280,000 of which $40,000 is in gains in 2020)
a Roth IRA (existing account, balance: $118,000 of which $18,000 is in gains in 2020)

I would like to maximize my tax deductions this year and move as much money as possible into both after-tax and tax-deferred accounts.

My question includes:

Can I contribute up to a max of $57K (employee + employer portion) to my Solo (Individual) 401K AND a separate amount to my Solo (Individual) Roth 401K ? Is the max contribution limit of $57k total across BOTH the solo 401K and solo Roth 401K? Otherwise, what is the contribution limit on the Roth 401K?
Can I either:
- (Ideally) Contribute up to a max of $57K (employee + employer portion) to my Solo (Individual) 401K AND an additional $37,500 to a Mega Backdoor Roth? Or...
- Contribute up to a max of $57K (employee + employer portion) to my Solo (Individual) 401K AND an additional $6,000 to a "regular" Roth? Or...
- Contribute up to a max of $57K (employee + employer portion) to my Solo (Individual) 401K AND an additional $6,000 to a Traditional IRA?

What can and can't i do? My goal is to deduct / defer the maximum amount possible.

Note: I tried to do my research before asking this question. Here are some of the links I read:

Thanks for any help with this.

dmertz · ‎October 10, 2020

Critter-3's information regarding the 401(k) contribution limits is somewhat incorrect. The $57,000 limit for 2020 is a per plan limit, not a per individual limit. It's the $19,500 per-individual limit that applies just to employee elective deferrals and Roth contributions to all plans in which the individual participates (except for 457(b) plans which have a separate $19,500 limit).

I'm going to directly address the original questions, so some of this might repeat what has already been said:

The sum of your employee elective deferrals and Roth contributions to the solo 401(k) (traditional or Roth) and the 401(k) at your W-2 employer is $19,500. This limit is per-individual. Assuming that you contribute nothing to a plan at your W-2 employer, you can split a total of $19,500 employee elective deferral and employer contributions any way you like between the traditional and Roth accounts in the solo 401(k).

The $57,000 limit is a per-plan limit for employee and employer contributions combined, however your self-employment income of $100,000 is far from the amount that would support that much of a contribution unless your solo 401(k) plan permits after-tax contributions that would take you beyond the $19,500 of elective deferrals and Roth contributions. Assuming exactly $100,000 of net profit from self-employment, your maximum employer contribution to the solo 401(k) would be $18,587 (all to the traditional account). If the plan permits after-tax contributions (and it might since you mentioned a MEGA backdoor Roth which involves after-tax contributions to a 401(k)), you could contribute the remainder of the $57,000 limit, $18,913 as an after-tax contribution to the traditional account in the solo 401(k).

You have enough compensation to also contribute the maximum $6,000 to a traditional IRA, but with your participation in the solo 401(k) that traditional IRA contribution would be nondeductible because your AGI will be above the limit for deductibility of the traditional IRA contribution. Your AGI will be too high to be able to contribute to a Roth IRA.

If your solo 401(k) plan does not permit after-tax contributions, the maximum that you will be able to contribute is $38,087 to the solo 401(k) ($19,500 employee and $18,587 employer) and $6,000 nondeductible to a traditional IRA for a total of $44,087. If your 401(k) plan does permit after tax contributions, add to that the $18,913 that I mentioned earlier. Depending on the plan rules, you might be able to make a rollover from the after-tax sub-account to a Roth IRA, but you likely will have to leave the other amounts and any earnings on those other amounts in the solo 401(k) until you reach age 59½.

Deferring income and getting money into Roth accounts are mutually exclusive. Even if you could make a distribution of the employer contributions before age 59½, whatever deduction you got for those contributions would be offset by the taxable amount of the rollover to a Roth IRA (or an In-Plan Roth Rollover, if the solo 401(k) plan permits).

You need to read the solo 401(k) plan agreement to find out what is and is not permitted by the plan.

