Basic Solo 401k to get more $ into Roth

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Topic Author
Jablean
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Basic Solo 401k to get more $ into Roth

Post by Jablean »

I think I want to open a Roth Solo 401k for my DH at Etrade. I will not be doing any back door or mega back door – way too many traditional IRAs in place to ever qualify for back doors.
 
After a layoff several years ago I’ve had to worry about the ACA cliff and using traditional IRAs and a SEP IRA to control our approach to the cliff and as a result Roths of any type were left behind. This year and for the foreseeable, my income has dropped and in so doing has left the ACA cliff to be easily managed on just one income. With two of us and 55+ catchup I can put quite a bit, $14,000, into Roths but anything we put into the SEP is the same as a traditional IRA. Even if we only put as much into the Roth 401K as we would have into the SEP it seems better and easier to get more into Roth now than to try and convert IRAs into Roths in later years.
  
Disadvantages – no Roth stretch option for DS (21)
Alternative – Stock Fund in taxable account – DS would get step-up value if inherited

Portfolio 
 $450,000 (current inherited RMDs $160,000) and traditional IRAs for the rest still 10 years from RMDs
$350,000 in Roths and HSAs
$250,000 in regular funds, emergency funds, a lot of this is sitting in cash already so no cap gains to pay
House – 300,000-400,000 no mortgage

I've read back over solo 401k threads but they all seem to devolve into backdoor discussions with some concern over big tax consequences if you don't understand the solo 401k rules. If I'm just doing a basic Solo 401K (with Roth options) and no backdoors am I likely to run into problems? I've always done everything myself - taxes, investments etc, spreadsheets are my friends.

I know I'll have to do something with the current SEP (although Google says SEPs are only 1 year plans anyway so I should be good if I don't put any new money into it during the year ) The plan would be to more of less officially close the SEP by transfering Fidelity SEP money to the new Solo 401K t-IRA account at eTrade and leave a 5 year SEP CD with the bank it's in until maturity in 2 years and then transfer it also. I don't see building this over the $250,000 reporting threshold in the few years we've got left but I know that's required as well as a closing report when we eventually roll it back to regular IRA/Roths.
Spirit Rider
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Re: Basic Solo 401k to get more $ into Roth

Post by Spirit Rider »

Pre-tax balances in all traditional, SEP and SIMPLE IRA accounts cause pro rata taxation with the Backdoor Roth. However, they have no effect on direct rollovers from a one-participant 401k to a Roth IRA to implement the MBR.

A one-participant 401k @E-Trade allows the election and use of their in-plan Roth rollover (IRR) feature. This allows Roth 401k deferrals and IRRs of the pre-tax employer contributions. This also allows increased Roth space without any pro rata taxation or the use of the MBR.

You are correct that a SEP IRA is only "maintained" for a tax year you make contributions for*. If no SEP IRA contributions have been made for the 2020 tax year, you can adopt a one-participant 401k and set a 1/1/2020 effective date.

*SEP IRA contributions made in 2020 for the 2019 tax year do not interfere with a 2020 one-participant 401k. There is no need to rollover the SEP IRA balance if the Backdoor Roth is not needed/used.
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tfb
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Re: Basic Solo 401k to get more $ into Roth

Post by tfb »

Jablean wrote: Tue Sep 15, 2020 2:34 am This year and for the foreseeable, my income has dropped and in so doing has left the ACA cliff to be easily managed on just one income.
When you are under the ACA cliff, contributing to a Roth 401k still decreases your tax credit by 10-15% of the contribution. It effectively raises your tax bracket by 10-15%, which makes your tax bracket not as low as it may seem. You may be better off staying with a traditional pre-tax 401k contribution.
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Topic Author
Jablean
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Re: Basic Solo 401k to get more $ into Roth

