Today we revisit the issue of doing the mega backdoor Roth in a solo 401k for those of you who are self-employed. For more background on solo 401k, please read Solo 401k When You Have Self-Employment Income.
As I mentioned in the previous article The Elusive Mega Backdoor Roth, mutual fund and brokerage companies who provide solo 401k plans, such as Vanguard, Fidelity, Schwab, TD Ameritrade, and E*Trade, don’t allow non-Roth after-tax contributions in their packaged plans. If you want non-Roth after-tax contributions you will have to step up and take it into your own hands: get your own documents and administer it yourself or outsource the administration to someone.
Originally I thought the overhead of obtaining and maintaining your own documents would cost too much to make it worthwhile for a solo 401k plan. Reader Nora Bethman is the President of a third-party administrator (TPA) for retirement plans. She told me it wasn’t necessarily so.
How Much Room
Before we go into the details, let’s see how much room you have for non-Roth after-tax contributions in your solo 401k.
You have the most room if your income from your self-employment business comes to $50k to $70k per person. If you are getting much more than $50k to $70k per person, say $180k per person or more, you will be able to hit your maximum with your $18k plus employer profit sharing contributions alone. If you are getting much less than $50k to $70k per person, then after your $18k and employer profit sharing contributions there won’t be as much left for non-Roth after-tax employee contributions.
To get an idea for how much room you have for non-Roth after-tax employee contributions, use this spreadsheet:
The spreadsheet is per person. If both husband and wife work in the business, divide up the income and enter it once for each person. It works for both full-time and part-time self-employment. If you only have self-employment income, just set the day job related fields to zero. Also be sure to choose the right tab depending on whether you are taxed as a sole proprietor (“unincorporated”) or S-Corp or C-Corp (“incorporated”).
Because the scenarios can be complicated, the spreadsheet may not be accurate for every case. Be sure to double-check with a professional before you make contributions.
Value In a Roth vs Taxable
Each dollar you can put into your Roth IRA is more valuable than the same dollar left in a taxable account. Using the spreadsheet below, you will see it can be 28% more valuable in 30 years or 11% more in 10 years.
Because of the tax-free growth in a Roth account, you need $2,800 more today in a taxable account in order to match putting $10,000 in a Roth and letting it grow for 30 years. If you must pay a small cost get that $10,000 into a Roth, it will be worth it. The more room you have for non-Roth after-tax contributions in your solo 401k, the more valuable it is to add this feature to your plan.
Plan Document and Adoption Agreement
A service provider will provide you a plan document and an adoption agreement which enable the non-Roth after-tax contributions and the in-service distribution of such contributions and earnings thereon. You pay a fee for the document. You will be the trustee.
As laws change, you will be asked to adopt amendments. You pay an ongoing fee to keep your documents updated.
FBO Accounts Or Pooled Account
With the plan document and the adoption agreement, you can open Investment-Only Accounts at Fidelity, or Company Retirement Accounts at Schwab, and maybe at other places too. The custodian doesn’t handle tax reporting for these accounts.
With just one or two participants, I would open a separate account for each participant and each money type:
- husband pre-tax
- husband Roth
- husband after-tax
- wife pre-tax
- wife Roth
- wife after-tax
This way you can track each bucket separately. These separate accounts for each participant are also known as “FBO accounts.” Note the pre-tax, Roth, and after-tax labels are purely your own nicknames. The custodian only sees 3 accounts for the same participant. They don’t know or care which is which.
You can also open just one account for the entire plan (a “pooled account”) and have your TPA track the different buckets internally. Vanguard only accepts pooled accounts. For just one or two participants, it’s easier and free to track them with separate brokerage accounts, but you can’t do it that way at Vanguard.
As the trustee, you are responsible for putting the right amount in the right account and track the different tax treatment. When you make a distribution from the after-tax account in the plan to a Roth IRA, you or your TPA will have to send a 1099-R to the IRS and send a copy to the participant. If you do the 1099-R yourself, you can e-file it online at tax1099.com for $3 a piece.
If the plan assets exceed the reporting threshold, you still do the 5500-EZ the same way as you do today. See Form 5500-EZ For Your Solo 401k.
Document Service Fees
The fees below are of course subject to change by the providers.
National Employee Benefit Services charges $775 for the setup plus $100/year for maintaining the document. Full administration including one distribution and one 1099-R per year comes in under $500 per year.
Employee Fiduciary includes non-Roth after-tax contributions in custom individual 401k plans. They charge $500/year in base administration fees plus 0.08% of plan assets.
Ascensus charges $205 a year for document compliance services only. It doesn’t include administration. You still need to hire an administrator. Call 866-604-7402. Hat tip to Rox on the Bogleheads investment forums.
I went with Ascensus because I’m comfortable with administering the plan myself. While I was at it, I also enabled in-plan Roth rollover, which I may do in the future. I’m keeping my assets at Fidelity in separate FBO accounts for each participant and money type. For a rundown of the steps I took in doing it through Fidelity, see Executing Mega Backdoor Roth In Solo 401k.
Readers not familiar with how to administer a 401k plan should go with a TPA for a modest cost. Laws and regulations are complex. There are many ways to mess up. Get professional help if you’d like to pursue this option.
Say No To Management Fees
If you are paying an advisor a percentage of your assets, you are paying 5-10x too much. Learn how to find an independent advisor, pay for advice, and only the advice.
Mark Zoril says
Hello Harry. I am curious about the actual mechanics of funding this. Do you simply send in an excel spreadsheet with each contribution type (FBO) and dollar amount to Fidelity? Also, did you end up doing this for 2014 (I assume since this is a qualified plan that the plan needs to be established by 12/31 of each year to fund for that year?) or just going forward for 2015 and how frequently will you fund the account? Will you do it monthly, or more towards the end of the year? Thanks.
Harry Sit says
I haven’t done the funding part yet. I imagine you will have to send a separate check or electronic fund transfer to each account. If you make a spreadsheet, you keep it for your own records. The documents must be adopted before 12/31 to be effective for that year. I will fund the accounts once a year to keep it simple.
Mark Zoril says
Thanks!
dan23 says
Nice job putting this together. Do you still have to pay an actuary or some other party some amount of money for this or are the document fees the only extra fees you pay over a normal solo 401k.
Harry Sit says
I will only pay the $195/year document compliance fees plus $3 a piece for filing 1099-R. Others not confident enough in doing it themselves can engage a TPA for all-in under $500/year. The extra $300 isn’t bad for professional assistance to get it started. It’s also tax deductible as a business expense. After a few years if you see it’s easy enough you can take over the administration and only pay for document maintenance.
Anonymous says
There are a few items that should probably be cleared up since there is a lot of confusion here.
A) Third Party Administrator (TPA) and Recordkeeper are 2 different things. Ascensus document management service is a TPA service(1 of several services that fall under TPA). It’s just not a *recordkeeping* solution which is Ascensus’s packaged 401k that is worse than an ETrade solo (also simplified plan doc).
B) It’s really hard to envision a practical way to have a full recordkeeping solution that allows you to pick your own custodian/investment lineup/etc. Reason is that recordkeepers usually input the data to be tracked in their recordkeeping software while checks/transfers are being remitted/initiated via them which means they’re going to plug into their one size fits all custodian for that. The FBO system listed above by Harry is just a method to retain one recordkeeping duty yourself by making it “self evident” by looking at what is going into each specific FBO account. But screw it up and you can easily get challenged in the future and have your plan disallowed (which would really stink).
C) “Full administration” is basically defined as the full TPA list: document management + 1099 + 5500EZ filing [+ maybe] producing a loan amortization if desired (could also argue that is a recordkeeping duty).
D) Ascensus 401k document management service is you repurposing their large multi employee 401k plan document for solo plan needs which is fine. But if you’re talking to them about solo 401k’s they’re likely going to get confused and start trying to connect you with their solo 401k solution (which again is a restricted document and bundled platform).
E) ***Those that are pretty confused should tread very carefully here. Each person that does this is biting off the recordkeeper duties. This is easier to screw up than I think Harry wants to let on. Forget to notify your TPA or accountant that plan assets went over $250k assets and file 5500EZ = big problem. Forget to notify your TPA or accountant that you made a distribution and miss a 1099 and you have a problem. Lose a loan amortization and you have a problem. Make a small mistake on which account you remit a payment to and you have a problem. And your accountant is going to be very confused if you’re not on top of exactly what you did and why when they’re filing your tax returns and the wrong accountant/dynamic there could really, really screw things up.***
Harry Sit says
Anonymous – If you do your contributions, distributions, and loans through your TPA/Recordkeeper I don’t think you will run into problems. That’s why you pay them. They will tell you how much you send to which accounts. They will know when you need a 5500-EZ when they prepare year-end accounting. They will do the 1099 because they did the distributions. They will keep track of loans.
Anonymous says
Harry, none of the options you listed above are recordkeeper solutions. Solutions that have recordkeeping (which for most independent firms they use Sungard Relius as their recordkeeping software paired with an omnibus account) wont work with your choice of Schwab CRA, IO Fidelity, etc. Instead you will find providers who only use one platform. Furthermore, recordkeeping based solutions so far have been way too restrictive in their plan documents to even allow “Mega Backdoor” as an option.
In each case where Mega Backdoor is an option you’re talking about hiring a TPA in some limited capacity **and the business owner retaining recordkeeper status**. That means that they’re responsible for routing contributions. They’re responsible for routing distributions. They’re responsible for informing their TPA/Accountant of any 1099’s, they’re responsible for informing their TPA/Accountant of the end of year balance for 5500EZ, and **they’re responsible for furnishing adequate records to the IRS in the event the plan is ever audited. The TPA has no such responsibility in these arrangements.**
Harry, if you were to envision a scenario where you had a “recordkeeper”, how would it even work? If you line up your own Fidelity IO Account + a completely separate “recordkeeper” the recordkeeper wont have an institutional view across all of these accounts nor any limited power of attorney with the custodian granting them the ability to pull funds into the account on your behalf. How do you even expect them to see your account information to verify numbers are lined up? Account statements? Shared login credentials? I can assure you that is about 5+ times the workload you’re saddling them with over the way the industry traditionally works and the cost would be prohibitively high.
I’ve personally solved some of these issues on the institutional level, but it’s not as straightforward as you let on.
Anonymous says
In the case of Schwab (and I think the same for Fidelity) if you’re a TPA and/or Recordkeeper looking for an institutional relationship you have to bring a minimum of ~$30 million in assets onto their platform.
Someone opening a Schwab CRA (Or Fidelity IO) account and separately contracting a TPA and/or Recordkeeper wont have those assets count in that TPA or Recordkeeper’s total with said custodian.
Now pretend that you’ve got all of these small businesses demanding different custodians: Fidelity, Schwab, Vanguard, TD, IB, etc. Even if you did have assets that counted towards your totals with a custodian… you would have that number total divided up into numerous locations. Your staff would need to familiarize themselves with paperwork/norms/policies at each custodian and they would need to login to their institutional views at each and every one.
That is of course assuming you were able to even get those assets to count when someone opens a CRA or IO on their own (which they don’t) and were able to get an institutional view (which for the most part they can’t).
So you’re stuck either looking for packaged plans where people’s notions of cost need to be adjusted massively (either decent sized asset based fees or over $1k per year plan costs) to find anything out there that would allow after tax contributions and had recordkeeping included. Or the business owner is stuck being recordkeeper.
Harry Sit says
Anonymous – Contact the two providers I listed in this article and ask what responsibilities they take on and how they work with the business owner? A small plan doesn’t need daily valuation. “Routing” contributions and distributions isn’t a problem as long as you get clear instructions. For a one-person business, it can be as simple as contributing once a year and distributing once a year (for the mega backdoor Roth). “Informing” the TPA/Accountant just means a check-in once a year.
