Executing Mega Backdoor Roth In Solo 401k

At the end of 2014, I amended and restated my solo 401k plan from a prototype plan sponsored by Fidelity to a prototype plan sponsored by Ascensus. I did that in order to enable non-Roth after-tax contributions for so-called mega backdoor Roth. See previous article Mega Backdoor Roth In Solo 401k: Control Your Own Destiny.

It’s been one full year. I went through the complete cycle from making the non-Roth after-tax contribution, distributing such contribution and earnings to a Roth IRA, to finally issuing a 1099-R as the plan trustee. This article documents the whole process. It will remind me what to do in the years to come. It also shows how it’s done in case others are interested.

I play four different roles in my solo 401k:

  1. as an employee participating in the plan;
  2. as the employer sponsoring the plan;
  3. as the plan administrator administering the plan;
  4. as the plan trustee investing plan assets.

I sign different documents, sometimes the same document twice, depending on which role I’m playing.

Elect Contribution

In a workplace 401k plan, you go to a website or you fill out a form to indicate how much you want to contribute to your 401k plan. For my solo 401k, I created a paper form as the plan administrator. I then filled it out as the employee and gave it to myself as the plan administrator.

Because I’m contributing my $18k to the plan at my day job, I chose to contribute 100% of my self-employment income as non-Roth after-tax contribution to my solo 401k. The election I made will stand for future years until I change it.

Send Contribution

My plan assets stayed at Fidelity. I opened new investment-only retirement accounts at Fidelity, one per participant per contribution type. I transferred existing assets to the new accounts.

I had to get a separate EIN for my plan. I already have an EIN for my business, but my business doesn’t own these accounts. When I had the plan under Fidelity’s prototype plan, Fidelity Management Trust Company (FMTC) was the trustee. The accounts were held in trust by FMTC. Now that I’m on my own, I needed an EIN for the plan itself.

Getting an EIN was quite easy, and it was free. I did it online with the IRS.

After I closed my books for the year, I used my spreadsheet Solo 401k Maximum Contributions to calculate how much I was allowed to contribute to my solo 401k. I created another form as the plan administrator to document the contributions by contribution type (employee after-tax versus employer profit sharing).

I sent a check to Fidelity together with its Investment-Only Retirement Account Contribution Form, which broke down the contribution to each account.

Invest

After the contributions were credited to each account, I logged in to Fidelity as the plan participant and I invested the contributions. This was no different than buying mutual funds or ETFs in a brokerage account.

Request Distribution

As part of the document package, Ascensus included a distribution request form and the IRS-mandated special tax notice. As the plan administrator I gave myself (the plan participant) the special tax notice together with a blank distribution request form. I filled out the distribution request form as the participant, requesting a direct rollover of the non-Roth after-tax contributions and earnings to a Roth IRA. I approved the distribution request as the plan administrator.

I then sent an Investment-Only Retirement Account One-Time Withdrawal Form to Fidelity. I already had a Roth IRA at Fidelity. I simply chose to distribute the entire non-Roth after-tax account (but leave the account open for the next year) in-kind as shares to the Fidelity Roth IRA.

After the shares were rolled over, I printed the transaction history that showed the value of the gross distribution and the original non-Roth after-tax contribution. The small amount of earnings would be taxable.

Issue 1099-R

When you do a rollover from a workplace 401k plan, the plan administrator will report it to the IRS and send you a 1099-R. When I’m administering the plan myself, I’m responsible for issuing the 1099-R and reporting it to the IRS.

I had to figure out what to put where on the 1099-R. The IRS has Instructions for Forms 1099-R and 5498. I read the first 17 pages for 1099-R. The pertinent part for what I needed to do is in just one small paragraph on page 5:

For a direct rollover of an eligible rollover distribution to a Roth IRA (other than from a designated Roth account), report the total amount rolled over in box 1, the taxable amount in box 2a, and any basis recovery amount in box 5. (See the instructions for Box 5, later.) Use Code G in box 7.

It’s all in the instructions. The hard part is to separate the wheat from the chaff and figure out which part applies. If I contributed $10,000 as non-Roth after-tax and I distributed $10,100, it’s just

  • The plan’s name and EIN as the payer
  • My name and SSN as the recipient
  • 10100.00 in box 1
  • 100.00 in box 2a
  • 0.00 in box 4 (no federal tax withheld)
  • 10000.00 in box 5
  • code ‘G’ in box 7
  • 0.00 in box 12 (no state tax withheld)

Once you know what to do, actually issuing the 1099-R is easy. I created an account at tax1099.com. They e-file 1099-Rs with the IRS (and some states) for $2.90 per form. I filled out the form visually. They would do the rest. I downloaded copies for the payer (the plan) and the recipient (the participant) as PDF files.