Post by Jablean »

tfb wrote: Tue Sep 15, 2020 10:10 am
Jablean wrote: Tue Sep 15, 2020 2:34 am This year and for the foreseeable, my income has dropped and in so doing has left the ACA cliff to be easily managed on just one income.
When you are under the ACA cliff, contributing to a Roth 401k still decreases your tax credit by 10-15% of the contribution. It effectively raises your tax bracket by 10-15%, which makes your tax bracket not as low as it may seem. You may be better off staying with a traditional pre-tax 401k contribution.
I may need more explanation on this. I think we are talking about how much of my ACA health insurance is paid for by the tax credit. In my state even skimming just under the ACA cliff I haven't had to pay any money toward health insurance. The credit has paid it all for the last two years. I think we paid 100 a month the prior year. Of course that may change with the rates in my state next year but for 2020 at least there is no health tax credit benefit to make less money. Now if I needed a gold insurance plan instead of run of the mill my answers might be different.
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Jablean
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Re: Basic Solo 401k to get more $ into Roth

Post by Jablean »

Spirit Rider wrote: Tue Sep 15, 2020 7:57 am Pre-tax balances in all traditional, SEP and SIMPLE IRA accounts cause pro rata taxation with the Backdoor Roth. However, they have no effect on direct rollovers from a one-participant 401k to a Roth IRA to implement the MBR.

A one-participant 401k @E-Trade allows the election and use of their in-plan Roth rollover (IRR) feature. This allows Roth 401k deferrals and IRRs of the pre-tax employer contributions. This also allows increased Roth space without any pro rata taxation or the use of the MBR.

You are correct that a SEP IRA is only "maintained" for a tax year you make contributions for*. If no SEP IRA contributions have been made for the 2020 tax year, you can adopt a one-participant 401k and set a 1/1/2020 effective date.

*SEP IRA contributions made in 2020 for the 2019 tax year do not interfere with a 2020 one-participant 401k. There is no need to rollover the SEP IRA balance if the Backdoor Roth is not needed/used.
So this made me think a bit more and I revisited the mega-backdoor. Decided that even if we could qualify I don't think I want to go through the hassle and timing. But it did make me look at the employer portion again because although I think I did see it went into the t-IRA side of the 401k (and discussions that this is why you don't want to use Vanguard for Solos because they don't allow you to have seperate accounts for the pre-tax t-IRA and post-tax Roth dollars in the Solo) but I had forgotten that in my calculations.

However looking at the numbers (tell me if I'm figuring wrong here):

DH & DW Roths 14,000 (this is all I can currently put into Roths)

or

DH Employee Solo Roth 401k - $19500
DH Employee catchup Solo Roth 401k - 6500
DH regular Roth --- 7000 (our taxable income after biz passthru should be around $41,000 (or AGI of $75,000) so no income limits)
DW regular Roth ---- 7000

for total Roth contributions of $40,000
Topic Author
Jablean
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Re: Basic Solo 401k to get more $ into Roth

Post by Jablean »

Since my goal is to equalize a bit more I think we would forego putting in the Employer contribution of 11,000. It would go in the t-IRA side of the Solo and yes would decrease some taxes now but if the 2026 rate increases go thru we'd be paying at 15% instead of 12% when taking it out.

I will be trying to convert some t-IRA to Roth in future years but with the ACA cliff there's not a lot of headroom for that so this big amount I can do using the Solo 401k seems a good deal.
terran
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Re: Basic Solo 401k to get more $ into Roth

Post by terran »

What is your total income? If it's low enough to get ACA subsidies it should also be low enough to make direct Roth IRA contributions without a need to backdoor.

As long as your husband has self employed income and no employees I don't see any red flags with opening an etrade solo 401(k). That's where I have mine. Unless your income is too high (out of the phase out range) tax deferred self employed retirement plan contributions reduce the Qualified Business Income deduction making Roth solo 401(k) contributions and traditional IRA contributions superior to the reverse.

Since you do your own taxes make sure you understand how to calculate the solo 401(k) contribution limits based on your husband's self employment income. Most tax software probably does it (not the Freefile version I use which is little more than the bare forms though), there are various calculators, or I use a spreadsheet I made out of the worksheet in Publication 560 because I like to understand what's going on more than putting a number in and getting a number out.
tfb wrote: Tue Sep 15, 2020 10:10 am
Jablean wrote: Tue Sep 15, 2020 2:34 am This year and for the foreseeable, my income has dropped and in so doing has left the ACA cliff to be easily managed on just one income.
When you are under the ACA cliff, contributing to a Roth 401k still decreases your tax credit by 10-15% of the contribution. It effectively raises your tax bracket by 10-15%, which makes your tax bracket not as low as it may seem. You may be better off staying with a traditional pre-tax 401k contribution.
This doesn't sound right. Are you saying that Roth 401(k) contributions reduce the ACA subsidy when compared to contributing to traditional (which sounds right to me) or do you actually mean they somehow reduce the subsidy compared to not contributing to a 401(k) at all (which would surprise me).