Business owner: “I’m ready to make my annual contributions and distribution now. What do I do?”
TPA/Recordkeeper: “Contribute $X to this account, $Y to this account. Distribute $Z from this account. Send me the statement when you are done.”
Anonymous says
I have talked to them before.
I agree that in a lot of cases self recordkeeping isn’t a hard task. I also agree that there are plenty of circumstances where the moving parts are kept to a minimum and don’t create many opportunities to screw something up.
I’m just saying that there are often numerous easy ways to screw something small up (particularly in a plan where Roth, profit sharing, and after tax are going on in same plan). The Ascensus solution isn’t going to help someone with that in any way. Since that is the cheapest option and the one most of the people in your comments immediately gravitated to… it might be worth pointing out that they’re CSRs aren’t going to help anybody with anything related to handling admin and recordkeeping properly.
PenServ’s EZK plan I think is a restricted doc/plan/custodian/etc. Even if it’s not the CSRs there are not going to hand hold newbies for $500 a year.
A tiny operation like Nora’s is basically the only people who will offer any handholding. The reason is that they don’t need to maintain robust systems/processes across hundreds of employees nor do they have to be 100% efficient with their time. But don’t be surprised when they realize that scope creep into loads of accounting, payroll, and recordkeeping questions *site unseen* causes them to rethink their cost structure.
Harry let me ask you this. For your plan that you’re using Ascensus for… did you roll over money into the plan from an IRA/401k/403b/etc.?
dan23 says
Thanks. Do you not need a TPA because it is just self and spouse and need them otherwise, or you never actually need a TPA (from a legal/tax rules perspective)?
Harry Sit says
A little bit of both. When you have employees there are many rules to make sure the employees’ rights and interests are protected. More participants also means more accounts to keep track of. I listed 6 accounts for self and spouse in the article. If you need to manage 15 accounts or 60 accounts it becomes unwieldy. While technically you can do it yourself, it’s more efficient to use a TPA. Without employees you have fewer rules to worry about and fewer accounts.
Anonymous says
How are you going to get a plan document without a TPA? No plan document and no volume submission to the DOL and you have no legal 401k plan.
Harry Sit says
Anonymous – Your definition of TPA isn’t my definition of TPA. Read it as Recordkeeper if you’d like.
Junior says
I was wondering if this makes sense to set up for a individual who has both 1040 and 1099 income. I fully max out my employee match at my 1040 job and have 1099 on the side that ranges from 10k-180k per year. I am the only employee and had a SEP-IRA now because I didn’t see much of a difference in contribution limits (since I max out the 17.5 with my employer already since I get a match on 6% of those funds). Would it make sense to now go through the process of setting up and maintaining the Solo 401K with this possibility of the mega backdoor ROTH? Thanks for all the post very helpful.
Harry Sit says
You use the spreadsheet to find out how much room you have and how much it’s worth. At $10k of 1099 income, you can put in maybe $8k a year as non-Roth after-tax contributions. At $180k, you can put in $16k. The real value is in the middle. If you have $90k in 1099 income, you can put in $34k a year as non-Roth after-tax contributions. I would say it’s definitely worth $500 a year in admin cost if you can do $34k a year. You decide whether it’s worth it if you can contribute only $8k or $16k.
Nora Bethman says
Hi Harry, I would just like to say thanks for mentioning my company, but I would also like to emphasize what was touched on in the comments, and that’s that you get what you pay for. My cost includes as many hours of phone and email client contact as is needed, research, answering questions and helping the client in any way I can. Ascensus will throw you an off the shelf document, and good luck getting a complex question answered. They won’t help you set up accounts, or tell you when a new IRS revenue ruling will benefit your particular situation. If you are sure you’ll never miss an IRS deadline, or fill out the wrong form, or make a mistake, then Ascensus is cheaper, but I’m not so sure it’s better, judging by some of the plans I’ve taken over from them and had to correct.
Junior says
Hello Nora. I tried to visit your site to leave a request for information and the fore would not submit. Since I am not near a phone I thought I would leave the request here. I am looking to set up a solo 401 k for myself and my wife that will allow non Roth after tax contributions. I am trying to accomplish the “Mega Backdoor Roth”. I want to make sure everything is done correctly so I was hoping for a scope and quote for services provided. Thanks
Larry Arbanas says
Excellent work! I have wondered for years how non-Roth employee after-tax contributions could be made to a 401k that is not provided by an employer. I was also interested in loan provisions.
On an initial review of the Ascensus PDQ forms presented on the web site for 401k plans and Individual 401k plans it appeared that the only contribution types allowed were (i) pretax elective deferrals, (ii) Roth elective deferrals, (iii) employer profit sharing contributions.
Non-Roth employee after-tax contributions, the subject of this blog entry, were not mentioned.
– Do you know if Ascensus has a separate plan to support these?
– Has Ascensus abandoned support for these since this blog entry was published?
– Am I misreading this some how?
Thank you for any information that you can provide.
Harry Sit says
You can make special requests in the plan design questionnaire in the notes section. When you submit it, make sure you call out those requests. If you have any questions just call them.
Siew Yean Lau says
Hi Harry,
I keep referring to your blog as my husband and I have been thinking of opening a solo 401k for him. He has a regular job as an employee and also a side job as an independent contractor making about 50k/year. I just contacted Ascensus for more information. They replied and showed us the kind of funds offered within the solo 401k they manage. The funds have high expense ratios, for example the Fidelity Target Date funds have expense ratios over 1%. They don’t offer Vanguard index funds. I find that very unattractive. I was wondering if you had a similar experience with them, and if you could share with us how you invested the funds within your solo 401k (that I you opened with them).
Thanks! Siew yean
Harry Sit says
I’m not sure which part of Ascensus you contacted. If you call the phone number I included in this article, and you tell them you only want the document service, they don’t manage your plan. You will be managing the plan yourself. You only get the documents and you open investment-only accounts yourself with Fidelity or Schwab following the links in the article.
If you have no experience in managing your own plan, I suggest going with a TPA.
Siew Y Lau says
Thanks Harry. I guess I thought they were a TPA. Can you recommend a reliable TPA? Thanks! Siew yean
Harry Sit says
I listed one in this article. I also heard of Penserv. I don’t have experience with either.
Anonymous says
They are a TPA. You’re just using them in a very limited capacity if your only using their doc management service (which is their standard multi employee document system).
Nora Bethman says
Junior, this is Nora Bethman. I’m sorry my website request for info form was not working properly. You can email me at [email protected]. Thank you!
broadreach says
Harry-
Great post. Can you comment on the mechanisms for rollover to Roth account once contributions are in the pre-tax and after-tax “sub-accounts” of the solo-401K:
The IRS website says that distributions from a 401K are considered a single distribution, allocated in pro-rated fashion between pre and after tax, even though the participant can direct the distribution to different destinations depending on pre or after tax status. The IRS Q&A states specifically that distributions from only the after-tax portion is not possible:
http://www.irs.gov/Retirement-Plans/Rollovers-of-After-Tax-Contributions-in-Retirement-Plans
Can I roll over just the after-tax amounts in my retirement plan to a Roth IRA and leave the remainder in the plan?
No, you can’t take a distribution of only the after-tax amounts and leave the rest in the plan. Any partial distribution from the plan must include some of the pretax amounts. Notice 2014-54 doesn’t change the requirement that each plan distribution must include a proportional share of the pretax and after-tax amounts in the account. To roll over all of your after-tax contributions to a Roth IRA, you could take a full distribution (all pretax and after-tax amounts), and directly roll over:
• pretax amounts to a traditional IRA or another eligible retirement plan, and
• after-tax amounts to a Roth IRA.
How do you plan to handle this?
Or do you plan to do plan to do an in-plan roth conversion of the after-tax contributions
Thanks.
Harry Sit says
A strict reading goes like this:
“Can I roll over just the after-tax amounts [without the earnings thereon] in my retirement plan to a Roth IRA and leave the remainder in the plan?
No, you can’t take a distribution of only the after-tax amounts [without the earnings thereon] and leave the rest in the plan. Any partial distribution from the plan must include some of the pretax amounts [i.e. the earnings on after-tax contributions].”
Anonymous says
Are you sure that TD Ameritrade doesn’t allow non-Roth after-tax contributions in the packaged plan? I was looking into theirs, and in the packaged plan I saw, it seems like section 3.10 calls out non-roth nondeductible employee contributions as allowed. Several other sections also reference employee nondeductible contributions.
Harry Sit says
Plan says “if elected in the adoption agreement …” but there is no way to elect such in the adoption agreement. That makes it all moot.
Anonymous says
Hm, yes. It seems strange to me that it makes such a mention, when there’s no mention of this in the Adoption Agreement. I suppose Ascensus (where I gather the document comes from) just uses one base document for effectively everyone, and gives different Adoption Agreements depending on what e.g. TD Ameritrade asks for?
There’s also a freeform “Other Plan Information” at the end of the Adoption Agreement. I assume the purpose of that is not to grant additional features like this…?
Also, I tried asking TD Ameritrade about this as well, to confirm with them, but they basically said they don’t deal with the fine print of any of this stuff, and they said they would not restrict contributions in this way (it’s up to the self-employed person to manage records for IRS interaction, etc). But I gather that you must follow what’s in the plan document, even if the custodian doesn’t enforce it, otherwise it’s considered an excess contribution or whatever.
(I’m just curious about this at this point; I’m not actually trying to shoehorn after-tax contributions into a plan that doesn’t seem made for it.)
Harry Sit says
Yes that’s how it works. Plan document has everything. The adoption agreement turns some of those features on and off. Not having it in the adoption agreement means the feature is off.
Nameless says
Thank you very much for the article. I had a question on the mega back door Roth for solo 401k.
Anyone know if you ccan make after-tax contributions with non-earned income?
Say you made 10 k in 1099 but want to max out to 53k with non- earned after tax dollars
Thanks
Harry Sit says
No. See calculator linked in the article.
pbs09 says
Harry – Congratulations, great work!! Can you comment on below –
If a single member S-corp had a 56k on W2 of off 80k revenue, offering 401k with nonroth option and wanted to contribute 18k elective and 35k nonroth; then this 35k must be pulled out of employee payroll as like elective deferral or is it okay to contribute from business account as it’s single member s-corp?
Is S-corp EIN and business name goes as PAYER on 1099-R when a single member S-corp offering a 401k with non roth option and in-service distribution and complete a distribution
What would be the due dates to issue 1099-R if we make the distribution before 12/31/15; or what if the distribution done before tax filing, assume between 01/01/16 thru 04/15/16; or what it is after tax filing, 04/15/16
What is the due date to contribute nonroth funds?
Harry Sit says
First of all you must have a plan like this in place by 12/31. It’s too late for 2015 now if you didn’t have it amended and restated by then. If you are setting it up for 2016, your TPA will guide you.
Sangeeta says
I have an income from a regular job which makes me in 40% Tax bracket.
1) I have 403(b) from employer with NO employer contribution where I put 18,000(I also have 457(B) but I donot contribute as the plan is not good.
2) My spouse works in VA and max out to her retirement Plan.(18,000)
3) We both have Back door Roth (from Non deductible Traditional conversion) for each of us of 5,500 at VanGuard
4) I started an Independent consultancy on the side where I expect Net business income =50,000
My question is do I need a TPA with this less income on 1099?If I open 401 SOLO with Vanguard and use your spreadsheet for UnIncorporated (?) and calculate the amounts and put in deductible=20% and 80% as Non Roth After tax to convert to ROTH.Am I right? I want to make sure that I understood it right.
Should I do it first to SEP IRA and then convert into Solo 401K?
