In preparation for converting my non-deductible IRA contributions to Roth IRA, I’m rolling over the pre-tax portion of my traditional IRA to my solo 401k. I set up the solo 401k last year primarily for this purpose — to provide a harbor for my pre-tax IRA money so I won’t get taxed proportionally on my Roth conversion. After the rollover, I should have only one small IRA, consisting of my non-deductible contributions plus or minus market fluctuations from now until I convert.
I have my solo 401k with Fidelity. When I called them about the rollover procedures, to my surprise, the rep actually discouraged me from doing so. To his credit, he made valid points. He knew what he was talking about. Fidelity trained them well.
He said the 401k has more restrictive rules on withdrawals. Before I reach 59-1/2, I can withdraw from a traditional IRA for any reason. I just have to pay tax and the 10% early withdrawal penalty. Not that people should do that but that option is there. If I put the money into the solo 401k, I have to qualify for specific hardship events before I’m allowed to withdraw and pay the tax and the 10% penalty. Fidelity’s solo 401k plan does not allow loans.
He also said rolling over money in an IRA to a solo 401k will get the solo 401k closer to an IRS reporting threshold. When a solo 401k plan’s assets reach $250,000, the plan administrator will have to file a Form 5500-EZ with the IRS every year. I can avoid the extra paperwork for more years if I don’t rollover IRA money into my solo 401k.
I would agree with him if I’m not preparing for the Roth conversion. I decided the benefits of low taxes on Roth conversion outweigh the restrictions on withdrawals and the extra paperwork.
The actual rollover consists of two steps. Because I’d like to keep the assets in my IRA, I would transfer in-kind to a new Fidelity Rollover IRA as a bridge. After that’s done, Fidelity needs a letter from me as the administrator of my solo 401k to accept the rollover from my Fidelity Rollover IRA. Then the bridge rollover IRA will be closed. Fidelity will not charge the usual $50 IRA closing fee.
I initiated the partial rollover online with Fidelity last Wednesday. I mailed the transfer of assets form on Thursday. By Tuesday, the rollover is completed. Four business days. Fidelity did a very good job.
With the rollover, I said goodbye to Vanguard Brokerage Service. Vanguard is a great mutual fund company, but its brokerage service is substandard. In order to avoid complications with the rollover, I wanted to change my dividend reinvestment election from automatically reinvest to taking the dividend in cash. I got this nice message when I tried to do so:
Vanguard Brokerage Service is saying their computers for processing dividend reinvestment elections go off their shift at 5 p.m. Eastern time. I honestly cannot think of any reason why computers work only a day shift.
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Funny, I just did the same last week. I agree the Fidelity Retirement people are good. One thing that I thought I’d mention that you didn’t cover in your post. With respect to Fidelity discouraging you from moving the money to the SE401K, I wouldn’t worry about not being able to access the money. One of the qualifying event is termination of the plan. With you as the administrator, if you want/need the money, you terminate the plan and move it to a rollover IRA where you can then access it. Easy enough.
Harry Sit says
Sammy_M – Yeah, terminating the plan would be the nuclear option. I don’t think I will need it but I do have that option. When I called Fidelity the second time asking about the wording for the letter of instructions for rolling over the bridge rollover IRA to the solo 401k, the rep knew exactly what I was trying to accomplish.
Rep: “If you don’t mind, may I ask why you’d like to rollover money into your 401k?”
Me: “I’m doing a Roth conversion next year.”
Rep: “You’ve made after-tax contributions to your IRA and you’d like to separate your basis?”
Fidelity reps are great.
I have used Fidelity for all my brokerage need for many years and had been wondering about the quality of VBS. After seeing this post and other posts complaining about the subpar system at the VBS, I stopped thinking about doing business with the VBS.
It appears that VBS is an after thought and Vanguard probably offered the VBS service mainly to accommondate transfers. It is a real shame because Vanguard is such a great mutual fund company. With the proliferation of ETFs, people can own Vanguard funds thru ETFs without having to have an account at Vanguard.
I hope that Vanguard will someday wake up to the new world and integrate their brokerage business into their core fund business for its own sake.