***

For $195 per year paid to Ascensus for document maintenance plus minimal cost for postage and issuing the 1099-R, I was able to put an extra chunk of money indirectly into my Roth IRA. It was quite worth it. Obviously if you want to play plan administrator and plan trustee yourself you have to know what you are doing. As the plan administrator and the plan trustee you also have other duties besides what I wrote in this article. If you don’t know how to play these roles, you can get help from a TPA (third-party administrator) for a few hundred dollars per year.

If your self-employment income is in the right range — not too low, not too high — it can be worth it to enable the mega backdoor Roth option in your solo 401k. You can use my spreadsheet Solo 401k Maximum Contributions to find out how much room you have for non-Roth after-tax contributions and then decide whether it’s worth the effort and the cost.

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Comments

  1. LiveFreely says

    Thank you for the very nice write-up as I am interested in the mega backdoor Roth as well. I have a full-time day job, but also have some unpredictable self-employment income. In the post, you mention that it might be worth it if the self-employment income is in the right range – not too low or too high. Can you please give some specific numbers? What level of income is considered not too low, and is still worth the hassle of establishing the mega backdoor Roth in solo 401k? Thank you very much for your insights!

    • Jon D says

      Over ~$200k in net self employment income could make the value of this strategy a moot point given other options.

      Under ~$10-15k (if you have a full time W2 day job) in net self employment income would likley be considered too low given expenses, hassles, etc.

      ^There could be exceptions to both of these. I can think of some, but these are some reasonable guidelines.

      Also it’s only worth while if you’ve used up all other alternatives (such as your elective deferral at work or in your own plan).

    • Harry Sit says

      LiveFreely – Use the spreadsheet linked at the end. Cell F29 shows the extra amount you can put into your Roth IRA indirectly via this move. I would say if it’s under $10k it isn’t worth the cost and effort. For someone with a day job and contributing the $18k max to the plan at the day job, Jon D’s range is about right. For someone only with self-employed income, the range is much narrower. It’s about $40k to $130k.

  2. Jon D says

    Some key questions:
    1) I’ve received opinions that in the case of a I401k there is no need for a separate EIN for the plan using this exact structure (doc service elsewhere, pension accounts from custodian). Another custodian agreed to take one without a separate EIN to “establish a trust”. Business EIN was sufficient. Can you comment on the legality of this?
    2) How important do you think maintaining deferral paperwork is with a I401k (assuming you don’t have pre vs post December 31st payroll period contributions)? Do you think payroll, transaction history, statements, and W2 all lining up and the fact that employee is also trustee is sufficient proof of intent to contribute?
    3) Any chance you can post a copy of the ascensus distribution form and IRS tax notice?

    • Harry Sit says

      1) The custodian will take it when they don’t do any tax reporting on the accounts. The question is when you issue a 1099-R for the distribution, whose tax ID you will use as the payer. The business isn’t paying you that money. The plan is. EIN is free. There’s no reason to skimp on it.

      2) When it comes to paperwork, the more the better. The contribution election has to be made before the end of the year. The best way to document it is just a piece of paper signed by you the participant. It’s free. If you want to contribute the maximum just say “100% of my pay subject to limits set by law.”

      3) I can’t post the form. The special tax notice is IRS standard text.

      https://www.irs.gov/pub/irs-drop/n-14-74.pdf

  3. Eric says

    I really LOVE this article, especially the 1099-R explanation. That’s one of the harder things in this process to understand. I went through the process of setting up a non prototype plan recently using your other article as a guide and using Nora (who you referenced) to help in the process. I would not have known where to start without your posts explaining the process, so THANK YOU!

  4. Khad says

    When I set up my Individual 401k with Vanguard, it was much simpler than what you describe. But apart from that, is there any reason to go through all that trouble versus simply making Roth contributions to my Individual 401k?

    • Jon D says

      What he is doing is for those that run into the maximum contribution limits and want to save more.

      Vanguard’s plan doesn’t allow what he’s doing.

    • Khad Young says

      Maximum contribution limits to what? Roth IRA? Roth Individual 401k? Just trying to figure out if any of the above would be helpful to me or not. I don’t believe it would be, but I appreciate the confirmation. Cheers!

