i401k to avoid ACA subsidy payback?

[2BRetiredsn]

I'm 63 y/o, self employed and as 2023 nears an end - am realizing I'm going to have to pay back some ACA subsidies as I made about $6000 more than I had estimated. Payback amount about $1350. To avoid the payback, I'm planning to open an i401k and will contribute $6000 to it before the end of the year. That should put me at an MAGI within my ACA estimate. I'm planning to put the money in the Vanguard money market - VMRXX as I'm planning to use the money to live on before I start collecting SS at age 67. My long term savings are in Vanguard stock and bond index funds. But I don't consider this i401k money to be long term. What do you think? Thanks in advance for any thoughts/feedback!

Oh, I already contributed $7500 to a Roth in 2023 - but as I read the IRS rules for i401k contributions - it appears another $6000 to i401k would still be well within contribution limits.

[sycamore]

I'm 63 y/o, self employed and as 2023 nears an end - am realizing I'm going to have to pay back some ACA subsidies as I made about $6000 more than I had estimated. Payback amount about $1350. To avoid the payback, I'm planning to open an i401k and will contribute $6000 to it before the end of the year. That should put me at an MAGI within my ACA estimate. I'm planning to put the money in the Vanguard money market - VMRXX as I'm planning to use the money to live on before I start collecting SS at age 67. My long term savings are in Vanguard stock and bond index funds. But I don't consider this i401k money to be long term. What do you think? Thanks in advance for any thoughts/feedback!

Oh, I already contributed $7500 to a Roth in 2023 - but as I read the IRS rules for i401k contributions - it appears another $6000 to i401k would still be well within contribution limits.

Setting up an i401k is a good option. Make sure you understand the requirements that come along with it. I don't have one myself but from what I've read here some people are surprised about various annual IRS reporting requirements, and potential fines for failure to meet them. There's typically an initial and annual fee paid to the custodian. It may be more trouble than it's worth.

As an alternative consider recharacterizing your $7500 Roth contribution to a Traditional IRA contribution. As a deductible contribution it would lower your MAGI by $7500 -- but check the income limits for deductibility to be sure.

[2BRetiredsn]

Thanks, Sycamore. I will definitely check on custodian fees and IRS reporting requirements. I'm also planning to run this idea by my CPA before I make a move.

I just clicked on your "recharacterization" link - that does seem like it might be the best option. A big benefit of that is I could leave my business savings account as is - which gives me peace of mind. When you're self employed, and never know if you'll have work from one month to the next, it's very re-assuring to have some money in the bank.

[peteyboy]

Look into the Vanguard and the Fidelity i401k options. Vanguard allows deferrals and contributions to be made via electronic funds transfer (EFT), not sure about Fidelity.

The IRS requires the 5500 EZ form be filed annually for a i401k over $250K and for the year the i401k is closed.

[HomeStretch]

In the self-employment scenario, there are several moving parts with i401k contributions, deducting self-employed HC premiums (SEHP) and ACA PTC. Making a traditional i401k lowers your ACA MAGI which increases your ACA PTC but it also lowers your QBI and SEHP deductions. Consider running a proforma 2023 tax return using tax prep software so you can see the full impact of a traditional i401k contribution.

In the [edit] “Funding Fidelity Solo 401k …” thread linked below Fidelity one-stop-shopping thread, a recent post said Fidelity recently increased the methods for funding i401k contributions to allow mobile check deposits and transfers.

viewtopic.php?p=7556013#p7556013

[2BRetiredsn]

In case someone needs this info in the future... the Vanguard i401k web info indicates that there is a $20 annual fee per fund that is waived if any participant in the i401k has $50k or more in Vanguard assets. So, fee waived for me. Also, you don't have to file a return with the IRS if you have less than $250k in the i401k. I will never reach that threshold. (you do need to file form 5500 when the account is closed) It doesn't appear there are any downsides to opening this account in my situation. I will need to get an EIN from the IRS - SS number is not sufficient. But that is the only hurdle - not a high one. I'm not too concerned about options for making contributions as I will probably only be making one per year. Thanks for the input!