Harry Sit says
Vanguard’s plan does not allow non-Roth after-tax contributions. If you want to do the mega backdoor Roth, you will need a TPA. Your $18,000 403(b) contribution counts toward your $53,000 maximum (only 403(b) counts; 401(k) does not). That leaves about $21,000 as your maximum non-Roth after-tax contributions. SEP IRA does not accept non-Roth after-tax contributions. No need to use a SEP IRA.
test says
Spreadsheet: Solo 401k Maximum Contributions
Looks this spreadsheet only contains numbers and there are no formulas. Do you mind to put the formulas there as well? Thanks!
Sangeeta says
Harry,
Sorry I had posted this on wrong thread: My question is below.Sorry to ask you the dumb questions but I am in learning stage,
On the spreadsheet,In Uncorporated, at the bottom you have mentioned :
1)Maximum Salary Deferral from self employemnt before catch up=0
2)Adjusted Net Business Profit after Elective Salary Deferral=49,330
3)Maximum Profit Sharing From self employment=9,866(19.732%)
4)Maximum catch up=0
I am confused in wording between #1 and #3 here.
Does it mean that I cannot have any contribution before tax OR does it mean that I can put 9,866 in tax deferred(tax deductible) contributions?Means how much I can deduct from my taxable self employment income? Or I can only do after tax contribution of 21,000 tobe converted to mega backdoor Roth.Thanks a lot!
Harry Sit says
You wear two hats in a solo 401k: as an employee and as the employer. #1 says you can’t contribute as an employee any more (because you already contributed the max to the plan at day job). #3 says how much you can contribute as the employer. That profit sharing contribution is tax deductible.
Thinksnow says
I am getting what seems like a funny result on the Solo 401k spreadsheet:
Salary Deferral in day job 401k, 403b or SIMPLE IRA (not 457) 18,000
Is the salary deferral above made to a 403b plan? no
Employer contribution to 403b plan 0
Are you age 50 or over this year? (enter yes or no) no
Compensation from self-employment, before salary deferral 60,000
Maximum Salary Deferral from self-employment 0
Maximum Profit Sharing from self-employment, after maximum salary deferral 15,000
Non-Roth after-tax contribution if plan allows 38,000
It thought my Non-Roth after tax would be limited to $20,000 with my $18,000 day job 401K deferral to stay under $53,000.
Harry Sit says
It’s not a funny result. Each unrelated employer get a separate $53,000 limit.
Thinksnow says
Harry, thanks for the correction. I should have known better and mentioned that you would likely tell me the calculation is correct and I was just confused.
In all my reading on solo 401k’s/backdoor roths I missed the point that the limits don’t follow the same rules as the employee deferral limit. I found a post on bogleheads where you point out the reference 415. Thank you for deciphering this as it doesn’t really doesn’t jump out as obvious. Reading law makes IRS pubs seem like a child’s books.
The White Coat blog has a pretty comprehensive post on multiple 401k’s.
With the right setup of employers, self employment, and partnerships you can put a heck of a lot in a 401k. If only my day job offered after tax contributions.
Viral says
Harry:
Thank you for this article. Much appreciated. I have a day job and also a side business with solo401k via Vanguard. I am curious to know what formula you used to calculate after-tax contribution.
Is there a limit on the after-tax contribution to 401k depending on the business income?
Harry Sit says
All types of contributions to the plan added together (except catch-up) can’t exceed the smaller of (a) your net business profit after expenses minus 1/2 of your self-employment tax minus employer profit sharing contributions; and (b) a limit set by law, adjusted for inflation annually ($53,000 in 2016).
Alan says
Harry – wanted to add another plan document provider I have found in my research – Discount Solo 401k (https://discountsolo401k.com). At $575 ($25 discounts available through some channels) for the initial cost and $100 a year to maintain it ends up cheaper than Ascensus at 6 years.
I haven’t initiated with them yet but so far they have been responsive and appear knowledgeable.
AK says
Harry,
Thanks for all the wonderful articles you publish. I’ve read your Mega Backdoor Roth articles a few times now and have a few questions.
I’m a Single-owner, S-Corp that began in August 2016. I currently have no solo 401K and am researching what I’d like to do here. I’m projecting having income between 150-170K, paying myself a salary around 80K, and having business expenses around 10-20K.
I plan on deferring 18K for employee pre-tax, 20K for employer, which leaves around 15K for aftertax, non-roth contributions to fill the 53K total contribution limit.
1) For the aftertax, non-roth contributions, do they have to come from payroll contributions or can they come directly from my personal bank account into the after-tax, non-roth account, or perhaps both?
2) If I have my own solo 401K with a custom plan document that has the provisions to allow the mega backdoor roth and I only take distributions from the separate after-tax, non-roth account to roll it over to a roth IRA, are those after-tax, non-roth distributions subject to the pro-rata rules? The IRS Notice at https://www.irs.gov/pub/irs-drop/n-14-54.pdf seems to imply that the pro-rata rules would still be applied. However, other sites seem to imply that the after-tax, non-roth distribution would not be subject to the pro-rata rules.
3) Any other consideration should I be thinking about given my situation?
Harry Sit says
AK – 1) Payroll. 2) The pro-rata rules would still be applied, but only within the non-Roth after-tax account. Earnings on the non-Roth after-tax contributions must be distributed together with the non-Roth after-tax contributions. 3) You should work with a third-party administrator to make sure you are taking all the necessary steps to properly administer your solo 401k plan.
Thinksnow says
I just called Ascensus to get more information on their document services. I initially asked about a solo 401k with that allowed after tax contributions. They said they do not offer this under the Solo 401K services, but instead through their regular 401K document service. It is just a small semantics tip for anyone calling them. I believe this distinction is only from their service perspective and that from an IRS standpoint you are a solo 401k by the fact that the only you and maybe a spouse are participants.
Thinksnow says
I called Penserv to find out information on their services. They offer a solo 401K document for $500/year. I asked about about non-roth aftertax contributions and was told this was not an option in their plan. I was also told that they don’t offer any form of plan administration for solo 401k’s.
I was talking to someone seemingly focused on Solo 401K’s, so maybe I was talking to the wrong group. At the moment it doesn’t look like they are an option unless someone can identify the correct contact.
Harry Sit says
Thanks. I replaced PenServ with Employee Fiduciary as an option. Employee Fiduciary confirmed with me in an email they support non-Roth after-tax contributions in their $1,500/year full-service administration but not in their $200/year individual 401k plans.
Thinksnow says
I am working my way through the Ascensus 401K plan establishment kit. What did you enter for the “Employer Account Number (financial organizations account number)”? I called and they suggest that this should be provided by my financial adviser, which doesn’t make sense in the case of a self administered plan. How did you manage this?
Also, did you list yourself as a trustee or check the trustee exempt option for self employed? I would assume with the trustee exempt option, they would just list you as the trustee in the plan documents.
I called and got incomplete explanations of how these two items are used in the plan documents.
Harry Sit says
I left “Employer Account Number” blank and I listed myself as the trustee.
tanvi says
I am still looking into whether to do sep IRA or solo 401 k- can you advise what should we do on top of what we are already doing?
and also see if mega backdoor entry roth is a worth while investment for us – for which we would need your service.
current scenario:
my husband is a physician and I am a pharmacist- our net income this year is 650,000
I contribute 18k with 5 % match at my employer with NO self employment income
+ 5500 Back door entry roth after tax at Vanguard.
my husband: works full time but starting some side physician practice this year still in the built up but he expect to make atleast 70-90 k next year. This year total self employment income will most likely come to 40,000 max.
He contribute 18K via employer towards 403b + 5500 back door entry after tax roth
so for his contribution towards solo 401k for the self employment income as employee is 0
As Employer he can contribute 20% of 40,000K – right? (~ 8000k) he anticipates to grow to atleast 70-80 k by next year.
Would it be beneficial to initiate the mega backdoor entry roth process this year? or wait till the next year?
and also what exactly do you do – step for megaroth- what does the TPA exactly do- full service. one.
do you have to choose your own banks like fidelity or scwabb open those3 accounts for him- first after obtaining the separate EIN or do folks like Nora take care of everything from guiding you step wise- opening accounts to everything?
Your advise will be appreciated.
thanks
Harry Sit says
If your husband doesn’t already have a solo 401k plan with the non-Roth after-tax contribution feature, he’d have to really rush to set one up. The plan must be established by 12/31 if he wants to make the employer contribution based on his self-employment income this year. The employer contribution amount will be the same between a solo 401k and a SEP. However the SEP will interfere with his $5,500 backdoor Roth. So he’s better off doing a solo 401k even without the non-Roth after-tax contribution feature. If he wants that feature he might as well do it from the start. That will open up over $30k in mega backdoor Roth this year.
Contact Nora and ask what she will help your husband with, what he will have to do himself, and whether/how he can still have the plan set up before the end of the year.
tanvi says
I emailed Nora- but she didn’t answer about 3-4 days ago.
But in short go for solo 401k as a last minute resort, to avoid mess up with backdoor entry..
1) however if in future- the self employment income stops and we do decide to ROLL over to IRA- then we would need to hold off on doing the backdoor entry ROTH for that particular year that we roll over to IRA for my husband right or would it take into account all the money we have in ROTH IRA via backdoor entry? because otherwise we would end up paying taxes on the money we have rolled over into the ROth so far- wouldn’t we?
2) Is there another way to contact NORA to see if we can get this rolling for this year?
3) What would you recommend for solo 401k keeping all of the above factors in mind- which institution /bank should I choose for solo 401k to go for if we were going to do the MEga roth in the future anyways?
4) How much time is acceptable for solo 401k- in terms of income interruption?
5) basically how often do you need to make distributions to the 401k plan can you wait till the close of the end of the year to estimate income and then put in at one time in your 401k plan?
6 ) for Mega Roth- would that affect the backdoor entry roth money we have been putting in for the past 2 years?
Harry Sit says
If he doesn’t want the solo 401k any more, he can also rollover to his employer’s 401k plan in order not to interfere with the backdoor Roth. If he rolls over to an IRA, it only affects backdoor Roth in that year and future years, not retroactively.
I have no business relationship with Nora. I see a phone number on her business website. https://nebspensions.com/Contact_Us.html
I used Fidelity and I’m satisfied with their service.
tanvi says
sorry I have one more question about the solo 401k to complicate further we established an LLC (for liability reason) about 1 month ago for his self employment for which I have the EIN number.
I was also a member of the LLC but he is the one working and sole proprietor- we still have to get a court order saying he can operate as sole entity but is operating under the LLC so he does not need to change any billing and other things
But in this case although I am the member.. I want the 401k for him under his name- how does it work- can he still apply for EIN as sole proprietor or he needs to use LLC- if I choose LLC it asks me for Members- and technicaly although the LLC has been establish he is not using it for his insurance biling purposes
Can I use the EIN for LLC to open the solo 401k plan or should I obtain a sole proprietor EIN for him?
Harry Sit says
I don’t understand what the LLC does for you if it’s not used anywhere. If it’s not used the LLC has no income, and nothing to make employer contribution with. A solo 401k is under an employer’s name. Inside the 401k there are accounts for the participants. It seems to me he’ll have to make the plan under a sole proprietor until the income is switched to the LLC, but I’m not a lawyer nor a CPA.
Anonymous says
Hi Harry,
I have been doing back door roth of 5500 which i did for this year too.
It is with Vanguard
1)Can I still do Mega Backdoor for my part time business based earning?
2)Should I do it for amount equal to cell F31 in your spreadsheet?
3) Because Nora has refused to do it for this year at the end of tax season, Can I do it myself with Ascensus and then do investment after Dec31 before April15?
I am not interested to invest tax deduct amount for business as I already maxed out my 401k at my day time job.But I just want to do mega backdoor roth part.
Harry Sit says
You aren’t familiar with administering a 401k plan. You can’t do it yourself with Ascensus. Work with a TPA for 2017 then.
