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Closing solo 401k, and backdoor roth mistake

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  • Closing solo 401k, and backdoor roth mistake

    Hello everyone,

    While I was a W2 employee with 1099 (on call) income, see my post. In December 2020 I started a solo practice, hired my first employee (non family member) in February 2021. At that point I believe I am ineligible to continue with solo 401k contributions. So here is the mess I have gotten myself into, in January 2021 (out of habit and not doing a great job of forward thinking) I contributed to IRA and transferred to roth (backdoor IRA). The problem is I want to open a SEP-IRA this year as my practice has done well, and as I only have 1 employee (who would not be eligible) making it the most attractive plan. So I want $0 in an IRA to avoid Pro rata rule for 2021. So my goal is to have $0 in IRA by the end of 2021. So I have 2 problems
    1) I need to close the solo 401k, but have nowhere to roll money into. My 401k from old job doesn't allow incoming transfers for non active employees
    2) I need open a Sep IRA and make contributions for the 2021 year

    My plan is to 1) See if I can not make contributions to the solo 401k, but keep it open until early 2022 where I would then transfer the pretax to my IRA and post tax to my Roth IRA

    2) Open a SEP IRA but not make 2021 contributions until 2022

    Any advice, comments, resources are much appreciated

  • #2
    As long as your solo-k plan stipulates that an employee must work f.t. 1 yr to qualify to participate, I believe you continue to be eligible to use the solo-k for 2021. And, regardless, if you have a reasonable belief that you may qualify to contribute to the solo-k in the future, you d/n/h to close it down. If I am correct, this would solve your problem. Otherwise, go with plan B and contribute to the SEP in 2022.

    I’m sure SR will drop by to clean up any problems with my response😁.
    Our passion is protecting clients and others from predatory and ignorant advisors. Fox & Co CPAs, Fox & Co Wealth Mgmt. 270-247-6087


    • #3
      Something else I need to check into is I likely wont have a W2 employee over 1,000 hours this year (thanks to turnover 2/3 of the way through the year), that may make the solo 401k plan sufficient to use this year.


      • #4
        As pointed out be jfoxcpacfp, your one-participant 401k adoption agreement likely had options to elect employee eligibility restrictions. The IRS allows restricting eligible employees to those; >= age 21, >= 1,000* hours/12 months and >= 1 year of service. If you elected those options, you can maintain the one-participant 401k until the employee becomes eligible.

        Note: The eligibility can be further restricted to limited entry points. Mainstream one-participant 401k plans require immediate entry on eligibility. Since you have an independent 401k plan document, you will have to check out if the are specific entry points. If you didn't elect employee eligibility restrictions, The employee became eligible on the date of hire.

        If you have eligible employees, the one-participant 401k must be amended to an ERISA 401k plan, frozen or terminated. Here again you will have to check with your plan document and/or document provider to determine if frozen plans are supported. A frozen plan allows the assets to remain, but no additional contributions can be made.

        If terminating the plan effective in 2/21 on the date of hire to be in compliance. you generally have 12 months to rollover the assets. That would allow your 12/31 pre-tax balance to be $0 and you could rollover in the next year before the date of hire anniversary.

        You will then need to file a final Form 5500-EZ regardless if you were ever required to file an annual form. This must be filed by the last day of the seventh month after the account balances are $0. Be very sure to do this as there are significant penalties just recently increased to up to $250K. Although there is a penalty waiver programs that can reduce this to $500/year with a $1500 maximum.

        Your plan to switch to a SEP IRA will not work if you were planning on the three (3) year of five (5) year eligibility restriction. Eligibility restrictions apply to all employees including owners. You will not be eligible until 12/2023 if you adopt a SEP IRA electing the 3 of 5 eligibility.

        Notwithstanding the eligibility issue, you could not adopt a 5305-SEP IRA plan (E-Trade, Fidelity, Schwab, TD Ameritrade and Vanguard) for the 2021 tax year. You can not maintain a qualified plan (401k) plan and a 5305-SEP for the same tax year. A 401K is maintained from adoption until termination. However, you could adopt a prototype SEP IRA plan (Merrill Edge and Schwab) which can coexist with a qualified plan.