    • TJ says

      Both! He’s maxing out $18k at work. The Mega Backdoor is in addition to any standard 401k and IRA space.

    • Khad Young says

      Got it. Thanks a lot, TJ. (And Jon D.) I guess I don’t have to worry about this quit yet. The hassle of it all sounds like a good problem to have, though, if and when I get to that point.

  5. TJ says

    It is frustrating that the self employed get significantly more tax avoidance opportunities. Why can’t we just have the same limits for everybody?

    • Harry Sit says

      It actually is the same limit for everyone. You just need a better employer. The previous poll showed that 40% of readers had access to mega backdoor Roth.

  6. Sit says

    Harry – I read you have used new EIN for the plan, I am little confused, I used my business EIN when I setup my plan with Ascensus and funded elective and nonroth accounts, Have I done anything wrong? would i have difficulty making the rollover to RothIRA and issue 1099-R to myself? I am yet to rollover nonroth. Thanks in advance!!!

  7. Sit says

    What in case of a big company offers nonroth on their 401k plan, how the 1099-R issued when an employee make a distribution when he get a chance?

  8. BRogers says

    “As the plan administrator and the plan trustee you also have other duties besides what I wrote in this article.”

    How difficult are these “other duties” and how would one go about learning how to do them? I’d like to utilize a Mega Backdoor Roth in my Solo 401k this year but am undecided whether I should attempt this myself or get help. I’ve been contemplating this ever since your previous, inspiring posts on the Mega Backdoor. This post had me decided to pull the trigger, until that penultimate warning paragraph anyway…

    • Jon D says

      Get help. Learn how they do it as they do it and then decide if you want to start doing it yourself after you understand it.

    • Harry Sit says

      Even when you use a TPA, you are still the official plan administrator and plan trustee. You will see what the TPA puts in front of you. After it becomes a routine in a year or two, maybe you will be able to attempt it yourself.

  9. Kate says

    Hello,

    I have a questions regarding your backdoor Roth article from 12/2014 (but can’t comment on that thread).

    Questions regarding step 1.
    1. How does one figure out how much of the traditional IRA is pre tax (vs. non deducible contributions) money that can be placed into the 401K (figure 1)? Is that something that fidelity tells you?
    For example, if I have a tIRA for 5 years and there are some dividends and interest that I have accumulated over these last 5 years, how do I find out what that amount is when everything is invested back into the pot?

    2. Is it possible to just empty of all the money from the traditional IRA into the 401k, without divvying up the pre tax and non deducible contribution? What are the pro/cons if this method (besides paying tax for the second time when distributing years later)?

    Thanks, sorry to hijack this thread.

    • Jon D says

      It’s supposed to be tracked on your tax return or your not doing it right.

      It’s form 8606. Ask your accountant about it.

    • Jon D says

      No.

      If you’re handling it yourself the distribution should be pretty quick after contribution and not much should have changed in value.

  10. Sit says

    Harry – I read you have used new EIN for the plan, I am little confused, I used my business EIN when I setup my plan with Ascensus and funded elective and nonroth accounts, Have I done anything wrong? would i have difficulty making the rollover to RothIRA and issue 1099-R to myself? I am yet to rollover nonroth., it’s single member s-corp. Thanks in advance!!!

    • Harry Sit says

      I took the trouble in getting a separate EIN for the plan because I believe it’s the right setup. It takes 5 minutes to request an EIN from the IRS and it costs nothing. I don’t understand the hesitation of just getting one for the plan. If you already used the business’s EIN to open accounts with the custodian, you can always have them change it after you get the new EIN.

  11. sit says

    In case of a major company offering nonroth option + a in-service distribution option – Any idea what an employee updates on box 1 (Payer) when issuing 1099-R?

    • Harry Sit says

      Just received a 1099-R from a major company’s plan. It had Fidelity Investments Institutional Operations Co. as the name of the payer. The EIN presumably belongs to this Fidelity entity. It’s not the same as the employer’s EIN on the W-2.

  12. Thinksnow says

    I currently have a W-2 job where I am maxing out my elective 401K contribution. I am starting a side consulting job and unsure at the moment how much I will earn. Am I correct in thinking that i can establish a solo 401K with Ascensus later in the year if my consulting income becomes enough to justify a solo 401k with after tax contributions? I believe I just need to establish the plan and make the election before 12/31/2016 and it does not matter when in the year I earn the income.