Dave says
Hi All,
I’m about to start my own solo consulting firm. I’m trying to determine the best set-up to take advantage of the Mega Back-Door Roth. Upon starting, I’ll have already filled 2/3 of my 401k for the year (12,000, pre-tax) at my current employer.
Data:
– I expect the consulting gig to bring in $100k+ on an annualized basis.
– I intend to file my taxes as an S-Corp, to minimize self-employment
– Will defer the full $18,000 in EE 401(k) deferrals
– Will fill my Roth IRA with the full $5,500
What are the differences if I set up a Solo 401(k) or SEP IRA?
Harry Sit says
The difference is there is no way to contribute the employee $18,000 or any non-Roth after-tax money to SEP IRA.
Thinksnow says
Dave,
Will you be doing this as your only source of income or as a side gig?
Solo 401K will allow for a backdoor Roth IRA where a SEP IRA will count pro rata for the conversion.
SEP is limited to the lesser of $54K or 25% of income.
Solo 401K with aftertax contributions will allow contributions up the lesser of $54K or net adjusted business profits.
With an S-corp you must pay yourself a reasonable salary. Depending on the nature of your work, it may be difficult to justify a salary much less than your consulting rate, particularly at only 100K/yr if it is full time. When you are consulting, most of your business revenue is based on your personal time value which you would normally be compensated for. If you utilize something like specialized analysis software that the business owns, revenue would be based on both your time and the value added by utilization of the software which gives some basis for not all revenue becoming income.
Thinksnow says
Do after-tax contributions get reported on your tax return? They shouldn’t have an impact, but I thought they would be reported to check against the contribution limits. I am using H&R block and didn’t see a place to report the after-tax contributions and am thinking I missed something.
Harry Sit says
They are not reported on the personal tax return.
DJ says
Is there a point to having a Roth 401k if you’re looking to mega backdoor anyway?
Harry Sit says
When you are setting it up you might as well include that option even if you don’t see a need for it now.
David Ann Arbor says
When you state, “I would open a separate account for each participant and each money type”
Pre-tax, Roth, after-tax… Note the pre-tax, Roth, and after-tax labels are purely your own nicknames.”
Does that mean Fidelity doesn’t realize the account you designate a Roth account is a Roth account? same with the Pre-tax account? Isn’t that something the IRS is somehow required to know about? Or does the IRS not need to know this, they just need to know you comply with the IRS rules and the 401k document is compliant ?
Harry Sit says
When Fidelity is the trustee (in their off-the-shelf plan), they need to know. They only offer pre-tax in their off-the-shelf plan so they don’t have to track different types. When you are the trustee, you (or your TPA) need to keep track; Fidelity doesn’t track any more. You are responsible for reporting to the IRS.
David Ann Arbor says
I’m a self-employed sole proprietor.
I won’t be able to exactly know my after tax contribution until January when I calculate the business income.
Do I have til tax day 2018 to do my 2017 after tax contribution folllowed by immediate Rolling into the Roth account ? And if I can Is the 1099-R due in 2019 or 2018 ?
Harry Sit says
Yes you can do it in 2018 before filing taxes. For a 2018 distribution from the plan, the 1099-R is due to the participant by Jan. 31, 2019.
David Ann Arbor says
The application for the non-prototype plan asks if one wants a pooled or an FBO account.
When I call up Fidelity, they state I need to do 3 separate non-prototype plan applications for the 3 accounts.
In your explanation you imply 1 non-prototype plan application provides the 3 sub accounts as long as in the application it is designated FBO. Since these are individual 401k plans – these two designations – Pooled or FBO – don’t seem to mitigate the need for 3 separate applications to be able to acquire 3 separate accounts.
Harry Sit says
I didn’t imply it. The word “application” didn’t appear in the article at all. For each account you open you need to fill out an account application. That’s normal for any type of account. A pooled account can reduce the number of accounts and the number of applications you need to fill out. You can have just one pooled account when you have a TPA tracking who owns what in what money type within the pool.
Christy says
Thanks for this article. It was very informative.
I have a logistical question. I currently have a solo 401K that is all pre-tax contributions. It does not allow for voluntary, non-deductible contributions. I am happy with this custodian and investment platform.
Could I set up a second solo 401k with Schwab using their CRA platform with a plan agreement set up by a firm such as Ascensus to allow for non-deductible contributions and in-service withdrawals to allow the funds to be converted to a Roth IRA with Schwab?
My basic question is can I have two, current solo 401ks with two different custodians that allow for different plan provisions (voluntary contributions and in-service withdraws)? It would make record keeping very straight forward as all pretax, deductible contributions are in one account with one custodian and the “Mega Back Door Roth” part would all be with Schwab.
Thanks for your help!
Harry Sit says
It’s theoretically possible but I don’t recommend it. Each plan is a separate legal document. Having two plan documents just makes it unnecessarily complicated. If you are going to use Schwab CRA for non-deductible contributions, you can just open another CRA and transfer in the pre-tax assets. If you really want to keep the pre-tax assets at the current custodian, convert the existing account to a CRA type of account at the current custodian. Ideally you have one plan document and one custodian (either Schwab or existing, pick one). Worst case you have one plan document and two custodians (both CRA-type accounts). The last thing you want is two plan documents and two custodians.
Eric says
Let me start by saying you have done the best job describing the details of the Mega Backdoor Roth of anyone that I have found on the internet –nice job.
I am trying to figure out how to optimize my Solo 401k, contributions. I am in the process of setting up a solo 401k for my S-Corp with MYSolo401k. I want to maximize my contributions while minimizing my taxes. I am soon to be 49 years old and my wife is 46. I have decent flexibility as I can set my compensation to be pretty much anything up to about $100k for 2017. I can also split this 100k between my wife and I. I don’t have much more income than $100k in my S-Corp to play with this year, although this is a side gig so I don’t need the income to live. My primary employer doesn’t offer a 401k so I don’t have to worry about balancing contributions with another employer/plan.
My dilemma is determining how to split the employer contribution portion. I am fortunate that I can decide not only how much to pay myself and wife, but I can also decide if the S-corp kicks in an employer match or not (upto 25% of Employees compensation).
Option 1
Take $54K in compensation for myself and my wife and 100% defer it, $18k per person as pretax Employee contribution and $36k in after tax contribution, which I would immediately do a “in service distribution” to roll into our Roth IRAs (aka Mega Backdoor Roth). The advantage being I would maximize our after-tax Roth contribution. The downside would be missing out on the tax benefit of reducing the S-corp income by the employer contribution portion (upto 25% of each our compensations $54K*.25=$13.5k) in this example $13.5K each. Of course the $13.5K would be pre-tax into each of our Solo 401k accounts instead that portion going into our after-tax contribution and ending up in my Roth IRA.
Option Two,
Take $54K in compensation for myself and my wife and 100% defer both, $18k per person as pretax Employee contribution and have an employer match of ($54k*.25) $13.5k as an additional pre-tax contribution ,making the total pre-tax contributions $31.5k (as appose to $18k in option 1) and an after-tax contribution $22.5k to max out my contribution at $54k. This approach increases the pre-tax contributions and increase the S-Corp’s expenses, hence reducing the S-Corp tax liability, but reducing the amount eligible to contribute to the after-tax contribution.
I think option two is the better than option, because this would allow me to lower my current tax liability, even if that reducing the amount I able to go into my Roth. Does this logic make sense, or should I max out my Mega back door Roth? I fully admit this is a great problem to have and even if I don’t make the most optimal choice, I am still grateful to have the opportunity.
Harry Sit says
Option 2 is better but the numbers you gave requires more than $100k from the S-Corp. You would need $108k for the salaries, $8k for employer part of the Social Security and Medicare taxes, plus $27k for the profit sharing, for a total of $143k. If you really only have $100k for everything, you will need to lower the salaries. You also need to withhold the employee part of the Social Security and Medicare taxes from the paycheck.
Eric says
I won’t know exactly how much I will have until closer to the end of the year, although you bring up some important points I failed to consider. Can I make the non-Roth after-tax contributions after Dec 31, but before the tax filing deadline or is the employer contribution portion the only portion that can wait until the filing deadline? Thanks for all you incredible insight! -Eric
Harry Sit says
The non-Roth after-tax contributions can only come from the S-Corp payroll. Just like when you work for someone else, you have to sign a form ahead of time to declare how much you’d like to contribute from your pay before you get paid. The S-Corp payroll drives the W-2. I don’t think you can run it after Dec. 31.
David Ann Arbor says
I’m trying to do the calculations on the spreadsheet and I’m coming up with something less than what you stated earlier, “All types of contributions to the plan added together can’t exceed the smaller of (a) your net business profit after expenses minus 1/2 of your self-employment tax; and (b) a limit set by law, adjusted for inflation annually ($54,000 in 2017).”
I’m using 2017 numbers. If I set the day job wages down to only $5,000, and the salary deferral for that day job is $0, yet keep the business income at 50,000, I come up with a total that is lower than letter a. formula above. I’m maxing out the salary deferral ($18,000) and including a catchup provision of $6,000. The profit sharing contribution is $9,294.
The non-Roth after tax contribution is only $3,881
Salary deferral of $24,000 + employer contribution of $9,294 + after tax of $3,881 = $37,175
This is $9,293 less than the adjusted net business profit(less 1/2 of your self-employment) of $46,468
I could use some help.
Thank you.
Avi says
David – you can’t contribute more than your total ‘compensation’ either and employer contributions are not considered part of your compensation – see the IRS explanation here: https://www.irs.gov/retirement-plans/one-participant-401k-plans
David Ann Arbor says
The employer profit sharing contribution was already taken into account in my calculation.
Salary deferral of $24,000 + employer contribution of $9,294 + after tax of $3,881 = $37,175
$46,468 = adjusted net business profit.
Avi says
No, you need to subtract the employer contribution of 9294 from your 46,468 to come up with your compensation as a self-employed individual which serves as a cap on total contributions of 37,174 (I assume the $1 difference is due to rounding somewhere). Your contributions + employer contributions can’t exceed that number.
The only thing I’m not certain about the the certain about is whether the catch-up contribution is included against that cap or not.
David Ann Arbor says
So after that employer contribution is deducted and leaves $37,174 left over, then $24,000 is deducted from that, and leaves $13,174
Otherwise you’re suggesting the employer contribution is being deducted 2 times.
Avi says
It isn’t that the employer contribution would be deducted twice it’s just a result of how compensation is calculated for purposes of the 415(c) limits (which is 55000 or 100% of ‘compensation’) as described in 401(c)(2) in particular where it says to account for employer contributions in (A)(v). This is the same reason that we use 20% to determine the employer contribution instead of 25% – the compensation of which we contribute 25% excludes the contribution itself leading to it being 20% of the total net earnings.
All this is just to illustrate that tax law is complicated and spinning your own 401(k) puts you deep in it. Which is why it is really great that we have resources like this calculator to simplify it and lead us to probe further into what drives it.
David Ann Arbor says
But the employer contribution was taken into account by the calculation. The after tax contribution is not based on a % calculation like the profit sharing is calculated. It’s simply the remainder of what’s left over.
Harry Sit says
Avi – Now that you mentioned it, I think the catch-up is not included in the test for 100% of compensation. It looks like the calculator included it. I will have to fix it.
David – In an odd way the employer contribution is used twice in the equation.
Avi says
Right, it isn’t calculated as a % but the total amount that can be contributed to the plan on your behalf (which includes your salary deferral, voluntary contributions and employer contributions) is limited by section 415(c) to either $55,000 or your ‘compensation, whichever is lower. ‘Compensation’ for those purposes (defined in 401(c)(2)) are calculated the same way they are for determining the ‘compensation’ upon which the employer can match 25% and that definition excludes the employer contribution from compensation.
