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

[kp79]

@dmertz thank you for the clarification and detailed reply, it is appreciated.

Some more questions if you don't mind:

1. On the numbers:

Actually, $18,587 is a bit off.  I didn't take into account that your net earnings from self-employment plus your W-2 income would exceed the $137,700 Social Security wage base for 2020.  With $100,000 of self-employment net profit and $60,000 of W-2 income, the deductible portion of self-employment taxes would be $6,157.  That means that your maximum employer contribution would be 20% *  ($100,000 - $6,157) = $18,769.  See Chapter 5 of IRS Pub 560 for the more complete calculation that includes factors that would only affect individuals with lower net profit.  This would make the maximum after-tax contribution be $57,000 - $19,500 - $18,769 = $18,731.

May I ask how you got $6157 because I may have to do the math myself (my numbers that I shared with you are simplified).

Also where does the 20% number come from? I see 25% mentioned here: https://www.irs.gov/retirement-plans/one-participant-401k-plans but they also say "For self-employed individuals, see the discussion on "Contribution limits for self-employed individuals")

By the way, chapter 5 of the IRS Pub 560 is impossible to navigate and understand. https://www.irs.gov/publications/p560

Is there a way to officially calculate this from within TurboTax? I don't want to over-contribute and incur any penalties.

2. I called eTrade (that I am opening the solo and Roth 401Ks with) today and confirmed that the plan allows:

• Allows in-Service Distributions Or Non-Hardship Withdrawals (possibly only if I open profit-sharing plan, though I am not sure what this is)
• Does NOT allow after-Tax Contributions Above and Beyond the $19,500 Pre-Tax Contribution Limits

This means that I can't make any after-tax contributions, so I imagine I will only be able to contribute:

• $19,500 for the employee deferral portion
• some amount for the max employer contribution (once I get clarity on the numbers)
• Nothing for the after-tax contributions, since my plan would not allow it.

As far as reporting, eTrade:

• does not report to the IRS/ provides 5498 tax forms for contributions made to the plan 
• does not report to the IRS / provides form 5500 for benefits plan
• DOES report to the IRS and provides 1099-R for distributions made from the plan

3. 

I'm not sure what you mean by a Roth-IRA conversion ladder.  Partial conversions are permitted, so you can convert as much or as little as you want in any given year, allowing you to manage your marginal tax rate.  However, if you make a nondeductible traditional IRA contribution and you have no other funds in traditional IRAs, you would generally want to convert the entire traditional IRA balance immediately since the conversion would be essentially nontaxable (except for possibly a small amount of taxable earnings while in the traditional IRA if the conversion does't happen immediately).

It seems like eTrade (my IRA custodian) does not allow after-tax contributions, so I may not be able to make a nondeductible traditional IRA contribution to my solo 401K.

Again, thank you.

[dmertz]

1.  Schedule SE Part I provides the calculation of self-employment taxes and the deductible portion of self-employment taxes.  (The only calculation change from the 2019 Schedule SE Part I is to the Social Security wage base, $137,700 for 2020.)

Draft 2020 Schedule SE:  https://www.irs.gov/pub/irs-dft/f1040sse--dft.pdf 

Chapter 5 of IRS Pub provides a clear, step-by-step calculation and is the calculation that TurboTax implements on its Keogh, SEP and SIMPLE Contributions Worksheet.  Even if you don't understand why each step is present, following the steps as indicated will lead to the correct result.

2.  I'm not sure how a self-employed individual would ever not be in-service.  eTrade is probably indicating that distributions are NOT permitted from the plan before age 59½.  Certainly the law prohibits in-service distributions of employee elective deferrals and Roth contributions from a 401(k) prior to age 59½, but it's up to the plan to determine whether in-service distributions of other amounts are permitted before age 59½.  An In-plan Roth Rollover (from the traditional 401(k) account to the Roth 401(k) account in the same plan) is permitted by law at any age but it's up to the plan to either allow or disallow IRRs.

A 401(k) is not an IRA.  Form 5498 only applies to IRAs.

3.  Contributions to a 401(k) are not IRA contributions.  A nondeductible contribution to a traditional IRA would be made to a traditional IRA, not to a 401(k).