View solution in original post

Critter-3 · ‎October 10, 2020

There is one Max contribution to ALL 401K options over all platforms ...

Solo 401(k) contribution limits

The total solo 401(k) contribution limit is up to $57,000 in 2020. There is a catch-up contribution of an extra $6,500 for those 50 or older.

To understand solo 401(k) contribution rules, you want to think of yourself as two people: an employer (of yourself) and an employee (yes, also of yourself). Within that overall $57,000 contribution limit, your contributions are subject to additional limits in each role:

As the employee, you can contribute up to $19,500 in 2020, or 100% of compensation, whichever is less. Those 50 or older get to contribute an additional $6,500 here.
As the employer, you can make an additional profit-sharing contribution of up to 25% of your compensation or net self-employment income, which is your net profit less half your self-employment tax and the plan contributions you made for yourself. The limit on compensation that can be used to factor your contribution is $285,000 in 2020.

Keep in mind that if you’re side-gigging, employee 401(k) limits apply by person, rather than by plan. That means if you’re also participating in a 401(k) at your day job, the limit applies to contributions across all plans, not each individual plan.

At your income level making a ROTH IRA contribution will not be allowed and any traditional IRA contribution will not be deductible ... it would add to the basis. When or if you ever convert the trad IRA to a ROTH the basis portion will not be taxed a second time ... you MUST keep a copy of the form 8606 with your IRA information so you or your heirs know of the basis in the account.

kp79 · ‎October 10, 2020

Thank you for the response. I did know most of those things about the solo 401K (from the links I mentioned).

I did not know that I would not qualify for a Traditional or Roth IRA at my income levels, or that the $57K was a contribution limit across all 401Ks...so thank you.

Some follow up questions:
1. I understand I can contribute up to a max of $57K (employee + employer portion) across my Solo (Individual) 401K AND Solo (Individual) Roth 401K. Assuming I can make a contribution of $40K into my 401K(s), can all of it go into the Roth 401K? or is the first $19,500 tax-deferred and have to go into the Solo (Individual) 401K?

2. To contribute to a Traditional IRA in 2020, your MAGI (modified adjusted gross income) needs to be less than $124,000. To contribute to a Roth IRA in 2020, your MAGI (modified adjusted gross income) needs to be less than $139,000
Are capital gains from investments counted in the MAGI (modified adjusted gross income) thresholds for the Traditional and Roth IRAs? If not, then my MAGI would be $100K (1099 income) + $60K (part-time W2 income). Assuming I made a contribution of 40K into my solo 401K, would my "tax basis" be reduced to $120K, so that I could contribute to the Traditional / Roth IRA?

3. If so, would I qualify for the Mega Backdoor Roth?

Thank you.

Critter-3 · ‎October 10, 2020

First you really should be talking to a local financial planner to get educated on all these retirement situations ... and where ever you have your solo 401K should also be able to explain your options.

Some follow up questions:
1. I understand I can contribute up to a max of $57K (employee + employer portion) across my Solo (Individual) 401K AND Solo (Individual) Roth 401K. Assuming I can make a contribution of $40K into my 401K(s), can all of it go into the Roth 401K? or is the first $19,500 tax-deferred and have to go into the Solo (Individual) 401K? The employEE portion can go in either account however the employER portion would go to the reg 401K only.

2. To contribute to a Traditional IRA in 2020, your MAGI (modified adjusted gross income) needs to be less than $124,000. To contribute to a Roth IRA in 2020, your MAGI (modified adjusted gross income) needs to be less than $139,000
Are capital gains from investments counted in the MAGI (modified adjusted gross income) thresholds for the Traditional and Roth IRAs? Yes they are if they are taxable on the return.

