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 does not include non-Roth after-tax contributions in its individual 401k plans but it does in its full-service 401k administration at $1,500 per year plus 0.08% of plan assets.
Ascensus charges $195 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.
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