To illustrate, if your adjusted earnings are $1,000 and you want to do the maximum employer match off 25% your ‘compensation’ will be $800 and your 25% employer contribution will be $200 (20% of adjusted earnings) and the total limit for the plan of all contributions will also be $800.
David Ann Arbor says
You’re creating an artificial 2nd limit that doesn’t match with Harry’s original formula that I mentioned at the beginning.
“All types of contributions to the plan added together can’t exceed the smaller of (a) your net business profit after expenses minus 1/2 of your self-employment tax; and (b) a limit set by law, adjusted for inflation annually ($54,000 in 2017).”
If the compensation is $800 after business profit sharing is taken into account, then $800 is the limit for salary deferral and voluntary after tax contributions. You can’t then state that an additional profit sharing has to be portioned out of that $800. It simply makes no sense.
It runs counter to the way Harry’s excel spread sheet worked last August when I used it.
Avi says
I’m not the one who created that artificial limit – that is the tax code:
26 U.S. Code § 415 (https://www.law.cornell.edu/uscode/text/26/415)
(c) Limitation for defined contribution plans
(1) In general Contributions and other additions with respect to a participant exceed the limitation of this subsection if, when expressed as an annual addition (within the meaning of paragraph (2)) to the participant’s account, such annual addition is greater than the lesser of—
(A) $40,000, or
(B) 100 percent of the participant’s compensation
The $54k limit is (A), there is an additional limit (B) which is what is capping the amount you can contribute.
David Ann Arbor says
And it says there’s an exception for self employed
“Special rule for self-employed individuals
In the case of an employee within the meaning of section 401(c)(1), subparagraph (A) shall be applied by substituting “the participant’s earned income (within the meaning of section 401(c)(2) but determined without regard to any exclusion under section 911)” for “compensation of the participant from the employer”
Avi says
That’s right – now go look at 401(c)(2) (particularly (A)(v)) here: https://www.law.cornell.edu/uscode/text/26/401
Harry Sit says
David – It’s my fault. I should’ve described the compensation piece better.
David Ann Arbor says
So do you know whether the catch-up is not included in the test for 100% of compensation?
And will the excel spreadsheet be fixed to reflect that?
Harry Sit says
David – For a W-2 employee, the catch-up is not included in the 415 test for 100% of compensation. However when the compensation is low enough the employee isn’t able to contribute the full catch-up because the catch-up itself still has to come from the compensation. So it’s included in a different way. For instance if a W-2 employee makes $20k, receives $2k profit sharing, and defers $18k, the maximum catch-up will be only $2k. The total contribution is $22k, which exceeds the $20k compensation, but the total employee contribution is still capped at $20k. The equivalent sole prop would have $22k in profit minus 1/2 SE tax, receive $2k profit sharing, and defer $18k plus $2k catch-up. The total including the catch-up still does not exceed the $22k in profit minus 1/2 SE tax.
Avi says
David – When did you make the 2016 and 2017 contributions?
David Ann Arbor says
Ok thanks Avi it looks like I’ll be ok because:
$57,667 Net Business Profit
$ 4,074 Deductible Self-employment tax
$53,593 Adjusted Net Business Profit
————————————————–
$10,719 Maximum Profit Sharing
$42,874 Employee Compensation
————————————————–
$18,000 Employee salary deferral ($6,000 >= age 50 is not included in the 415c limit)
$10,719 Employer profit sharing
$14,155 Employee after tax voluntary contributions
I only contributed $12000 Nov. 2017
wudged says
Not trying to argue, just trying to understand: Bringing back up the “double” deduction of the employer profit-sharing contribution in order to determine self-employed compensation – you mention Section 401(c)(2)(v) is what defines this.
This says “with regard to the deductions allowed by section 404,” and that section seems to apply to trusts and annuities. Does this still apply to qualified plans such as a 401k?
Avi says
Qualified plans under section 401k are a form of trust plan that is covered by section 404.
Harry Sit says
wudged – The first sentence in the general rule under 404: “If contributions are paid by an employer to or under a stock bonus, pension, profit-sharing, or annuity plan, or …” Profit sharing is right there in the list. The typical 401(k) plan is a profit sharing plan with a cash or deferral arrangement.
David Ann Arbor says
That explains why my self employed 401k plan has the word trust in it.
wudged says
Thanks – I had read the profit sharing part at the beginning of 404, but thought a 401k was not considered a trust. That’s the part I was questioning.
David Ann Arbor says
Well based on the above information it looks like I overcontributed in 2017 to the after-tax account of my non-prototype plan with Fidelity. With my business income of 57,667 I can only contribute $8,156 to the after-tax account to roll over to Roth.
I have no idea how to unwind that. I haven’t submitted my 2017 tax return yet.
Newton says
Hrm…this has been a good discussion. I am in the same boat as David in not previously realizing how profit sharing interacted with compensation and that the limit is compensation, not adjusted business profit. It looks like the spreadsheet has been updated to account for this at some point in the past year (thank you!).
Now to figure out what to do about my 2016 excess after tax contribution (about $6500). It has already been rolled over to a roth IRA. I assume it is either withdrawn or the excess is carried over against the 2017 limit. I believe the 6% penalty applies, but I am just digging into this, so not sure yet.
Avi says
When did you make the 2016 and 2017 contributions?
Newton says
I made my 2016 contributions in march 2017, and have not made my 2017 contributions yet.
I made only profit sharing and after tax contributions for 2016 as I max my elective deferal at my day job.
Avi says
Good, so my thinking is you can fix this by changing your own documentation of that after-tax contribution – part of it would be a 2016 contribution (up to the limit) and the rest would be part of your 2017 after-tax contribution (which could be contributed since it was 2017). The immediate rollover to the IRA isn’t an issue (I assume you have filed a 1099 for the rollover). As long as you don’t still have an excess for 2017 you should be okay with no penalties – just document the correction for your own records and make a note of what you will do in the future to ensure you don’t make the same error again.
Of course I’m not a tax attorney or accountant – but this is my read on what to do to stay in compliance.
Newton says
Avi, thanks for this, it is along the lines of what I was thinking. I will check this out further.
I would still like to understand how excess contributions should be treated for my own understanding.
I am realizing that I don’t know (or more likely forgot) how Nondeductible Employee Contributions are categorized in IRS docs/law. This seems to be a critical thing I should really understand and important to understanding all this.
David Ann Arbor says
Hello Newton,
To fix an overcontribution mistake to the After-Tax portion I found a webpage on the IRS website that seems to address it.
https://www.irs.gov/retirement-plans/fixing-common-plan-mistakes-failure-to-limit-contributions-for-a-participant
Also, the advice suggested to me on the Bogleheads Forum from Spirit Rider was,
“I would venture to guess that the majority of one-participant 401k sponsors are not aware a self-employed individual’s compensation is reduced by employer contributions. I would further suggest that it is likely that many sponsors of roll-your-own 401k plans doing Mega Backdoor Roths are similarly exceeding the 100% of compensation 415c limit.
This is a “Failure to satisfy the defined contribution annual additions limit.” 401k plan error. This must be corrected under the IRS Employee Plans Compliance Resolution System (EPCRS). Luckily, I believe this qualifies as an insignificant operational error and is eligible for the Self-Correction Program (SCP) without contacting the IRS or paying a fee. The correction is quoted below.
“For excess annual additions that are elective deferrals or employee after-tax contributions, the plan must distribute the respective elective deferrals or employee after-tax contributions with allocable income.”
You will need to request the removal of the excess annual addition and earnings from the Roth IRA. You will receive a 1099-R from the Roth IRA custodian next year and report it on your 2019 tax return.”
You should document the correction steps you took and what you will do to insure this will not happen again. Then just place the letter in your one-participant 401k file. That should be the end of it. Not so bad after all.
Newton says
Still digesting all this, but I believe the 2x effect of profit sharing of reducing compensation while also counting against 415 limits likely makes after tax contributions preferable for those of with lower income side jobs and looking to maximize post tax assets.
For 2017 415 Limits
1) Use only after tax contributions until your net profit exceeds $54,733 (no profit sharing)
2) Phase in profit sharing for net profit from $54,733 to $68,416
3) Above $68,416, take max profit sharing.
You will need to run your own numbers. This is the same as the Roth (after tax) vs pre tax argument, except in this case, pre tax contributions reduce after-tax space 2x. In many cases this will make after-tax preferable.
Harry Sit says
That’s why I added a field in the spreadsheet for the profit sharing percentage between 0% and 25%.
David Ann Arbor says
I really like the Excel Spreadsheet now. It really does the trick! Thank you Harry.
Curious says
Hi Harry,
Great post, and I’m so glad that I found it!
I’ve a question about your account setup at Fidelity. I see that you setup 3 kinds of FBO accounts:
*Pre-tax
*Roth
*After-tax
Any reason why you didn’t setup a 4th kind of account for pre-tax employer profit sharing contributions? Or do you make both pre-tax elective and profit sharing contributions to the same pre-tax account?
Thanks!
Harry Sit says
I have no plan to touch it before 59-1/2. Therefore separating employee pre-tax from employer profit sharing makes no difference. You can use a 4th account if you’d like.
Kevin O says
Hi, Harry-
Excellent article. I have two questions:
1. You say that people with high self employment income don’t have much room to take advantage of a mega backdoor Roth because they can instead max out their 401k contribution through elective deferrals and employer profit sharing contributions. But someone with high self-employment income can do a mega backdoor Roth instead of maxing out their pre-tax contributions if they wish, right?
2. E-Trade offers an individual Roth 401k that allows non-Roth after-tax contributions and in-plan rollovers to the Roth sub account. Is this not sufficient to achieve a mega backdoor Roth? Is it because they commingle non-Roth after-tax contributions and pre-tax elective deferrals in one sub account, and don’t have a separate sub account for (or keep track of) the non-Roth after-tax contributions?
Thanks for your thoughts.
Avi says
I don’t see anywhere in the E-Trade adoption agreement where it allows you to choose to allow after-tax voluntary contributions – where did you see it?
Someone with high enough income to defer $55k in their solo-401k could choose to do after-tax contributions instead of employer matching contributions(assuming they have a plan that allows it) but with that level of income it is likely suboptimal to do so.
Kevin O says
Avi, you are correct. The E-Trade Individual Roth 401k does not allow non-Roth after-tax contributions. An E-Trade rep originally told me on the phone that it does. That’s why I made my original post. After reading your reply, I read the E-Trade plan documents posted on their website. The Basic Plan Document (sec. 3.10) says non-Roth after-tax contributions (they call them Nondeductible Employee Contributions) are allowed if the Adoption Agreement allows them. But there is no place in the Adoption Agreement to allow them.
I called back E-Trade, and a different rep told me they don’t allow it. So, you are correct. Thank you.
Eliza - Minimal MD says
Do I have to make the employee and employer contributions? I would prefer to put the while $55,000 in after tax. That way, I can just roll it all over to a Roth IRA. It seems like having three different groups of money is confusing.
Harry Sit says
You don’t have to, but most people with higher income prefer to max out the pre-tax portion before doing the after-tax portion.
JD says
It depends on how much income you have. The employer contribution reduces the amount of compensation you’re receiving. I think (and I’m only 70% confident here), that you’d need $110K of profit to make a $55K employer only contribution.
It’s complicated.
Ray says
Thank you for a great write up, Harry. Probably one of the most comprehensive explanation of the mechanics of a Mega Backdoor Roth.
I’ve a few questions for you and anyone who have done the Mega Backdoor Roth.
I am an owner of a S-Corp and currently W-2 myself $70,000/year. I established a Solo 401K thru discountsolo401K and opened 2 non-prototype accounts and a Roth IRA with Fidelity.