  13. Harry @ RSG says

    This is great, I think I’ll be able to use this. I have an llc as s corp for 2016 and I’m about to set up a solo 401k for it. I don’t have any w2 income and I’ll be paying myself $50k from my s corp.

    From your spreadsheet, it looks like that means I’ll be allowed to defer $18k of salary plus $12.5k of profit sharing plus $19.5k roth contribution.

    1. It sounds like it’s worth it for me right? So if I want to get help I need to find a TPA? I e-mailed Nora but never got a response. Any other options/leads?

    2. I also have my wife who I may be hiring for 2016 and could pay her a salary of $24k (just enough so she can defer $18k and profit share $6k), would I get to do $19.5k roth for her too and how would that change things?

    • Harry Sit says

      Just to be clear, that’s 19.5k non-Roth after-tax contributions, to be distributed to a Roth IRA. Plug her income into the spreadsheet. I assume she has another job. Is she deferring $18k there? The spreadsheet will tell you what she can do.

    • Harry @ RSG says

      Yes that’s correct, I’ll do $19.5k non-roth after tax contributions to be distributed to my roth IRA (this is the mega backdoor roth part right).

      I can also do a regular backdoor roth ($5.5k per person) too right?

      My wife is a student, so no day job income.

  14. Harry @ RSG says

    Update, spoke with Nora, she was having e-mail problems so follow up if you never get a response 🙂

    This seems like an absolute no brainer for me, I’m trying to find the downside. I have no day job income and if I pay myself $50k w2 income from my biz, I can defer $18k + $12.5k profit sharing with a solo 401k.

    If I set up a solo 401k with a TPA (Nora’s company would charge $775 setup plus around $4-500/year ongoing), I would then be allowed to roll over $19.5k to a Roth!

    Using your spreadsheet from another post, at an 8% return over 30 years, from just ONE year of contributions, I’d make $43,000 more vs investing that same money in a taxable account. Is there any reason not to do this?

  15. JR says

    I just started a job last year where I am paid through an S-corp in Texas. I am paid $167,500 through W-2 and $167,500 through K-1 distributions (both pre-tax and pre-expenses–S-corp “makes” $335,000 per year). I also started a solo 401k at TD Ameritrade (which I plan on maxing out at $53,000 per year–18k as employee and 35k as employer profit sharing). Would it be worth it financially for someone in my situation to move and restructure my solo 401k to allow for non-Roth after tax contributions (in order to make mega backdoor roth contributions)? I looked at the spreadsheet you have on the blog, but I’m not sure what qualifies as “compensation from self-employment” (just W-2 income or W-2 and distribution income [K-1])? Thanks in advance for your response.

  16. harry @ rsg says

    I was planning on doing this for myself this year for my llc as s-corp. I was also planning on hiring my wife and paying her $24k so we could deduct $18k + $6k. Still have to pay payroll taxes on that $24k but allows us to get extra pre-tax deferral.

    Now if I paid her say $40k instead, we could defer a total of $28k leaving $12k which would mean we could do the mega backdoor roth for her too on that $12k. So my question is, is it worth it ?

    Seems like it is since if I use your solo 401k vs taxable calc, and compare $12k roth vs $13,800 ($12k + additional payroll costs of 15% x $12k) taxable investment, we’d still come out about $10,000 ahead over 30 years.

    • Harry Sit says

      If she earns more than the Social Security wage base, the payroll tax is only 2.9%. Try to get at least one of you over that number from all jobs, currently $118,500.

  17. rj says

    Harry – It’s about new EIN for the plan.
    Are these the right steps to be followed for new EIN for retirement plan and relate to the existing business? and this new EIN is the one provided to Ascensus for setting up the 401k plan? Please advise me. Thanks,

    EIN application online has ‘View Additional Types, Including Tax-Exempt and Governmental Organizations’ —> Employer Plan (401K, Money Purchase Plan, etc.), it say – ‘If you already have an EIN for your business, you can use that EIN or you can apply for a separate EIN. Please consult with your retirement plan professional to determine whether you need a new EIN for your plan.’,

    On next pages, looking for responsible parties -individual/existing business; if you choose ‘Existing business’ and provide name of existing business and EIN and then select ‘I am the owner, trustee, or plan administrator for this plan’, it seems it’s going to create a new EIN for the retirement plan and it’s correlating to the business;

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