If not, then my MAGI would be $100K (1099 income) + $60K (part-time W2 income). Assuming I made a contribution of 40K into my solo 401K, would my "tax basis" be reduced to $120K, so that I could contribute to the Traditional / Roth IRA? You can always make a traditional IRA contribution ... it is the deductibility that is in question ... best advice I can give is to NOT make any contributions to any plan until you have your final numbers at the end of the year ... you have until the filing deadline to make them so don't be in a hurry where you are forced to remove excess contributions. See the info below:

Modified Adjusted Gross Income (MAGI)

The IRS uses your modified adjusted gross income (MAGI) when it comes to IRA limits. This number can be close (or identical) to your adjusted gross income (AGI). It takes your AGI and adds back certain deductions, including:

Half of any self-employment taxes
IRA contributions and Social Security
Losses from a publicly-traded partnership
Passive income or loss
Qualified tuition expenses
Rental losses
Student loan interest
The exclusion for adoption expenses
The exclusion for income from U.S. savings bonds
Tuition and fees

To calculate your modified adjusted gross income, find your AGI from your tax return. It's on line 8b of the newly redesigned Form 1040.9 Then, use Appendix B, Worksheet 1 from IRS Publication 590-A to modify your AGI for IRA purposes.

3. If so, would I qualify for the Mega Backdoor Roth? This is basically a conversion after making regular contributions ... of course a backdoor only really works if you have no basis in your 401K or traditional IRA ... please talk to someone locally for more personalized advice.

Critter-3 · ‎October 10, 2020

@dmertz Care to weigh in ??

kp79 · ‎October 10, 2020

@Critter-3 thank you for clarifying...

I am a bit disappointed though, sounds like I can't take advantage of any further deductions :(

Is there a way to bring my AGI (or MAGI) down somehow, so that I qualify for the mega backdoor roth?

Also @dmertz if you have any suggestions I would love to hear them.

Thank you both.

Critter-3 · ‎October 10, 2020

You seem to be fixated on the "mega" backdoor roth ... it is only the conversion of the roth 401K contributions you can make during the year and the reason you cannot make the max is due to the business net income ... so make more income to max out the contribution so you can max out the conversion.

kp79 · ‎October 10, 2020

@Critter-3 I actually meant Contributing

$39,500 to a solo 401K or Roth 401K (as a sole proprietor / business....$19,500 plus $25,000 calculated as 25% of 100K )
AND
an additional 37.5K to a backdoor Roth as an individual

That is what I am trying to accomplish (if that is legally possible)

Critter-3 · ‎October 10, 2020

How a mega backdoor Roth works

The mega backdoor Roth allows you to put up to $37,500 in a Roth IRA or Roth 401(k) in 2020, on top of the regular contribution limits for those accounts. If you have a Roth 401(k) at work (and the plan allows for the mega option as described below), generally you can choose whether the final destination of your mega contributions is the Roth 401(k) or a Roth IRA. If your employer offers only a traditional 401(k), then your mega contributions would end up in a Roth IRA.

Here’s a quick summary of what you need to have in place for the ideal mega backdoor Roth strategy:

A 401(k) plan that allows “after-tax contributions.” After-tax contributions are a separate bucket of money from your traditional and Roth 401(k) contributions. About 43% of 401(k) plans allow after-tax contributions, according to a 2017 survey of large and midsize employers by consulting firm Willis Towers Watson.
Your employer offers either in-service distributions to a Roth IRA — that is, you can take money out of the 401(k) plan while you’re still working at the company — or lets you move money from the after-tax portion of your plan into the Roth 401(k) part of the plan. If you’re not sure, ask your human resources department or plan administrator.
You’ve got money left over to save, even after maxing out your regular 401(k) and Roth IRA contributions. In 2020, that means being able to save more than $25,500 (that’s $19,500 to a 401(k) plus $6,000 to a Roth IRA), or more than $33,000 if you’re 50 or older ($26,000 to a 401(k) and $7,000 to a Roth).

Critter-3 · ‎October 10, 2020

PLEASE TALK TO A PLAN ADMINISTRATOR AND GET EDUCATED ON WHAT IS ALLOWED.

kp79 · ‎October 10, 2020

Thank you for clarifying.

dmertz · ‎October 10, 2020