I’ve had a solo 401(k) at Fidelity for 4 years, they’ve been helpful. Vanguard ddn’t offer them when I set mine up. Now I need to open more funds within the account, and want to go with Vanguard funds. Rather than pay Fidelity $75 per fund to buy into these, I’m moving everything to Vanguard. I guess I’m going exactly opposite to the move you are making. I don’t buy/sell stocks or ETFs, so the VBS spectre isn’t an issue.
The tax stuff is complex, lots of interconnected variables. For example, before contributing to the Solo 401K my income is in the 25% marginal rate. If I contribute enough, it puts my “last taxable dollar” below the 15% ceiling, which is a good thing. But, (through Dec 2010) there’s the Cap Gains rate “sale”: 0% CG on everything up to the top of the 15% bracket ($67,900 for 2009). So, it makes sense to add a lot MORE to my solo 401K (even though I’ve already reduced my taxable income to the 15% bracket-where I expect to be in retirement, so this would normally be a “wash”) in order to drive down my taxable income still further and get more headroom between my income and this $67,900 ceiling–so I can sell more of my appreciated assets tax free.
But wait–all this loading of assets into the 401K (money I’m taking from my taxable accounts) leads to another problem down the road. When I withdraw the funds from the 401K, I’ll have to pay taxes on the cap gains at the regular income rate, which can be quite a bit higher than the cap gains rate. So–maybe I shouldn’t have put those assets in the 401K in the first place. Aggh!
I haven’t found an on line calculator that lets me optimize this decisionmaking–I’m just using the TLAR method now. I’m maxing out the solo 401K (salary deferral and profit sharing components) , selling appreciated assets in taxable accounts until I hit the 25% bracket again, and will worry about the tax ramifications when i start withdrawing the money. After all–who knows what the cap gains rates will be in 10 years? In the past they’ve been all over the place.
Thanks very much for the site. I’m new here, there’s a lot of great info.
Harry Sit says
vigilant1 – Thank you for stopping by. I think you made the right decision. I like the “bird in hand” approach. Take advantage of the capital gains tax “sale” now and worry about the taxes on 401k withdrawals later. There might be other opportunities down the road to lower your taxes.
Great topic, I’ve been wondering about this myself since 401(k) plans are exempt from the conversion calculations. I have a ton of tax-deferred cash in a SEP-IRA, which gets in the way of funneling non-deductible IRA contributions into a Roth IRA.
Curious why you opted for Fidelity over Vanguard when it comes to your solo 401(k)? You mention unhappiness with VBS — was that the determining factor?
Since I don’t have a solo 401(k) (yet), I’m curious what you know about the rollover rules for getting the money back out into an IRA at some point down the road. This is presumably similar to regular 401(k), where you can do so after separation of employment, but how does that work for self-employed? Could you set up a new LLC and start taking your income through that, effectively ending your relationship with your original company?
As an aside, I just realized that my wife doesn’t have any traditional (tax deferred) IRA contributions to worry about, so we should be able to do the non-deductible contribution followed by immediate conversion route for her without jumping through any hoops.
Harry Sit says
nickel – Vanguard’s solo 401(k) plan does not accept incoming rollovers from IRAs. It only accepts rollovers from another solo 401(k). That eliminated them from the consideration. I can’t think of a good reason to get the money back into an IRA right now. You are in control of the solo 401(k). You can invest in anything you want. The 5500-EZ form is pretty straight forward if you have to file one (> $250k in assets). You can terminate the plan if you really want to.
I just opened up a solo 401(K) at Etrade (called an individual 401(K) on their site) with no fees and with a loan option that Fidelity regretfully does not have. Etrade’s financials seem to be improving so I felt safe placing my retirement monies with them. There is no fees associated with the account or with the loans but there also isn’t the caliber of customer service that I have been used to having accounts with Fidelity. Do any of you have any experience with Etrade regarding solo 401Ks?
Hey, any idea when the rollover to the 401(k) has to be done? Does it just have be done before the conversion, or does it have to be done before the start of 2010? In other words, could I do the rollover early next year and then do the Traditional-to-Roth thing? Or are the conversion calculations based on (for example) the numbers at the start of the year?
Harry Sit says
nickel – I’m not sure what the absolute deadline is. If you do the rollover in 2009, it’s squeaky-clean when you do the conversion in 2010, no matter which date is used to calculate the pro-rata tax for the conversion: 1/1/2010, date of conversion, or 12/31/2010.