My original plan was to contribute pre-tax $ of $19,000 employEE deferrals and $17,500 employER profit sharing ($70,000 * 25%) for a total of $36,500.
The remainder of my contributions would be going to the after-tax 401K sub-account ($56,000 – $36,500) totaling $19,500.
My plan was to immediately roll the $19,500 after-tax money into the Roth IRA and leave the $36,500 in the pre-tax 401K sub-account.
However, after reading some of the comments above and going over this article: http://www.irs.gov/Retirement-Plans/Rollovers-of-After-Tax-Contributions-in-Retirement-Plans , I am not sure what to do now.
Should I roll the entire pre-tax amount of $36,500 into a Traditional IRA and the entire after-tax amount of $19,500 into a Roth IRA?
Follow up to the above question (assuming it is possible to do so), can I perform quarterly rollovers from 401K to IRA since I will be contributing to the 401K throughout the year.
Will I need to file a 1099-R each time I perform a rollover or can I file one 1099-R at the end of the year for the cumulative amount rolled over from the after-tax 401K to Roth IRA?
Many thanks in advance.
Harry Sit says
See previous reply: https://thefinancebuff.com/after-tax-contributions-in-solo-401k.html#comment-17538
You only need to file one 1099-R for the cumulative amount of the distributions.
JD says
I believe that you can’t contribute $19,500 to the Roth. Your total available to contribute is limited to your compensation. Whatever you take in employer profit sharing reduces your compensation.
$70,000 profit – $17,500 employer = $52,500 available compensation
$52,500
-$19,000 employee
-$17,500 employer
= $16,000 available for after tax (Roth)
If it looks like I’m counting the employer contribution twice, it’s because I am. I think that’s the way it works.
Harry Sit says
Ray’s $70k is W-2 salary from the business, not profit.
CM says
Hi Harry,
Great article! I haven’t found any other source which explains the process of mega backdoor Roth like you do. After reading the thread and the comments it seems that there’s a preference for rolling over the after-tax 401k contributions to Roth IRA instead of moving them to a Roth 401k. Is this primarily due to the number of investing options that might be available in an IRA? What if I just move the money from after-tax 401k to Roth 401k? Is that also considered a distribution (and hence requiring a 1099-R), or is it a non-event as far as IRS is concerned?
Thanks again for the thread!
Avi says
I use a Roth account within my 401k when I do conversions – in a Solo 401K you have access to the same options you would for investment as an IRA. And you do need to issue a 1099-R for the conversion even when it is within the same 401k trust.
Gir says
Hi Harry,
Great article. Had a question. I have solo 401K with Schwab. Independent contractor only. No W-2.Now I created 401 K documents for the Roth I401k and also for checkbook control( no plan on Alt investments etc). Including spouse but she may not get income in 2019. Tried to open CRA with Schwab and 2 participants . Asked for sub accounts for Pre tax and Roth for each individual. Was told not possible. Should I open 2 CRA with 2 participants in each me and spouse use one for pre tax and other for ROTH( pre tax). I am not planning mega backdoor but may be in future. Has the option in solo 401 K documents. Got drafted for a flat fee. Question
1. Can I have 2 CRA accounts with same 401K trust EIN and 401k documents. Makes my life easier for accounting purpose
2. Should I be able rollover existing solo 401k with Schwab to CRA account under pretax my name.
3. If spouse does not take income though a participant on years not taking income do they need to be compensated as profit sharing or is it fine to contribute only for years she is taking income. I may be filing as marries filing separately to keep tax and liability angles separate.
Thank you
Harry Sit says
You open two separate CRAs for each person; total 4 accounts, . They are not sub accounts, just normal CRAs independent of each other. You should be able to transfer existing assets to the new account. You will have to ask the person/company who drafted your plan about what your plan says on allocating profit sharing to you and spouse.
Sandeep says
I’ve found this article incredibly insightful, and hope to be able to take advantage of utilizing supplemental 1099 income. My question is if I already contribute to the limit ($19K) in my employer’s 401k plan (for which I receive W2), and for simplicity sake I make $15K in 1099 income through a side gig (sole propriotor) which I want to contribute all to an after-tax, non-Roth solo 401k, how much can I contribute? I’m having problems using the spreadsheet to come up with the answer.
Andrew says
National Employee Benefit Services and Employee Fiduciary are noticeably more expensive than MySolo401k and Rocket Dollar, yet MySolo401k and Rocket Dollar claim to offer the same services with respect to doing a mega backdoor Roth in a solo 401k. Is there some reason to prefer National Employee Benefit Services and Employee Fiduciary over MySolo401k and Rocket Dollar? Do the more expensive places offer something that the less expensive ones don’t?
Harry Sit says
National Employee Benefit Services and Employee Fiduciary administer 401k plans for employers with multiple employees in addition to solo 401k plans. It’s not clear to me what MySolo401k, Discount Solo 401k, and Rocket Dollar do in plan administration beyond providing a document and keeping the document updated with required changes. If you are put in charge of plan administration and they only answer questions when you ask, then you don’t necessarily know the questions you should ask. I see it as the difference between actually administering a plan versus maybe giving you some pointers but still leaving the plan administration to you. I can be convinced otherwise if someone shows me those other providers actually administer the plan for you.
saildawg says
Harry,
Thank you so much for the articles and calculator. I do not quite understand all the nuances, but the calculator has given me the confidence to go forward. In playing with the numbers it seems that on 50k 1099 earnings total contributions are actually larger if I use 0% PSP vs 25% (note 19k employee contribution from W2 with wages $250,000)
For 0% I get $0 PSP + 49,330 after tax non roth = 49,330 total
For 25% I get 9,866 in PSP + 29,598 in after tax non roth =39,464 total
I am going to use 25% as I am in a high marginal tax bracket so PSP is more valuable, but was hoping to understand why there is a difference. Thanks for everything.
Harry Sit says
From the business’s point of view, after it makes the profit sharing contribution, the rest is paid to the owner as compensation. The rule says the total contribution of all types (elective deferral + profit sharing + after-tax) can’t exceed the compensation. Because profit sharing is on both sides of the equation, $1 in profit sharing reduces after-tax contribution by $2.
Sophia says
Hi Harry,
Some questions about distribution of the solo 401k maximum allowed 2019 contribution ($56k if under 50 and $62k if 50 or over) among “salary deferral,” “profit sharing,” and “non-Roth after tax contribution”: Your great calculator (thank you!!) first maxes out “salary deferral” and “profit sharing” and then puts the rest of the allowed amount (assuming solo business has enough net profit) in “after tax.” Would it be allowable to say put $0.0 in the salary deferral and instead put that $25 k (or $19 k if under 50) in “after tax” along with the amount the calculator suggests? An example might be $76,000 in business profit (over 50): The calculator gives $25,000 for employee deferral , $14,126 for profit sharing and $22,874 for after tax. Could one put $0 in employee deferral, $14,126 in profit sharing and $47,874(=25K+22,874) in after-tax? Or, taking it further, could one even just put all $62,000 in after tax and $0 in employee deferral and $0 in profit sharing?
I guess the pros of being able to do this are as follows:
-Once the 401k goes over $200,000, there is additional annual reporting required, so it might be nicer to put the money in after tax and shift out to Roth IRA each year to avoid the reporting hassle.
-In general, there seems to be less flexibility with the salary deferral portion – once it is put in the solo 401 k, it needs to stay there until plan is closed or until distribution time.
-Once business profits for the year drop under the level of $76k or so, one can’t max out the $62,000 limit, because the profit-sharing contribution is subtracted twice from the biz income in determining how much biz income there is to put into these retirement accounts. Thus, putting that “profit sharing” amount into after tax instead, if allowed, would help people with biz income under $76 k put away more in retirement funds (get closer to the $62 k max) if they like.
The con might be:
-If the after-tax contribution is quickly rolled into to Roth IRA each year (to maximize the benefit), it may be better not to maximize the contribution/ attract attention to it and instead put as much into salary deferral and profit sharing first, as calculator suggests. The reason would be that this is a less widespread practice and perhaps not the original intent of allowing after-tax. Or another way to put this: If the original intent of After-Tax option in the relevant legislation was to allow those that have more to put away into retirement funds to go beyond the salary deferral and profit sharing, maybe it is better to stick with the original intent in how we implement (maxing out salary deferral and profit sharing first), even if technically we could do otherwise and put $62k in after tax and soon thereafter rollover to Roth IRA.
Would love to get your thoughts on this issue of whether we should be sure and max out the employee deferral and profit sharing first (as in your calculator), or we could well consider instead putting more into after tax as described above if there seem to be benefits.
Harry Sit says
The maximum contribution spreadsheet already has an input for the desired profit sharing (0% – 25%). You can set it to 0% if you’d like to do more after-tax. Beyond that, I would follow the spreadsheet, especially when you are 50 or over, because the catch-up amount is only activated after you max out the salary deferral. Note the salary deferral can be either pre-tax or Roth.
Sophia says
Hi Harry – Thanks a lot! I understand now that, for the 50 and over crowd, if we want to maximize solo 401 contributions, then we should max out the salary deferral (19k+6k), but that then the rest (37K for 2019) could go into after tax if we prefer to pay taxes now (perhaps to benefit from QBI) and/or if our income is less than $75k so that the after tax option allows us to put away a greater total amount in the 401k than would be possible if we did the employer contribution. Filling out an extra form (5500) once the solo 401k goes over $200k is certainly worth the ability to put away the extra $6k catch-up contribution each year.
AJ says
Very interesting thread…here’s my situation. Currently have a Fidelity solo 401k from when I was self-employed about 10 years ago. Been w-2 since then but this year should have about 75-100k in self-employment net profit. Will be w-2 employee again starting in about one month and plan to max out salary deferral of 26k—I’m over 50–in new employer plan. Would like to set up new solo 401k strictly to make after-tax contribs with an eye to doing mega backdoor. Not sure if I need to terminate Fidelity solo—can’t do after-tax contribs there. Thinking of rolling fidelity account into traditional IRA, terminating plan, then setting up new solo 401k that allows after-tax and making only after-tax contribs and doing mega backdoor—this would all happen by year end 2020. Any issues or potential problems? Also do you have an updated calculator to help determine max after-tax contribs I can make for new solo 401k in my scenario. Thanks for any input.
Sophia says
Hi AJ: Interested to hear what Harry says on this. From my experience setting up a self-directed solo 401 k after having a prototype solo 401 k at TD Ameritrade, I understood that I needed to close the prototype plan accounts if they were for the same business (which it was). I did roll the prototype plan investments into the new self-directed one but it was a huge hassle as TD Ameritrade could not grasp I was moving “like” to “like.” Finally it worked out, though. Probably, closing down the prototype and rolling into IRA would be a lot easier, though not sure if there are any caveats if it is for the same business. (I think in my case I thought I shouldn’t just shut down one plan and start a new plan since the business was continuing, but don’t think I verified that that was a requirement.) If you do do the rollover to the self-directed 401 k, then I think you are “restating” the plan rather than starting a new one and there may be a few advantages to that (like being able to rollover employer contribution earlier to an IRA), but if you can move everything to an IRA then you wouldn’t need that advantage and probably the only remaining one is having more $$ to do self-directed stuff (if you are doing non brokerage firm stuff) or having more $$ for a loan at some point. But you may also hit the $200k limit where you have to do an extra form each year sooner.
David Ann Arbor says
I think you have to get a company that provides you plan documents to restate your Fidelity solo 401k plan which I think what this blog post is all about.
Then with the restated plan documents you’ll be able to make after-tax contributions to your 401k that are then rolled over into the Roth.
Your accounts at Fidelity are transferred over to non-prototype accounts. You’ll have a pre-tax account for the account that had tax deferred contributions, another after-tax contribution account, and then a Roth account. Or you could roll the after tax contribution into a Roth IRA.
