Maximizing solo 401k contribution

[hesformes]

I want to maximize my 401k contribution, but I want to prioritize my self employment health insurance premiums deduction over the 401k. When I check the Maximize 401k Contribution box, it decreases my health insurance premiums deduction. Is there a way that I can take the full health insurance deduction and have Turbotax automatically calculate what the max 401k contribution would then be?

[Anonymous_]

I'll page @dmertz for this and your other question.

[dmertz]

TurboTax cannot do that automatically.

I do exactly the same since the amount deductible for self-employed health insurance will never be taxed while the amount deducted for 401(k) contributions is only tax-deferred.  You yourself will need to subtract your self-employed health insurance premiums and the deductible portion of self-employment tax from your net profit and contribute only what remains of the net profit.  You won't be able to use the Maximize box to calculate this.

If your 401(k) plan supports Roth contributions, you could use the same compensation for which you receive the self-employed health insurance deduction to make a Roth contribution to the 401(k).

You might also consider contributing to an IRA an amount equal to the self-employed health insurance or the annual IRA contribution limit, whichever is less.  The same compensation for which you get the self-employed health insurance deduction will support an IRA contribution.  MAGI will determine how much you are eligible to contribute to a Roth IRA or how much of  a traditional IRA contribution might be deductible.

[hesformes]

Thanks for your thorough reply. I'm not sure I understand all of what you said. I have already contributed the full $8k to my personal, non-business traditional IRA. I don't know if that affects what you said about IRAs. I'm assuming I can't contribute any more to any IRA, but I hope the 8k already contributed doesn't affect what I can do with the 401k as you described above. Also to make sure: If I contribute the maximum to my 401k minus the 10k for insurance premiums, are you saying I can contribute the 10k to a Roth 401k? If so, could that also be a SEP or Simple IRA? I'm not sure Fidelity has a Roth 401k.

[dmertz · Accepted solution]

Since you've already made the maximum permissible IRA contribution you can ignore my suggestion to make such a contribution.  With a $10,000 self-employed health insurance deduction you have sufficient compensation to support the IRA contribution since $8,000 of that $10,000 is doing double duty.  The IRA contribution therefore has no effect on the amount that you can contribute to the 401(k) while still keeping the $10,000 self-employed health insurance deduction.

Fidelity's self-employed 401(k) plan does not include a designated Roth account so no Roth contribution can be made to that plan.

There can't also be a SIMPLE IRA plan and there is no point to a SEP plan since the maximum permitted employer contribution to the SEP plan would be the same as the maximum permitted employer contribution to the 401(k) plan.

[hesformes]

If I could find a financial institution in which to open a Roth 401k, would I then be able to contribute to the Roth the amount of my health insurance deduction while still maximizing my non Roth 401k in the manner in which you suggested? Also, could a Roth SEP or Simple replace the Roth 401k for this purpose? Sorry if these questions are redundant. I'm probably not following you completely. Thanks for your patience.

[dmertz · Accepted solution]

With regard to 2023, if you have yet to establish a 401(k) plan you could look for one that includes a designated Roth account.  I think that Vanguard has one.  If you already have the Fidelity 401(k) plan then I don't think that you have that option for 2023 but could potentially move the 401(k) to another provider for 2024.  Same for a SEP or SIMPLE plan.  A SEP plan won't allow employee contributions, so that probably would not serve your needs.

Roth contributions for a SEP or SIMPLE plan were only recently introduced by the SECURE 2.0 Act and the IRS Has only just released guidance related to those.  You would need to determine if your plan permits those.

[hesformes]

If I find a Roth 401k for next year, given a similar situation (i.e. decreasing traditional 401k contribution to accommodate a health insurance premium deduction), can I then, in addition to that 401k contribution, make a contribution to a Roth 401k in the amount of the health insurance deduction? Also, my understanding is that I can make contributions to 401k for 2023 up until April 15, 2024. Couldn't I set up a Roth 401k before then and make a 2023 contribution into that account?

[dmertz · Accepted solution]

"can I then, in addition to that 401k contribution, make a contribution to a Roth 401k in the amount of the health insurance deduction?"

Yes, subject to the overall limit on elective deferrals and employee Roth contributions combined.  The amount that you are eligible to deduct for the self-employed health insurance deduction is not reduced by the amount of an employee Roth contribution to the 401(k).

"Couldn't I set up a Roth 401k before then and make a 2023 contribution into that account?"

The "Roth 401(k)" is not a separate plan, it's a separate designated account within the 401(k) plan, plan permitting.  If you already have a Fidelity self-employed 401(k) plan established for 2023, that plan does not support having a designated Roth account.  If you have yet to establish a 401(k) plan to receive your contributions for 2023, you could establish one with a provider that has a plan that supports a designated Roth account.  For a first-year plan, you have until the due date of your 2023 tax return (without extensions), to establish a plan to which you can make an elective deferral or employee Roth contribution by that deadline.