I did some trial numbers on Form 8606 and it seemed to suggest 12/31/2010 is the absolute deadline for the IRA to 401k rollover. But the form is confusing to me. I’m not confident enough to suggest 12/31/2010 to other people. I would stick to 12/31/2009 to be safe.
I have been thinking about rolling my IRA into my solo 401k (at Fidelity) as you describe. I talked to Fidelity about it and they were not sure it was possible. The 401k can have only pre-tax money. Since my IRA has pre-tax and after tax money, they were not sure it was possible to roll any of the IRA into the 401k. The perspective was that just as with a withdrawal from an IRA, the rollover is done proportionately, eg, if you roll 1/3 of the IRA, then you are rolling 1/3 of the pre-tax and 1/3 of the after tax parts. This is true independent of whether the pre-tax and after tax parts are in separate accounts or co-mingled.
I talked to my tax guy today and he was not sure either but is still researching it.
My main questions, did you need to take any special actions to account for or separate the pre-tax and after tax parts of your IRA when doing the rollover into the 401k? Have you researched any of the IRS publications to verify that separating the pre and after tax parts of an IRA by rolling into a 401k is allowed?
Maybe I just need to keep calling Fidelity until I get some one that is familiar with this process.
Harry Sit says
brewster – If you are paying your tax guy, you should let him do the work and earn it. Otherwise you should pay me 🙂 Yes I have done my research and I didn’t have to do anything extra except making sure I leave enough behind.
TFB: Just got off the phone with Fidelity and was told that I can’t do the SEP to 401(k) rollover this year because I’ve already made contributions to the SEP during 2009 and I’m not allowed to have both accounts in the same year (?). I said that I had already maxed out what I’ll be putting into the SEP, so I won’t actually make any 401(k) contributions until next year. He checked with the help desk and they were still of the opinion that I cannot do this. I have a call in to our accountant, but I’m wondering if you can shed some light on this… Did you contribute to your SEP during the year before you executed the rollover?
I was also surprised to learn that I have to adopt the new 401(k) with Fidelity and then work with Vanguard to get the money moved. Does that sound right to you? All of my rollovers in the past have involved filling out paperwork with the recipient institution and then letting them go get the money themselves.
Harry Sit says
nickel – The SEP bit does not make any sense to me, although I never had a SEP. I started with a solo 401k. I think the rep confused between establishing a 401k versus contributing to one. Checking with your accountant is a good idea.
You do have to adopt the new 401k with Fidelity. If you want to keep the same Vanguard funds, they will want you to do the two-step I mentioned in the post anyway. So your asset transfer will be initiated from a Fidelity IRA. You can do that online. It only took a few days for me. After the assets arrive at a Fidelity IRA, you write a letter and roll over the IRA to the solo 401k.
Great explanation of using a solo 401-K to shelter pre-tax IRA dollars.
Let’s say I move ALL my pre-tax IRA dollars to the solo 401-K and do a Roth conversion of my post-tax IRA balances only.
What happens if I decide later on that I want to convert some of the pre-tax dollars to a Roth IRA. How do I do that? Any limitations here? The Fidelity guy said once I’ve transfered the IRA into the 401-K I can’t get it out….Roach Motel?
Bonus Question….I have a Vanguard solo-401-K because they have the Roth option, but they don’t accept transfers as you know. Fidelity accepts transfers but doesn’t have the Roth option. You see any problems maintaining solo 401-K plans with both providers?
Harry Sit says
Brad – Not being able take money out of solo 401k as easily as you can with a Traditional IRA is a limitation. Except being under your own control, a solo 401k works just like any other 401k. When you have a 401k with an employer, you can’t take money out and convert to a Roth IRA until you terminate employment, retire, die, or become disabled.
However, you seem to have conflicting objectives. On one hand you don’t want to pay taxes on your conversion. On the other hand, you want to pay taxes on your ongoing contributions to your solo 401k and make it Roth. If you pay tax on the conversion and contribute to a Traditional 401k, you will achieve the same thing.
Technically it’s possible to maintain two 401k plans. You just make your life more complicated that way. If your situation is really complicated, you should talk to a paid advisor.
sep ira rollover student says
Trying to figure out if I should do a SEP IRA rollover. Lots of info here.