[kp79]

@dmertz @Critter-3 

I have a separate but related question (please assume that we are still in 2020 when you’re answering this, my custodian, E*TRADE, allows for me to backdate  contributions to dec 31st if you’re only a few minutes past the deadline)

I have both:

1. Solo Roth 401k

2. Solo 401k

I have self employment income of 100k for the 2020 tax year (and total income: self employment + w2 + capital gains of 250k for 2020) 

Q1. Can I contribute 57k into the individual Roth 401k for 2020 tax year (for both employee and employee portion)? What would my contribution limits for the individual Roth 401k plan be?

Q2. If I don’t contribute to the individual Roth 401k:

Can I contribute 57k into the individual 401k for 2020 tax year (for both employee and employee portion)? What would my contribution limits for the individual 401k plan be?

Q3. Any thoughts on mixing and matching between the 2 accounts? What would you recommend?

many thanks..

[dmertz]

I think Q1 and Q2 have been addressed previously above.  To summarize:

A1.  No.  The limit for Roth 401(k) contributions for 2020 is $19,500, (plus $6,500 catch-up if you are over age 59½, but the catch-up doesn't apply to you since you are 41).  The limit is on the combined total of employee elective deferrals and Roth contributions, so whatever amount of employee contributions you put into the Roth 401(k) reduces the amount that you can put into the traditional 401(k).  This limit applies to all of your employee contributions similar plans in aggregate (but not to 457(b) plans which have a separate limit).

A2.  See A1 for the employee contribution limit.  Employer contributions can only be made to the traditional 401(k).  With $100k of SE income and $60k of W-2 income, your maximum employer contribution would be $18,769.

You've said that your plan does not allow after-tax contributions to the traditional 401(k) account, so the amount in A1 and this A2 are the maximum permissible, $19,500 employee (traditional and Roth combined) plus $18,769 employer (traditional).  (The amount of your W-2 income as a slight effect on determining the maximum employer contribution in this case.)

A3.  Tax rates are lower now than they are expected to be in the future; the tax rates are schedule to revert to the pre-218 rates in 2026.  That means that Roth contributions are likely to more beneficial now than later.  Since you appear to want to put the maximal permissible into in your retirement plan, putting it all into the traditional account could result in large tax bills in the future to get that money back out due to the growth being tax deferred rather than tax free.  Many people fail to plan how and when they will take money out of their retirement plans; it's just as important to get an early start on that planning (now) as it is for putting money into the plans.

[kp79]

@dmertz 

Thanks for that insights - every point you made was very helpful. It's also useful to know that Employer contributions can only be made to the traditional 401(k).

One clarification (contrary to what I had said earlier): It seems my plan DOES allow after-tax contributions to the traditional 401(k) account.
Here are the specific clauses in my plan:
* Allows Elective Deferrals
* Allows In-Plan Roth Rollovers
* Allows Direct In-Plan Roth Rollover
* Allows an outstanding loan amount be included in a Direct In-Plan Roth Rollover
* Accepts Indirect In-Plan Roth Rollovers

Do these mean the plan allows after-tax contributions? (I would assume so, I selected "yes" for every box when setting up the plan). What would my contribution limits to the EMPLOYER portion of my Individual 401k and Individual Roth 401k be in this case? (I assume EMPLOYEE limits dont change and still can be a max combined of $19,500)

Can I do this?
step 1: EMPLOYEE contributions: Put $19,500 in my Individual Roth 401k (employee portion). Put $0 in my Individual 401k (employee portion) since I have used the $19,500 limit up for the Roth 401K above
step 2: EMPLOYER contributions: Contribute $57000-$19500 = $37,500 into my Individual 401k, given my income levels? Or would it be $18,769 as you mentioned, or would it be different since my plan seems to allow after-tax contributions?
step 3: Then, immediately roll the entire EMPLOYER contribution amount from my Individual 401k into my Individual Roth 401k? (no tax deferral benefit)

Some related q's:
1. Would a MEGA BACKDOOR Roth be necessary / useful to me, to maximize my contributions to a Roth?
2. On top of all this, can I still do a regular backdoor Roth contribution of $6000 (contribute to my traditional IRA and immediately roll it over into my Roth IRA)?
3. Lastly, can I open a solo / individual 457(b) plan on top of what I am doing above to increase my retirement contributions / deferrals?

[dmertz]

The specific clauses you listed for your plan have nothing to do with permitting after-tax contributions to the traditional account in the 401(k).  It's likely that your plan does not, leaving you with no way to do a Mega Backdoor Roth.