[PaddyMac]

Ditto to above. We moved $50K to a Vanguard brokerage account and it removes all fees from the 401k. Of course, if you only have one account, it's only $20 a year.

The paperwork for small balances is not a lot, and when it gets higher, it's still easy. I sign onto the federal site, have all the info that Vanguard sends you, duplicate the last year, and then enter the new balances. 10 mins tops.

The Vanguard 401k also has the option of adding a Roth 401k, which is always the EmployEE side as well as a nice catchup contribution for seniors. So you can sock away a lot more in Roth space. Over the years, I've sold a lot from our brokerage (paying 0% cap gains) and moved it into Roth 401k. And now there are no RMDs on Roth 401ks thanks to the new tax laws.

Having said that, if you want a simpler life, you could open a SEP-IRA. This is the EmployER side of the 401k only, there is no paperwork, but you do need to do the calculation to figure out about 20% of your net profit. I find the EmployEE side of the 401k much easier as it's a simple flat amount (provided you have matching earnings) so I always filled up that bucket first and then did the EmployER side at tax time.

[MrBobcat]

Looks like you only have to play the ACA income game for a couple of more years.

Personally I'd just recharacterize this years Roth contribution and be done with it, close second for me would be just to pay the extra $1,350.

[pizzy]

In the Fidelity one-stop-shopping thread, a recent post said Fidelity recently increased the methods for funding i401k contributions to allow mobile check deposits and transfers.

Can you link to this comment in that thread? I couldn’t find it and wanted to read the comments.

[2BRetiredsn]

Looks like you only have to play the ACA income game for a couple of more years.

Personally I'd just recharacterize this years Roth contribution and be done with it, close second for me would be just to pay the extra $1,350.

MrBobcat ... you nailed it with the ACA income game reference! Unfortunately, I always have to keep an eye on how much I'm earning with that in mind. Given what I do and how much I earn - I won't ever get to the cap.

As for your last two comments ... definitely good to consider. For me, this money business is largely psychological. It's tempting to recharacterize the Roth as traditional and be done with it. But, I like the idea of getting $6k out of my business checking and get it earning 5%. Also, having a lower balance in there will keep me motivated to keep earning money. I'm close to retirement but not quite there. Anything to keep me motivated is a good thing. As for just paying the $1350 - that's psychological, too. For one thing - that's what I earn in about 2 weeks of work. So it's not nothing. For another, I like knowing that by making these i401k contributions I can lower my MAGI, keep the ACA subsidy - and not have this nagging feeling that I'm earning too much.

[2BRetiredsn]

Personally I'd just recharacterize this years Roth contribution and be done with it, close second for me would be just to pay the extra $1,350.

MrBobcat ... you got me thinkin'. What happens with taxes if I recharacterize the Roth? I already paid taxes on that money. If it becomes a tIRA won't I have to pay taxes again upon withdrawal?

[celia]

I'm 63 y/o, self employed and as 2023 nears an end - am realizing I'm going to have to pay back some ACA subsidies as I made about $6000 more than I had estimated. Payback amount about $1350.

Also look at this move from the perspective of when you are retired. Even though you might save $1350 in ACA subsidies and the tax on $6000 now, later you will have to pay taxes on the amount that $6,000 has grown to. If you already have "too much" in tax-deferred now, this will make it worse. The point at which you should analyze this, in my opinion, is if you have $500k in tax-deferred if filing Single or $1M if filing MFJ.

We have lots of past threads on this. The future counterpart to this would being subject to IRMAA surcharges on your Medicare premiums. Since they have a two-year look-back for your MAGI, what you do in the year you turn 63 will impact your age-65 Medicare premium.

So, if this applies to you, I would just pay back the subsidy for this year.

[celia]

Personally I'd just recharacterize this years Roth contribution and be done with it, close second for me would be just to pay the extra $1,350.

MrBobcat ... you got me thinkin'. What happens with taxes if I recharacterize the Roth? I already paid taxes on that money. If it becomes a tIRA won't I have to pay taxes again upon withdrawal?