I have same problem, but I just realized this issue. I have rollover IRA from precious 401k and I have non-deductible IRA
(both in seperate accounts) Now can I rollover my rollover IRA to current 401k
and then roll over non-deductible IRA to Roth
would I still have tax consequences??
Thanks for the thorough explanation; I am looking into exactly the same thing with my company’s 401k. One the I would like to have clarified is whether the transfer to the 401k of pre-tax dollars in the IRA includes the tax-deferred gains or is limited only to the deductible contributions made previously?
Harry Sit says
@Tai – Include gains.
TFB – I hope you keep checking back to this post for questions and comments. I’m considering opening up a solo 401(k) in order to be able to do the back door Roth conversion with the non-deductible contributions portion of my IRA, but I had three questions for you:
1. Can I open a solo 401(k) for myself (I can generate some separate self-employment income) even if I already have a 401(k) plan at the firm in which I am a partner, and thus my existing 401(k) is also funded by other self-employment income?
2. I will have to fill out the Form 5500-EZ. How difficult has that proved to be for you? I notice it asks for an EIN that is not supposed to be your SSN; do you have to obtain an EIN for the 401(k) plan, or do you obtain an EIN for your self-employment “business,” even though you don’t have any employees?
3. I just made my 2012 non-deductible contribution into my IRA last week. Will that affect if and when I can do the rollover from my IRA to the solo 401(k), and when or in what amount I can convert the left-behind non-deductible contributions to a Roth IRA this year?
Thanks for your help.
Harry Sit says
Fred – (1) Yes, it’s a different business, but you can also roll into your existing 401k plan.
(2) Not difficult at all. Download the blank form. You will see. Yes you get an EIN even if you don’t have employees.
(3) No effect on rolling pretax money to a 401k. Not much effect on converting the non-deductible money either. In the update to my other post Backdoor Roth: A Complete How-To, I suggested adding a time buffer between contribution and conversion. If you already have non-deductible money in your IRA from previous years, I don’t think you need a big buffer. By the time you are done with rolling the pre-tax money, you will already have a buffer.
Brian Thompson says
The company I work for suspended our simple 401, They have not made contributions or payroll contributions for over a year, Can I roll my simple ira from the company that I work for to my solo 401 I set up with my own businees?
Since the simple plan is suspended even though I still work there, shouldnt I be able to roll it over to a solo 401?
Harry Sit says
Brian Thompson – You mentioned both SIMPLE 401k and SIMPLE IRA. What is it exactly? With a SIMPLE IRA, you can take the money out and roll it over to another plan after participating in the plan for two years. No such clause for SIMPLE 401k. I’m not sure how exactly it’s suspended. Is the plan terminated or being terminated? If it’s already terminated, you can rollover the money elsewhere. If the employer is waiting for a determination letter from the IRS for the termination, you will still have to wait until that happens. See Retirement Plans FAQs regarding Plan Terminations from the IRS.
Q1: I opened a Roth IRA over 5 years ago with $500. I contributed another $2,500 2 years ago. If I take an early distribution of $3,000 would I have to pay a penalty, or does the penalty only apply to the taxable portion (amounts attributable to earnings)?
Harry Sit says
No penalty for withdrawing your own contributions.
I had a conduit IRA with funds from a previous employer’s pension plan. I wanted to move part of the funds into a 401k and the rest into a new IRA account with a different custodian, and I know should have been able to do two direct transfers from the conduit IRA, but I ran into difficulties with the custodian and chose to initiate an indirect rollover in order to facilitate getting the money moved. Is there a problem with taking an indirect rollover and then dividing the funds between the two plans within 60 days? Is it necessary to move all the money at once in this case, or is it acceptable to fund the 401k first and then move the rest of the funds received into an IRA within the 60-day window?
There is a rule for no more than one indirect rollover in one year. However I’m not sure whether taking one distribution from one account and rolling over to two accounts is counted as one or two. I posted the gist of your question to Jim Blankenship, CFP, EA, the author of An IRA Owner’s Manual. Please read Jim’s article More On the One-Rollover-Per-Year Rule and watch for his answer there.
Thanks for the greatly helpful set of articles. As suggested I checked with my company regarding rolling over IRA to 401K and was told it’s a no. I’ll check with Vanguard(which holds the 401K) tomorrow to be sure.