457(b) plans can only be established by government organizations (qualified 457(b) plans) and tax-exempt entities such as charities (nonqualified 457(b) plans).

[kp79]

@dmertz thanks and I see. I will find out (by calling Etrade) specifically on whether they allow for after-tax contributions. In the remote case that they do, what would my EMPLOYER contribution limit become? I assume the mega backdoor Roth becomes possible in that circumstance.

What formula was used to calculate $18,769?

On top of all this, can I still do a regular backdoor Roth contribution of $6000 (contribute to my traditional IRA and immediately roll it over into my Roth IRA)?

Thanks!

[dmertz]

You appear to have sufficient compensation to be able to make a nondeductible contribution to a traditional IRA.  There is no limit on how much you are permitted to convert to Roth and if you have no other money in traditional IRAs, your conversion will be tax free.

The calculation of the maximum employer contribution is done on the Deduction Worksheet for Self-Employed in IRS Pub 560.  TurboTax implements that worksheet as the Keogh, SEP and SIMPLE Contribution Worksheet.

[kp79]

@dmertz thank you. To make sure I am understanding correctly (this will help me this year and future tax years, so I appreciate your answers)

I have these accounts:

Roth IRA: $130K

Traditional IRA: $330K

(new) Individual 401K: $0

(new) Individual Roth 401K: $0

Can I do this for 2020 tax year?
step 1: EMPLOYEE contributions: Put $19,500 in my Individual Roth 401k (employee portion). Put $0 in my Individual 401k (employee portion) since I have used the $19,500 limit up for the Roth 401K above
step 2: EMPLOYER contributions: Contribute $18,769 into my Individual 401k as you mentioned, given my income levels (this is assuming my plan does not allow after-tax contributions) Would this be deductibe or a non-deductible employer contribution? I am confused about this.
step 3: Then, immediately roll or transfer the entire $18,769 contribution amount from my Individual 401k into my Individual Roth 401k? (no tax deferral benefit). Can I do this, or would the money have to stay in my Individual 401k? If I am not permitted to do this, then it does not make sense to contribute the $18,769 at all (since deferring taxes wont have any advantages, as you said previously).

Appreciate you clarifying!

[dmertz]

1. Yes.
2. Yes. assuming exactly the amounts of self-employment profit and W-2 income you indicated, otherwise the amount of your employer contribution would be a bit different.  Employer contributions must be deductible, otherwise they are excess contributions subject to penalty.  In this case, employer contributions appear on line 15 of Schedule 1, self-employed retirement deduction.
3. Yes, this is an In-plan Roth Rollover, but it's not "for" 2020.  Since it will be done in 2021, this will be reportable and taxable on your 2021 tax return.  (The decrease in your taxable income on your 2020 tax return from the self-employed retirement deduction will effectively be offset by the increase in your taxable income on your 2021 tax return from the In-plan Roth Rollover).  You must do the In-Plan Roth Rollover as a Direct In-Plan Roth Rollover.

[kp79]

@dmertz thank you so much. I will try to see if etrade can backdate it for 2020, because I may not have self-employment income to report in 2021. Fingers crossed.

Btw on top of all this, can I still do a regular backdoor Roth contribution of $6000 (contribute to my traditional IRA and immediately roll it over into my Roth IRA)? Is the deadline for this passed (Dec 31 2020) or do I have until April 15 to do this?

[dmertz]

The deadline for making contributions to a solo 401(k) is not year-end.  The deadline for making your election  to make an employee contribution is year-end, but the deadline for actually depositing your employee contribution to the solo 401(k) is as soon as is practical after determining your net earnings, but not later than the due date of your tax return.  (You should still try to determine your net earnings as early as is practical.)  The deadline for making the employer contribution to the solo 401(k) is the due date of your tax return.  You'll simply tell E*TRADE that both are for 2020.

[kp79]

@dmertz you have been a great help and I cannot thank you enough.

I hope you dont mind me tagging you in the future if I have more tax questions like this. Once again appreciate it.

[TaxFiller4]

Which brokerage / service provider with adoption agreement to provide 401(k) plan that allows “after-tax contributions.” After-tax contributions

[Critter-3]

After tax contributions is called a ROTH 401(k) and most companies that manage a 401(k) do both since it is the same money coming in to them either way.  You need to do some research to find and compare the management costs for your size of business.  The forum does not allow posting or advertising of any kind.