[hesformes · Accepted solution]

Thank you very much for your answers. You've made it clear how to go about maximizing my tax benefits regarding my 401k and how to input all this into Turbo Tax. Thanks again

[potatoes77]

Wow, this is probably a really great answer to my question as well.  Could I make an example to see if I understand?

Let's say my spouse makes $20K net income after self employment taxes, etc.  Say our total income including capital gains is $200K and neither she or I have any other job in 2023.  So our medical insurance premiums, covered partially under the Affordable Care Act would be roughly $16K.  

In previous years, when I was employed with health care coverage, I would put my spouse's entire $20K income into her individual 401k (traditional) at Vanguard to reduce my current taxes.  Now that I'm unemployed, can I:

1. Deduct the $16K insurance premium (Turbotax puts on Schedule 1 Line 17)?

2. Also contribute $16K to my spouse's 401k with a "new" Roth designation (Turbotax puts on Schedule 1 Line 16)?

3. Also contribute the remaining $4K to her individual 401k or some other traditional account?

I just wanted to confirm this is what you are saying... 1. & 2. are allowed to do double duty for some reason, and therefore my spouse will get the benefit of no more taxes ever on the $16K Roth contribution.  For 3., would the $4K need to go into an IRA because the 401k won't accept contributions of both types in the same year?

Also, when I first entered everything, I just did like I have always done... I entered my spouse's 401k contribution as being traditional.  Then on Turbotax schedule 1 I got both a $16K deduction for health insurance and a $20K deduction for the 401k.  Is this acceptable? Would the IRS say this is not cool to take both deductions from the same $20K income and disallow one or the other?

Thank you for the help!  It is very appreciated!!!

[hesformes]

I am replying for fun, since it is my original question you are seeking further information on. Please wait for confirmation from someone who knows a lot more than me.

The roth contribution and medical insurance premium deduction can do double duty because you get no immediate tax benefit from the roth contribution, so it is not a deduction against your self-employment net profit. The insurance deduction is an actual $16k deduction, so you have $4k remaining to deduct from your net profit. I believe that you can put that into a non roth 401k. Despite the roth doing double duty with the insurance premium deduction, you can't put more than your net profit for both roth and traditional 401ks combined.  As for a traditional IRA, that is separate from your business and so you put the full allowable amount (7  or 8k depending on your age) into that regardless of what you put into the 401k.

I'm curious to see if someone who knows what they are talking about confirms the above.

[dmertz]

"can I:

1. Deduct the $16K insurance premium (Turbotax puts on Schedule 1 Line 17)?

2. Also contribute $16K to my spouse's 401k with a "new" Roth designation (Turbotax puts on Schedule 1 Line 16)?

3. Also contribute the remaining $4K to her individual 401k or some other traditional account?"

1.  $16k can be deducted on Schedule 1 line 17 if the insurance is in your spouse's name or the name of your spouse's company and the sum of this $16k and the Premium Tax Credits do not exceed the cost of the insurance.

2.  $16k can also be contributed to the designated Roth account in your spouse's 401(k) plan, assuming that plan provides a designated Roth account.  A designated Roth contribution is not deductible, so this contribution is not included anywhere on the filed tax return.  It is included on TurboTax Keogh, SEP and SIMPLE Contribution Worksheet used to determine the maximum total contributions to the traditional and Roth accounts in the individual 401(k).

3.  The $4k that remains of the $20k net earnings after making the designated Roth contribution can be deferred to the traditional account in the 401k and deducted on Schedule 1 line 16.

4. The $16k contributed to the designated Roth account will also support contributions to traditional or Roth IRAs for both you and your spouse.

[dmertz]

hesformes is correct except that the amount deferred to the traditional account reduces the amount of net earnings available to contribute to a traditional or Roth IRA.  With only $4k deferred to the traditional account, enough ($16,000) remains of the net earnings to support maximal traditional or Roth IRA contributions for both spouses (until the individual annual limit goes above $8,000 in the future).

[potatoes77]

dmertz and hesformes, Thank you!

I think you've answered this question but I just wanted to confirm:  Is it OK to take a $16K insurance deduction, and also put $20K into my spouse's individual (traditional) 401k in order to get a $36K deduction on schedule 1?  My goal is to minimize the amount of additional taxes that I have to pay this year.  Although Turbotax allows this $36K deduction on schedule 1, it doesn't seem mathematically right to take a $36K deduction based on $20K in earnings.

Thanks again!