Harry Sit says
The first rule in a solo 401k is to realize that a solo 401k is not a bigger IRA. Don’t adopt, amend, or terminate a solo 401k willy-nilly. If you take some action, only do it for the long term.
Therefore, if having self-employment income again is only this year and it will go away next year, just make the employer contribution to the existing Fidelity plan. You won’t be able to contribute as much, but it’s not worth making a bunch of moves and risking something going wrong for just one year.
If you will have $75-100k in self-employment income per year in addition to your W-2 income for the foreseeable future, then consider hiring Employee Fiduciary, amending and restating the plan to Employee Fiduciary’s document, and transferring the existing assets. Don’t terminate the plan.
AJ says
Hi Sophia–Thx for your input. The Fidelity plan was for self-employment between 2005-2012…haven’t contributed to it since then. It does have in excess of 250k so I have been doing 5500SF filings. This year since I’ll have meaningful self-employment income, I’d like to contribute ideally only after-tax dollars, since I’ll have w-2 job where I can max out my 26k pre-tax or Roth contribs. I can’t do what I want thru Fidelity–no ability to do after-tax–so I’m considering something like Employee Fiduciary, Solo401k.com or the like. I’d prefer not to rollover the Fidelity into the new plan…rather terminate it and roll it into a traditional IRA. Wondering if there is a need to wait a certain time–one year?–before I set up a new solo 401k after I terminate the old…or whether I could have a new one created in same calendar year I terminated old one. Technically I could say it’s a different business…it’s 8 years later and doing something related but different enough from prior self-employment. Curious what Harry has to say about all this too. I am sophisticated enough that I don’t think I need full-fledged TPA…just want to clarify the feasibility of doing it the way I laid out. Appreciate further input.
AJ says
Thanks for your input Harry. Are familiar with mysolo401k.net or solo401k.com as an alternative to Employee Fiduciary? They are more reasonably priced and both seemed very knowledgeable when I spoke with the compliance officer at one and one of the principals at the other.
Harry Sit says
Because the stake is high, I wouldn’t go cheap on this. Chalk up the difference of a few hundred dollars a year as your E&O insurance. You want a larger organization like Employee Fiduciary that doesn’t depend on only a handful of people. You want them to take charge as opposed to answering questions on demand only when you know what questions to ask.
Sandeep says
I actually used discountsolo401k and got my plan through them. However, I didn’t feel comfortable managing the plan myself, so I found a third party administrator to manage it after I received the initial plan documents. It costs me $500/year, but I personally think it’s worth it.
Sophia says
I’m also using Discount Solo 401k as well as my self-directed solo 401 k plan document provider, though I don’t have a third party administrator. Discount Solo401k has been good about answering my questions and during set up directed me to a bank that could also handle these kind of accounts. Per Harry’s input, I agree that I would not have done this were I not going to use it annually, at least for a few years. I think the first year was $500-$600 and then there is an annual fee of $100, whereas the prototype plans at brokerages are free/ no start-up or annual fees. On the other hand, if you are somehow in the income sweet spot for after tax/mega-backdoor roth, or have another reason you cannot meet the maximum 401k contributions and want to, the after-tax option is wonderful for letting you max out 401k contributions. As/if your SE income rises, then you might at some point hit the annual max by a combination of your employee contribution (at work in your case) and 20% of your SE earnings for the solo. One thing I haven’t looked into is how difficult it would be to switch back from the self-directed plan to a prototype plan if it eventually was no longer worth the annual fee (that is, if the after tax was no longer needed, etc.). It was quite a hassle for me to get my funds transferred from prototype account to self-directed account and I imagine it might be even harder the other way around. In fact I think one brokerage I checked with told me they would not accept a rollover into their prototype plan from a self-directed one, but I haven’t checked lately.
David Ann Arbor says
It’s probably just a matter of calling Fidelity or going to their office and switching back to their prototype plans. I imagine they’ll just have you fill out forms and move the assets over to their corresponding accounts in the prototype plan.
Mcraepat9 says
Harry, was curious if you knew anything about Ascensus and their individual K document compliance service? I called today and they indicated that their solo 401(k) document service does not permit voluntary after-tax non-Roth employee contributions, so it seems MBR is not an option. That must be a change from when you did this via Ascensus documentation? Or am i missing something?
I have a thread outlining my ongoing experience going on BH.
Harry Sit says
If you want voluntary after-tax non-Roth employee contributions, Ascensus will do it in their “standard” plan. It’s just a different document template.
Now that Employee Fiduciary is offering the full administration service, which wasn’t an option when I started, I would just go to Employee Fiduciary. They’re only a few hundred dollars more than Ascensus and you get everything, not just the document. And you get a larger organization, not just one person. Chalk it up to accessing their professional liability insurance in case something goes wrong. The stake is too high if something does go wrong when you DIY. You’re already saving a lot of taxes with mega backdoor Roth. You want to be sure to keep saving that much year after year and not have it collapse on you.
Always Curious says
First, THANK YOU! The information on solo 401ks and the MBR on this site are the best I have found anywhere. This has been immensely helpful.
Here’s my question: I’m setting up a custom solo 401k account (non-prototype plan). Looking at the forms they mention a bunch of different accounts held within the 401k. These include profit-sharing, elective deferrals, roth deferrals, voluntary (after-tax), transfer, and rollover.
When setting up brokerage accounts is there any advantage to making separate accounts for every type? I was planning to make three accounts:
– Pre-tax (profit share, elective deferrals, transfers, and rollovers)
– Roth
– Voluntary after-tax (for MBR)
Would it be better to make separate accounts as below?
– Profit-sharing
– Elective Deferrals
– Rollovers
– Transfers
– Roth
– Voluntary after-tax
I’ll be keeping detailed records of every contribution, but am not sure if there will be significant differences in how the profit-sharing, elective deferrals, and rollovers are treated when I enter the distribution phase or start filing the 5500ez.
Future rollovers may include traditional IRA and transfers would be a previous employer 401k, if that matters.
Thanks again!
Harry Sit says
The purpose for separate accounts is for tracking different tax treatment and distribution rules. Your three accounts are the minimum for different tax treatment. Further breaking out the pre-tax account into elective deferrals, profit sharing, and rollovers/transfers can enable in-service distributions of profit sharing and rollovers before 59-1/2. If you’ll never distribute/withdraw profit sharing and rollovers before 59-1/2, it’s OK to comingle them with elective deferrals.
If you use Employee Fiduciary for your plan, they will track all these nuance for you. See reply to the previous comment.
Danthony Eadweight says
I’m trying to weigh pros/cons of talking to my employer about setting up a 401k that allows after-tax contributions.
One thing that concerns me, that I don’t see brought up in your great article, is ‘testing.’ I don’t know a lot about the subject, but the company is <8 people, and the compensation varies wildly. While I might choose to max pre & after tax, I could see other employees contributing little to none.
I make about as much through this employer as I do on my own via 1099. A solo 401k seems like it might allow me to put away as much without the risk of failing testing—is there a flaw in that line of thinking?
Harry Sit says
This post is about a solo 401k for the self-employed without employees. Testing doesn’t apply here. This other post The Elusive Mega Backdoor Roth includes discrimination testing in a plan where you work as an employee. It’s very difficult to pass testing at such a small employer. You can try, but it probably won’t work.
Joe says
I was doing some part-time consulting work before, I got an EIN, and set up a solo 401k through Fidelity (I think the account opened is a profit sharing Keogh, in case that makes a difference) to do a backdoor Roth that year. When I filed taxes that year and the following year, there was a Schedule C-EZ for my consulting income those two years. I have since stopped earning income for my self-employed consulting work, and I was wondering:
– Can I contribute to the 401k plan if my self-employed business income is now $0? (I assume no, but just checking)
– Can I still keep my solo 401k plan open? (I assume yes, but just checking)
– When filing taxes, do I still have to file a Schedule C and report $0 income for that self-employed work as long as my consulting business is “open”?
– Do I have to “close” my self-employed business somehow (close the EIN or file any special forms), or can I keep it open and “dormant” in case in the future it becomes active again?
– And if I can keep it dormant, I assume that if in the future I earn income for it again, I would just file a Schedule C that year (and be able to contribute to the solo 401k), right? Or is there anything else if I skip reporting for it for some years while earning $0 for it?
Thanks so much!
Harry Sit says
You can’t contribute to the solo 401k if you don’t have self-employment income but you can keep it open in case you’ll have self-employment income again in the future. You don’t have to file a Schedule C when you don’t have self-employment income in that year. You can keep the EIN in case the business becomes active again. When you have self-employment income again, you file Schedule C again. If your business is registered with the state or county as an LLC, a fictitious business name, etc., you may have to keep renewing your registration.
Joe says
Thank you for your help!
taxsavings says
Can non-Roth after-tax employee contributions in solo 401k come from savings account(after tax money) if pay check contributions not enough?
Harry Sit says
If you’re talking about paychecks from an S-Corp (or an LLC taxed as an S-Corp), no. The contributions must come from paychecks. A sole proprietor or an LLC taxed as a sole proprietor typically doesn’t have paychecks.
Michael says
Hi Harry,
Can you confirm what you mean by: “If you’re talking about paychecks from an S-Corp (or an LLC taxed as an S-Corp), no. The contributions must come from paychecks. A sole proprietor or an LLC taxed as a sole proprietor typically doesn’t have paychecks.”?
Specifically, I have an LLC that has elected pass-through taxation. I would like to use the net operating income from this LLC to do after-tax non-roth contributions to a solo 401k. Are you saying that I would be unable to because net operating income from an LLC that has elected pass-through taxation is not a “paycheck,” or are you only specifically referring to a situation in which you are either an S-corp or an LLC that has elected S-corp taxation?
Thank you!
-Michael
Harry Sit says
Because taxsavings mentioned paycheck, I inferred his or her business must be an S-Corp (or maybe a C-Corp) or an LLC that elected to be taxed as an S-Corp. In that case, the contributions must come from paychecks, not from a savings account.
When your business is a sole proprietor or an LLC taxed as a sole proprietor, the contributions can come from a savings account. The maximum contribution amount is still based on the net profit of the business.
Sophia says
An additional query/ comment: I have heard that Congress is likely to do away with the option of after tax 401 k conversion to Roth IRA and therefore in effect do away with Mega-Back-Door-Roth starting beginning of 2022. It seems that their rationale is that such options benefit the hugely rich. Yet, contrary to that, I think the Mega-Back-Door-Roth can actually be said to level the playing field between people who make more and thus can easily max out the 401 k contribution via 20% of their earned income and those who can only max out the contribution by doing after-tax and conversion to Roth IRA and would be stuck with a lesser contribution (or at least one stuck in after-tax) if the rules of the game change.
Is it worth trying to help Congress understand this (that it’s not just the rich but in fact, some with lower incomes)?
Is the news I’m hearing that this change in the rules is very likely correct? It seems this means those of us who are paying annually for tailored self-directed solo 401 k plans primarily to be able to do the mega-back door roth may want to unwind them. So that raises another question, since the custom plans require a trust and the prototype plans at the brokerage do not, does that mean that we need to close down the plan and start a new one – or could we transform a trust based plan back to a prototype one with no trust (reverse of what some of us did before when we converted our prototype ones to self-directed trust-based ones)?
Harry Sit says
The news is discussed in What If Congress Bans Backdoor Roth and Mega Backdoor Roth?. If it passes, you may consider amending and restating your plan to a prototype plan at a brokerage next year. Or if this is only for a side gig and you have a good 401k plan at a day job, you may also consider terminating it and switching to a SEP-IRA. The maximum employer contribution to a solo 401k and to a SEP-IRA is the same. I’ll write a new post about this if it goes that way.