Jablean, either way, this is a good point to consider. I think tfb just means that compared to making traditional 401(k) contributions there's an extra "tax" in the form of lost ACA subsidies for contributing to Roth instead. I think this is 8-9% without a band and more if you cross one of the multiples of the Federal Poverty Level that pushes you over a cliff into a new band of subsidies. Here's a good exploration of the topic I've run across: https://seattlecyclone.com/marginal-tax ... r-the-aca/.
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tfb
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Re: Basic Solo 401k to get more $ into Roth

Post by tfb »

Jablean wrote: Tue Sep 15, 2020 10:38 pm In my state even skimming just under the ACA cliff I haven't had to pay any money toward health insurance. The credit has paid it all for the last two years. I think we paid 100 a month the prior year.
ACA health insurance rates vary greatly by geography, household size, and age. It's possible that when you choose a Bronze plan, the credit will cover 100% of the premium, but if your income is low enough you can also qualify for a lower deductible, lower co-pays, and a lower out-of-pocket maximum. That's worth money too. The best approach would be to estimate your income both ways (pre-tax or Roth) and get quotes from the ACA exchange using both income scenarios and see what you will get. The difference in health insurance rates and the difference in out of pocket expenses will be your extra tax for doing Roth versus pre-tax.
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tfb
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Re: Basic Solo 401k to get more $ into Roth

Post by tfb »

terran wrote: Thu Sep 17, 2020 9:19 am
tfb wrote: Tue Sep 15, 2020 10:10 am When you are under the ACA cliff, contributing to a Roth 401k still decreases your tax credit by 10-15% of the contribution. It effectively raises your tax bracket by 10-15%, which makes your tax bracket not as low as it may seem. You may be better off staying with a traditional pre-tax 401k contribution.
This doesn't sound right. Are you saying that Roth 401(k) contributions reduce the ACA subsidy when compared to contributing to traditional (which sounds right to me) or do you actually mean they somehow reduce the subsidy compared to not contributing to a 401(k) at all (which would surprise me).
The former, as the last sentence said the OP may be better off staying with a traditional pre-tax 401k contribution instead of Roth. The OP isn't contemplating not contributing to a 401(k) at all.
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mdchemist
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Re: Basic Solo 401k to get more $ into Roth

Post by mdchemist »

Given what you've stated, you're below the ACA cliff and have a household of two (or maybe three?), you appear to be in the 12% tax bracket. Your traditional IRA balance of $450,00 would result in RMDs starting at about $17,000 per year (depending on IRA growth and how much the inherited IRA is depleted) which is much less than the standard deduction for MFJ. Is there a reason you want to pay tax now in order to get more money into Roth accounts aside from trying to even out the traditional/roth balances?

You don't mention any pensions or how long you plan to work but assuming no pension and that you retire a few years before claiming social security, wouldn't it make more sense to continue making traditional IRA contributions so they can be converted to Roth in the 0% or 10% tax brackets?
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Jablean
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Re: Basic Solo 401k to get more $ into Roth

Post by Jablean »

Thanks for the links @terran I've got more reading to do on the IRS page but the other link seems to agree with me about Roths being good for those like me in the lower brackets already.

@tbd - good point on the other ACA effects for deductibles and out of pockets. I'm able to use an HSA eligible plan plus my state has it's own Medical Savings plan for expenses. I'll keep things in mind as we renew for next year.
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Jablean
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Re: Basic Solo 401k to get more $ into Roth

Post by Jablean »

mdchemist wrote: Thu Sep 17, 2020 9:56 am Given what you've stated, you're below the ACA cliff and have a household of two (or maybe three?), you appear to be in the 12% tax bracket. Your traditional IRA balance of $450,00 would result in RMDs starting at about $17,000 per year (depending on IRA growth and how much the inherited IRA is depleted) which is much less than the standard deduction for MFJ. Is there a reason you want to pay tax now in order to get more money into Roth accounts aside from trying to even out the traditional/roth balances?