No, you haven't paid the taxes yet since you didn't file your 2023 taxes yet. You paid estimated taxes. If you end up having more taxes withheld than your tax liability for the year, then you will get a tax refund when you file!

You have the option to decide if the $7,500 contribution is deductible or not up until you file your taxes. If you recharacterize the $7,500, the tax on that will be paid when you withdraw from the tIRA (or 401K).

Note that if you recharacterize $7,500, the custodian will adjust the amount that is moved to the IRA so that the gain or loss on that money is also taken into account. It will end up as if you had made that contribution directly to the IRA in the first place.

[MP123]

Good suggestion upthread to model this in tax software first.

The $6k contribution will lower your MAGI for ACA purposes (increasing your PTC), but it will also reduce your Sec 199a QBI deduction by $1200, which will increase your taxable income by the same amount. It's probably still a net positive thing to do, but it may not save you as much as you think.

That's assuming that you're eligible for QBI in the first place, of course. And if you're on the edge of the phaseout things can get interesting.

[2BRetiredsn]

I'm 63 y/o, self employed and as 2023 nears an end - am realizing I'm going to have to pay back some ACA subsidies as I made about $6000 more than I had estimated. Payback amount about $1350.

Also look at this move from the perspective of when you are retired. Even though you might save $1350 in ACA subsidies and the tax on $6000 now, later you will have to pay taxes on the amount that $6,000 has grown to. If you already have "too much" in tax-deferred now, this will make it worse. The point at which you should analyze this, in my opinion, is if you have $500k in tax-deferred if filing Single or $1M if filing MFJ.

We have lots of past threads on this. The future counterpart to this would being subject to IRMAA surcharges on your Medicare premiums. Since they have a two-year look-back for your MAGI, what you do in the year you turn 63 will impact your age-65 Medicare premium.

So, if this applies to you, I would just pay back the subsidy for this year.

I won't be subject to IRMAA surcharges on Medicare premiums so no worry there. I will just barely be in the 22% tax bracket (at 2023 tax rate) when I'm 73 and collecting SS and making RMDs. So, that's not really a factor, either. But, given all the feedback, I'm thinking I just might pay back the $1350. Bogleheads advice is to keep it simple and that is the most simple option. I do love this forum! Thanks so much for your input.

[2BRetiredsn]

Good suggestion upthread to model this in tax software first.

The $6k contribution will lower your MAGI for ACA purposes (increasing your PTC), but it will also reduce your Sec 199a QBI deduction by $1200, which will increase your taxable income by the same amount. It's probably still a net positive thing to do, but it may not save you as much as you think.

That's assuming that you're eligible for QBI in the first place, of course. And if you're on the edge of the phaseout things can get interesting.

Thanks MP123. My current QBI deduction is about $4700. I didn't realize that would go down if I lower my MAGI. So, yeah, not the savings I anticipated. I'm leaning toward just paying back the subsidy. Easy peasy.

[HomeStretch]

In the Fidelity one-stop-shopping thread, a recent post said Fidelity recently increased the methods for funding i401k contributions to allow mobile check deposits and transfers.

Can you link to this comment in that thread? I couldn’t find it and wanted to read the comments.

pizzy, sorry I had the wrong thread name. But it looks like you subsequently found the right thread: viewtopic.php?p=7556013#p7556013

[MP123]

Good suggestion upthread to model this in tax software first.

The $6k contribution will lower your MAGI for ACA purposes (increasing your PTC), but it will also reduce your Sec 199a QBI deduction by $1200, which will increase your taxable income by the same amount. It's probably still a net positive thing to do, but it may not save you as much as you think.

That's assuming that you're eligible for QBI in the first place, of course. And if you're on the edge of the phaseout things can get interesting.

Thanks MP123. My current QBI deduction is about $4700. I didn't realize that would go down if I lower my MAGI. So, yeah, not the savings I anticipated. I'm leaning toward just paying back the subsidy. Easy peasy.

