In order to pay minimal taxes when you do a backdoor Roth, you should have no balance in any other traditional, SEP or SIMPLE IRA. If you have a large balance in those accounts, you can rollover the money into an employer-sponsored plan such as a 401k or a 403b before you do the backdoor Roth.
When your employer plan has poor investment options, there’s an alternative: set up a solo 401k for yourself. Then you can rollover your traditional, SEP, or SIMPLE IRA to your own solo 401k.
What Is a Solo 401k
The IRS describes a solo 401k this way:
The one-participant 401(k) plan is not a new type of 401(k) plan. It is a traditional 401(k) plan covering a business owner with no employees, or that person and his or her spouse.
Perfect For a Micro-Business
A solo 401k is perfect for a one-person or husband-and-wife business with no other employees. The business doesn’t have to be a full-time endeavor. Nor does it need to generate a large income. I started my solo 401k when I had only a few hundred dollars a year from self-employment.
Husband-and-Wife Sole Proprietorship
If you are married and both husband and wife want a solo 401k account, the easiest setup would be to operate the business as a “qualified joint venture.”
In short, both husband and wife own the business, both materially participate in it, and you split the income and expenses. You don’t set up any LLC or S-Corp. You just file a joint return with two Schedule C’s and two Schedule SE’s as sole proprietors. You would set up one solo 401k plan with two participants.
If you have one person as the owner and the other as a W-2 employee, you would have to run payroll ($30/month at one online payroll provider). Maybe it’s OK for a larger business. It’s not worth it when your business is making only a few hundred dollars a year.
If you have one person as the owner and the other person as an independent contractor on 1099, you would have two separate businesses, and two solo 401k plans with one participant each. It’s more complicated than just having husband and wife co-own the same business.
Setting Up a Solo 401k
First get an EIN from the IRS online. Then fill out some paperwork from a solo 401k provider. I use Fidelity and I recommend it without reservation for this purpose. Fidelity has detailed getting started guide on its website. Fidelity doesn’t charge any setup or maintenance fee.
Vanguard’s solo 401k doesn’t accept incoming rollovers from IRAs. You can’t use it to enable the backdoor Roth. In addition, it doesn’t allow you to invest in lower-cost Admiral shares or ETFs. It ends up costing more than Fidelity.
Contributing to a Solo 401k
Contact your solo 401k provider for how to rollover existing assets from your traditional, SEP, or SIMPLE IRA.
Use my spreadsheet to calculate how much you can contribute from your self-employment income each year. See Solo 401k For Part-Time Self-Employment. Tax software such as H&R Block or TurboTax can calculate it too. Although it isn’t much when your self-employment income is low, I would still contribute each year when you have self-employment income. It keeps the plan active.
Investing In a Solo 401k
Fidelity lets you invest in practically anything in a brokerage account. See previous post on the best index funds and ETFs at Fidelity.
No CPA Needed
You don’t need a CPA when you run your simple business as sole proprietorship. Tax software such as H&R Block or TurboTax is fully capable of producing the necessary tax forms for your micro-business.
When your solo 401k plan assets exceed $250,000, you are required to file a Form 5500-EZ every year before July 31. It’s also a very simple form. Fidelity sends the necessary information for it every year. It takes less than 5 minutes to complete.
If you are self-employed just by yourself or together with your spouse, with no employees, a solo 401k can do everything a SEP IRA does. In many cases you can contribute more to a solo 401k than to a SEP IRA, but never the other way around. If you currently use a SEP IRA, you should consider switching to a solo 401k, especially if you want to enable the backdoor Roth.