John says
Hi Harry,
Great article. Had a question. Who maintains beneficiary document, plan provider or financial institution where account is maintained. In case plan provider maintains beneficiary document, and is comparatively small firm, how to ensure spouse and kids inherit, after plan administrator / trustee passes away.
Which authority governs beneficiary documents, in case plan providers are not reachable, as a fall back option.
Does custom plans need to be ERISA compliant or governed by ERISA rules.
Harry Sit says
The Plan Administrator maintains the beneficiary document. The employer is the designated Plan Administrator in many plan documents.
ERISA doesn’t apply to solo 401(k) plans.
John says
With Solo 401K plan and two trustee with Ascensus, how is TD Ameritrade account titled. Any due diligence or let TD
1. Title in A/c
1.1. A/c 1. Trustee 1 Trustee 2 for Plan name F.B.O. Trustee 1
1.2. A/c 2. Trustee 1 Trustee 2 for Plan name F.B.O. Trustee 2
2. A/c Opening form section Trustee and Co-trustee
For 1.1 and 1.2 A/c, one has to provide both trustee and Co-trustee name along with their ssn or 1.1 with Trustee 1 only and ssn.
Harry Sit says
If the plan has two trustees, both of them should be listed. The individual accounts are for the participants. Imagine if you hired professional trustees. The accounts should be [Plan Name] FBO [Participant 1], [Plan Name] FBO [Participant 2], etc. The professional trustees are responsible for the entire plan.
John says
Hi Harry
With custom Ascensus Solo 401K plan and two trustee, how is TD Ameritrade account titled. Any due diligence or let TD determine how title:
1. A/c Title with Plan EIN
1.1. A/c 1. Trustee 1 Trustee 2 for Plan name F.B.O. Trustee 1
1.2. A/c 2. Trustee 1 Trustee 2 for Plan name F.B.O. Trustee 2
2. A/c Opening form section Trustee and Co-trustee
For 1.1 and 1.2 A/c, one has to provide both trustee and Co-trustee name along with their ssn or 1.1 with Trustee 1 only and ssn.
or A/c title need to be setup with Plan EIN as:
3.1. A/c 1. Plan name F.B.O. Trustee 1
3.2. A/c 2. Plan name F.B.O. Trustee 2
with blank Trustee and Co-trustee information and no social
Harry Sit says
Again, imagine you hired third-party professional trustees. The accounts are owned by the plan, with the plan’s EIN. They are for the benefit of the participants (not trustees). So they should be [Plan Name] FBO [Participant 1], [Plan Name] FBO [Participant 2], … The custodian needs to know who the trustees are and therefore who have the authority to act on behalf of the plan. Whether the custodian actually lists the trustees together with the plan name in the account title itself is up to the custodian.
Jim says
Hi Harry, great info on this site! You wrote that the solo 401k brokerage plans (from Fidelity, Vanguard, etc) do not allow after-tax contributions to be able to even do a mega Roth conversion. This is a simple/silly question, but why can’t one contribute to the solo 401k held at one of these brokerages and then not deduct it? Would that not become a non-deductible contribution that you could then convert into a Roth and track the basis (like for a backdoor Roth IRA)? Sorry if I am missing something with trying to do a mega Roth starting with a solo 401k and a simple process (like you would do for a backdoor Roth at these brokerages). I know you went through all of the steps you described you had to do, so I was just wondering. Thanks!
Harry Sit says
You can do Roth contributions up to the $19,500/$20,500 limit in a Vanguard plan. Even if you don’t deduct the employer profit-sharing part, it will still be 100% taxable when you convert it to Roth. No one wants to pay tax twice.
Avi says
You have to keep in mind that a 401k plan is a more complex entity than an IRA, designed in law to be managed by companies with lawyers specialized in its intricacies.
The structure of a particular 401k plan guides what types of contributions are allowed in that plan. If the plan doesn’t allow for after-tax contributions (which are different from Roth contribution) then there is nothing you can do to make them permitted (save changing the plan documents).
Even if you didn’t deduct them on your personal taxes, they would still be pre-tax employee or employer contributions and would be taxable on any conversion to a Roth account (which also may or may not be allowed by the plan documents).
You need to get it out of your head that anything to do with managing a 401k plan is simple – there are enough off the shelf options to make the basics of it easy, but the tax and labor law behind is anything but simple.
Sophia says
Here is my understanding: The type of contributions you make are governed by the “plan document.” The brokerages have their own prototype plan document that you must use if you want to set up specified solo 401k accounts with them. And I don’t think any of them allow for after-tax contributions (though I have not checked recently). In fact, I think Schwab in the past did not even allow for Roth – maybe they do now.
Many who see a real advantage to mega-back-door Roth use third parties that have plan documents allowing after-tax, but then you have to get different types of accounts with the brokerages to suit this situation. The problem now is that we don’t know if build back better (or something else that comes along) will outlaw mega-back-door Roth (the latest version of bbb has this in there and it’s expected to stay in there). If mega-back-door Roth is outlawed and that would be your main reason to pay for a third party plan, it may not make sense to do it as there is some cost involved, such as $500 to $600 at startup and $100 annually for updates to the documents, whereas the brokerages do not charge for documents or their updating.
Kevin O says
Hi, Harry-
E*Trade has revised their Individual 401k Plan Documents to allow non-Roth after-tax contributions. In 2021, they made me restate my Individual 401k to comply with new IRS rules, and the restated Basic Plan Document (sec. 3.05) and the restated Standardized Adoption Agreement (sec. 3, Part C) allow non-Roth after-tax contributions. They call them Nondeductible Employee Contributions.
Their Individual 401k has one account for pre-tax contributions and a second account for Roth elective deferrals. However, they told me that they will not allow me to open a third account for the non-Roth after-tax contributions.
E*Trade believes I can do a Mega Back Door Roth without having a separate account for the non-Roth after-tax contributions. They said I would have to make the non-Roth after-tax contribution to the pre-tax account, and then do an in-plan rollover of such contribution (and any earnings thereon) to the Roth account. And if I do it immediately after the contribution, there might be no earnings thereon. They said I would be responsible for keeping track of such contribution and the earnings thereon.
Harry, my questions are:
1. Since E*Trade won’t let me open a separate brokerage account for the non-Roth after-tax contributions, can I still do a Mega Back Door Roth?
2. If I can do a MBR, can I do an in-plan rollover of just the non-Roth after-tax contributions (and any earnings thereon) from the pre-tax account to the Roth account? Or would the IRS rules require me to rollover the entire pre-tax account, in which event, could I: (a) rollover all the pre-tax contributions (and any earnings thereon) in the pre-tax account to a Traditional IRA, and (b) rollover all the non-Roth after-tax contributions (and any earnings thereon) in the pre-tax account to the Roth account?
Thank you very much for your guidance.
Harry Sit says
It appears E*Trade updated their document to support Mega Backdoor Roth but they haven’t updated their operations to support it yet. Their suggestions are only hacks. I wouldn’t be comfortable using them.
If you really want Mega Backdoor Roth, go to Employee Fiduciary, pay their $500/year fee, and do it right. If the $500 fee makes it not worth it, don’t do it.
Kevin O says
Harry, thanks for your reply.
John says
In custom Solo 401K plan, we did In-plan Roth conversion from After-tax to Solo 401K Roth A/c # 1 for 2K and A/c # 2 for 5K respectively for two beneficiaries.
I have question regarding 1099-R:
1. To report in-plan Roth conversion, I need to file two 1099-R for each beneficiary?
2. My understanding is that Payer’s TIN and recipient’s TIN is of Plan trust for both beneficiary’s 1099-R. Is my understanding correct?
3.1 If recipient’s TIN is that of plan and is same for beneficiaries, how is 1099-R distinguished for both beneficiary’s A/c # 1 and A/c # 2.
3.2 1099-R should be
Payer’s name – “Plan name”,
Receiver’s name – “Plan name”
or 1099-R
3.3 Payer’s name – matching A/c title – “Trustee 1 Trustee 2 FBO Plan name FBO Trustee 1”
Receiver’s name – matching A/c title – “Trustee 1 Trustee 2 FBO Plan name FBO Trustee 1”
And
Payer’s name – matching A/c title – “Trustee 1 Trustee 2 FBO Plan name FBO Trustee 2”
Receiver’s name – matching A/c title – “Trustee 1 Trustee 2 FBO Plan name FBO Trustee 2”
respectively.
Harry Sit says
First of all, terminology. The persons with accounts in the plan are plan participants, not beneficiaries. Beneficiaries are the persons who will get the accounts in case a participant dies.
Second, the 1099-R forms were due to the participants on January 31. You’re already late.
Third, it makes no sense to issue a 1099-R to the plan itself. The recipient on each 1099-R should be the participant, with their name, address, and Social Security Number. The participant will receive the 1099-R and report it on their personal tax return. I don’t know why you have account #1 and account #2 but if you’d like to issue two 1099-R’s to each participant, there’s an account number field on the form to distinguish one account from another and it only costs $3 a piece to issue a separate 1099-R for each account versus combining them into one.
John says
Thanks for your reply and input. Please let me know if below understanding is correct.
I have setup Trust’s EIN for Solo 401K Plan. Solo 401K After-tax A/c and Solo 401K Roth A/c are under Trust’s EIN.
1.I thought in my case in-plan Roth conversion is done and funds are staying within the plan (Solo 401K After-tax A/c to Solo 401K Roth A/c), not going to individual Roth IRA. This will be trustee-to-trustee transfer, that is why recipient name should be Solo 401K Plan Name, with Distribution code G in box 7, with A/c number.
2.Once above is done, in future I will rollover funds from Solo 401K Roth to Individual Roth IRA, in that case recipient on 1099-R should be the participant, with their name, address, and Social Security Number, Distribution code 2 in box 7, with A/c number.
Harry Sit says
Not correct. The participant should be the recipient in both cases.
John says
Thank you Harry.
Alex says
Hey Harry,
If I had before tax funds in trad IRA and roll them over to Solo 401(k) do I need issue 1099-R and file taxes or I don’t need do anything?
Harry Sit says
The IRA custodian issues the 1099-R. You include it on your tax return.
Mark J says
Hi Harry,
my wife and I have a solo 401k for 2 years now, with Schwab, coz we both had 1099 income then. now my wife only has W2 income and I still have both W2 and 1099 income. so she isn’t contributing to solo401k anymore. I still contribute to it, but we always convert all of it to my roth IRA, via megabackdoor roth ira conversions.( I did that for my wife too, when she used to contribute to it).
so essentially, we both have zero dollars in the solo 401k, and all the money is the Roth IRA. however, I still pay yearly maintenance fees to this 3rd party company, that initially set up the solo 401k for me. I read in your article one can manage the account himself. can I do that with my account as well, given my situation? (essentially, I want to stop paying maintenance fees to this 3rd party company). I plan do keep doing MBDRoth IRA every year, and keep no money in my solo 401k accounts. please advise. thank you.
Harry Sit says
I don’t know what this 3rd party company does or how much you’re paying but you’ll still need to keep paying a third party to maintain the plan document when you want to continue the mega backdoor Roth.
Sophia says
Yes, I understand for compliance they have to update the solo 401k documents every six years or so and that’s why you couldn’t just leave your 3rd party provider and go on indefinitely without them.
John says
Hi Harry
With 3rd party custom plan does TD Ameritrade allow past Dec 31, 2022 to continue contributing to Solo 401K mega backdoor Roth.
If no, by any chance is there a list of account provider for above.
Harry Sit says
When you have a third-party plan, the custodian doesn’t know or care about the type of contributions you put into each account. They only handle the investments. The plan administrator tracks taxes. If you have a TD Ameritrade plan now, you may need to open new investment-only accounts for the third-party plan.