Lowering your MAGI won't necessarily reduce your QBI deduction. It depends on how you do it. If you make a contribution to an i401k it will reduce your business income (that your QBI deduction is based on) and that will reduce your QBI deduction.

But if you lower your MAGI by recharacterizing your Roth contribution as a deductible IRA contribution (as mentioned above) then it will reduce your MAGI but not change your QBI deduction, since the IRA contribution isn't an expense of the business.

[sc9182]

Good suggestion upthread to model this in tax software first.

The $6k contribution will lower your MAGI for ACA purposes (increasing your PTC), but it will also reduce your Sec 199a QBI deduction by $1200, which will increase your taxable income by the same amount. It's probably still a net positive thing to do, but it may not save you as much as you think.

That's assuming that you're eligible for QBI in the first place, of course. And if you're on the edge of the phaseout things can get interesting.

Thanks MP123. My current QBI deduction is about $4700. I didn't realize that would go down if I lower my MAGI. So, yeah, not the savings I anticipated. I'm leaning toward just paying back the subsidy. Easy peasy.

Lowering your MAGI won't necessarily reduce your QBI deduction. It depends on how you do it. If you make a contribution to an i401k it will reduce your business income (that your QBI deduction is based on) and that will reduce your QBI deduction.

But if you lower your MAGI by recharacterizing your Roth contribution as a deductible IRA contribution (as mentioned above) then it will reduce your MAGI but not change your QBI deduction, since the IRA contribution isn't an expense of the business.

Oh, you may have made the Roth-hawkish folks mad now !

[2BRetiredsn]

Good suggestion upthread to model this in tax software first.

The $6k contribution will lower your MAGI for ACA purposes (increasing your PTC), but it will also reduce your Sec 199a QBI deduction by $1200, which will increase your taxable income by the same amount. It's probably still a net positive thing to do, but it may not save you as much as you think.

That's assuming that you're eligible for QBI in the first place, of course. And if you're on the edge of the phaseout things can get interesting.

Thanks MP123. My current QBI deduction is about $4700. I didn't realize that would go down if I lower my MAGI. So, yeah, not the savings I anticipated. I'm leaning toward just paying back the subsidy. Easy peasy.

Lowering your MAGI won't necessarily reduce your QBI deduction. It depends on how you do it. If you make a contribution to an i401k it will reduce your business income (that your QBI deduction is based on) and that will reduce your QBI deduction.

But if you lower your MAGI by recharacterizing your Roth contribution as a deductible IRA contribution (as mentioned above) then it will reduce your MAGI but not change your QBI deduction, since the IRA contribution isn't an expense of the business.

MP123 - now that's very helpful info! I just did some searching online to confirm that a traditional IRA contribution will reduce MAGI but not QBI deduction. I found it on a CPA website. So, I think recharacterization of the Roth is definitely the way to go. Thank you!! I don't want to pay for tax software to model this. I've been reviewing my 2022 tax return to figure out how my CPA calculated the QBI, etc and that's been helpful.

[2BRetiredsn]

Quick update ... I did the recharacterization this morning on the phone with Vanguard. Very simple process - only took about 5 minutes. Thanks so much for all the input! I'll say it again - I love this forum.

[PaddyMac]

I'm leaning toward just paying back the subsidy. Easy peasy.

Strange things can happen so I would not pay back the subsidy until you do your tax return. During the first year of Covid, we blew through the ACA cliff and I was prepared to pay back a lot of our subsidy. Then the Administration waived the penalty that year and we didn't have to pay it back!

[2BRetiredsn]

I'm leaning toward just paying back the subsidy. Easy peasy.

Strange things can happen so I would not pay back the subsidy until you do your tax return. During the first year of Covid, we blew through the ACA cliff and I was prepared to pay back a lot of our subsidy. Then the Administration waived the penalty that year and we didn't have to pay it back!

You had good timing for sure! I think that by recharacterizing the Roth contribution to traditional IRA I won't have to pay back the subsidy. Even if there is some to be paid back it will come out of my tax refund. I'm generous with my estimated tax payments and always get plenty back.