You don't mention any pensions or how long you plan to work but assuming no pension and that you retire a few years before claiming social security, wouldn't it make more sense to continue making traditional IRA contributions so they can be converted to Roth in the 0% or 10% tax brackets?
Yep house hold of 3 MFJ and a DS21, no pensions. I'm not sure my DH will retire - he has to find his own replacement. Your points are all good to consider. I think the change to RMDs at 72 instead of 70 gives us a few extra years where we can both be on Medicare and not worry about ACA subsidies. DH63/DW59. To do the IRA/Roth rollover I would have to make sure to have enough cash on hand for yearly expenses so that I don't roll over so much that it gets me up in the higher tax brackets. I guess I'm going to have to look at retirement planners that take all this into consideration. I run my own excel tables looking at RMDs and SS but I haven't plugged tax consequences in, although as you say we may be on the low enough rung to not worry. I may trade in time to figure this all out (and some current tax benefits) for ease of use down the road. My DH and DS, while math aficionados, are not financial savants and getting them to even talk about this stuff is nose hair pulling.

There is thinking about inheritance consequences for the kid since we are older parents. Inherited IRA RMDs while navigating the ACA cliff added to my complexity
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Jablean
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Re: Basic Solo 401k to get more $ into Roth

Post by Jablean »

Spirit Rider wrote: Tue Sep 15, 2020 7:57 am Pre-tax balances in all traditional, SEP and SIMPLE IRA accounts cause pro rata taxation with the Backdoor Roth. However, they have no effect on direct rollovers from a one-participant 401k to a Roth IRA to implement the MBR.

A one-participant 401k @E-Trade allows the election and use of their in-plan Roth rollover (IRR) feature. This allows Roth 401k deferrals and IRRs of the pre-tax employer contributions. This also allows increased Roth space without any pro rata taxation or the use of the MBR.

You are correct that a SEP IRA is only "maintained" for a tax year you make contributions for*. If no SEP IRA contributions have been made for the 2020 tax year, you can adopt a one-participant 401k and set a 1/1/2020 effective date.

*SEP IRA contributions made in 2020 for the 2019 tax year do not interfere with a 2020 one-participant 401k. There is no need to rollover the SEP IRA balance if the Backdoor Roth is not needed/used.
I wanted to come back into the thread and thank you for this. I was getting ready to pull the trigger and then thought - oh no I did contribute to the SEP this year for last year - does that destroy my one year timeline. But I knew somebody had said something and yes you had covered that without my asking - yay! Thanks.

I had to run back through all my turbotax pdfs to see when we started a schedule C for him.

I am still trying to figure out how to answer question 10 (reason for applying) on the EIN application on DH's sole proprietorship. Is it for a pension plan? or other?
terran
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Re: Basic Solo 401k to get more $ into Roth

Post by terran »

Jablean wrote: Tue Sep 22, 2020 1:35 pm I am still trying to figure out how to answer question 10 (reason for applying) on the EIN application on DH's sole proprietorship. Is it for a pension plan? or other?
Will this be used for the 401(k) only (some people do this, I don't) or also for his business (I use my business EIN for my solo 401(k))?
Topic Author
Jablean
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Re: Basic Solo 401k to get more $ into Roth

Post by Jablean »

terran wrote: Tue Sep 22, 2020 2:08 pm
Jablean wrote: Tue Sep 22, 2020 1:35 pm I am still trying to figure out how to answer question 10 (reason for applying) on the EIN application on DH's sole proprietorship. Is it for a pension plan? or other?
Will this be used for the 401(k) only (some people do this, I don't) or also for his business (I use my business EIN for my solo 401(k))?
I wound up saying "for banking purposes" as they didn't give the pension plan option or other with the online application. Right now the only plan is for the solo 401k.
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