However in my research I came across someone mentioning rolling over from IRA to a low-cost annuity as an alternative to rolling to a 401K. Looking at the Fidelity site they have a low-cost Personal Retirement Annuity that charges 0.25% fee a year. Would you have any thoughts on this?
Appreciate your feedback.
John – I don’t think that will fly. The ‘A’ in IRA stands for Arrangement. An Individual Retirement Arrangement can be either an Individual Retirement Account or an Individual Retirement Annuity. If you move money from an Individual Retirement Account to an Individual Retirement Annuity, it’s still an IRA — Individual Retirement Arrangement.
Thanks Harry. I spoke to a senior adviser at Fidelity today and she confirmed what you stated.
Guess I need to go down the Solo 401K route then.
The rep however did mention that that IRS is keeping an eye on people with Solo 401K whether the account is being contributed into year-to-year beyond the initial transfer/roll-over from the traditional IRA. I don’t know how real that is but figure would share that for everyone’s information.
Now a followup question – if one was to contribute to the solo 401K account, does the contribution count toward the $5000 IRA yearly limit or it’s under a separate contribution bucket all together?
John – The solo 401k and IRA contribution limits are separate.
My wife has a small rollover IRA ($14K) that we set up after she left her previous employer (403b). However, we are hoping to use the backdoor Roth conversion for her (i have done so for myself, and thanks for your great guidance). Not sure with this small amount if it is worth it, but I was considering the solo401k option for her rollover IRA to separate the basis and avoid the taxes (from the pro rata rule).
Guess I am wondering
1. what else can i do with the rollover IRA to help get rid of the potential ongoing tax burden with future backdoor Roth conversions?
2. If we choose to do the solo 401K, and the income generated from the (self employed) business is minimal, can we still contribute (larger) amounts?
Harry Sit says
She can convert the 14k and pay tax on it. Or she can roll it into an employer 401k or a solo 401k. That’s about it. If she sets up a solo 401k, after she rolls the IRA into it, she should keep contributing to the plan. The contribution limit is linked to her earnings from self-employment. If she makes $1,000 a year from self-employment, she can contribute nearly $1,000. The rollover doesn’t count toward the annual contribution limit.
Help!!! In 2013 I opened a solo 401K w/ Sharebuilder and did a direct rollover of 100K from my Vanguard IRA. The IRS audited me today and disallowed the rollover stating that – because I was the owner of the business, they view this as an investment in the business and not into qualified plan. As a result, they now want to tax and penalize me on the 100K as if it were a early distribution.
Is this right? Has anyone heard of this? What should I do?
Harry Sit says
I’m not a tax professional. I only say what I would do if I run into this myself. I would show the IRS the statement entry when the money went into the new account. I would point out the title of the account is a trust company holding the money for a retirement plan. The account does not belong to my business. I would show the prototype plan document, the determination letter, and the adoption agreement as evidence that the plan was established properly. If those don’t convince them, I would seek professional help.
Mark W says
Sorry, I’m not a tax pro either, but this sounds ridiculous. Harry’s approach makes sense to me. There’s not much logic to their position (not that this matters). How would the rollover be different from regular contributions to the Solo 401K–are those also “investments in the business” and not tax deductible?
Another source of information would be the “Fairmark” site–lots of tax experts hang out there.
34 posts and nobody has addressed the issue of protection? Surprising. I am not an attorney, but here goes:
Never co-mingle company and non-company accounts because this may expose your company accounts to creditors.
“The Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 clarified the rights of debtors and creditors to retirement assets in federal bankruptcy proceedings, but state attachment and garnishment of such assets outside bankruptcy is still a concern.
Employer-sponsored individual retirement accounts (IRAs) are protected without dollar limit in bankruptcy proceedings, but other traditional and Roth IRAs are protected up to an inflation-adjusted $1 million. Owner-only plans may be subject to attachment by creditors outside bankruptcy.
Eligible rollover distributions from qualified retirement plans retain their protection, but required minimum distributions and hardship distributions may not.
Courts have disagreed on whether an IRA inherited by an heir other than a surviving spouse is exempt from the new owner’s bankruptcy estate.
A prohibited transaction may cause an IRA to lose its status and become subject to attachment by creditors.”