        I suggest considering amending to an ERISA safe harbor 401k plan. Guideline offers a "core" safe harbor 401k plan at $49/month + $8/month/participant ($780/year/2 participants). Since you have an existing 401k plan, you will have to use the "max" plan at $129/month + $8/month/participant ($1740/year/2 participants) for the first year.

        Think of it as a startup cost. Almost all 401k plan providers require a significant startup fee for amending/transitioning an existing 401k plan. However, the "max" plan may be the best choice moving forward. It supports the new comparability method profit sharing. This allows the 401k plan to have multiple groups (owner + one or more additional). This could allow you to maximize your annual addition limit while limiting the other group(s) to a minimum of 5% - 7% profit sharing.

        *The SECURE ACT reduced this to 500 hours/12 months with three years of service. However, service before 1/1/2021 is not counted. The earliest this can affect any plan is 1/1/2024.
        Last edited by spiritrider; 09-13-2021, 08:41 AM. Reason: Added SECURE ACT possible reduction to 500 hours/12 months


        • #5
          Thanks spiritrider , I am going to re-read your comment a few hundred times to digest it and will report back, just wanted to say thank you in advance!


          • #6
            Originally posted by spiritrider View Post

            Your plan to switch to a SEP IRA will not work if you were planning on the three (3) year of five (5) year eligibility restriction. Eligibility restrictions apply to all employees including owners. You will not be eligible until 12/2023 if you adopt a SEP IRA electing the 3 of 5 eligibility.
            Thank you again for your response. I am setting up a meeting with my document provider. I was hoping you could expound the quote above. If my 401k has been funded for 2020, but terminated in 2021 without any contributions for 2021, I still would not be able to open a SEP IRA with employee eligibility restrictions?

            My ideal scenario is close 401k in 2021, transfer assets to IRA in 2022, open SEP IRA 2022 and contribute for 2021 tax year. I am guessing this will not work, but not quite sure as to why.
            If I didn't have a 401k previously I could just open the SEP IRA with eligibility restriction?

            Thanks again,


            • #7
              Your problem with SEP IRA eligibility restrictions has nothing to do with whether you maintained a 401k in 2021.

              Your above quote from my post and SEP IRA rules and regulations are quite clear. Any eligibility restriction you elect on the SEP IRA adoption agreement, must apply to you as well as any other employees. Unless you adopted a prototype SEP IRA before you hired the an employee and exempted yourself from the restrictions. This means that if you adopt a SEP IRA with a 3 of 5 year eligibility restriction, you will not be eligible to receive SEP IRA contributions until three years after the inception of the business and the employee will not be eligible to receive SEP IRA contributions until the 3rd anniversary of their date of hire.

              Contributions can not be made to a 5305-SEP IRA for the 2021 tax year, because a 401k was maintained in 2021. Contributions to eligible employees could be made to a prototype SEP IRA for the 2021/2022 tax year and/or a 5305-SEP IRA for the 2023 and subsequent tax years if you terminate the 401k in early 2022. As I already pointed out, this is simply a restriction on the type of SEP IRA and by association the allowable custodians (Merrill Edge, Schwab, etc...). E-Trade, Fidelity, TD Ameritrade and Vanguard only offer 5305-SEP IRAs.

              One question would be whether the practice is the same business as you previously had or is a new business. This would determine when your clock starts ticking for the eligibility period you select.


              • #8
                It is a new business with new EIN


                • #9
                  Then the only practical option I see for a SEP IRA. Adopt a prototype SEP IRA from Schwab for 2021 with a 1 of 5 eligibility restriction. This would allow you to receive full SEP IRA contributions for 2021, but the employee would not be eligible until 2022.

                  If the latter is not acceptable, you could elect not to make SEP IRA contributions for 2022. Then there would be three options:
                  1. Make no employer retirement plan contributions for 2022.
                  2. Adopt a SIMPLE IRA for 2022. A SIMPLE IRA sponsor must provide their employees with 60-,day notice/enrollment packet by 11/2/2021 for it to be effective on 1/1/2022. You would want to be working on it within the next month to meet that deadline.
                  3. Adopt an ERISA safe harbor 401k for 2022. The employee notice must be 30 - 90 days or 10/3/2021 - 12/2/2021 for a 1/1/2022 effective date.


                  • #10

                    Update, discussed this with my solo 401k provider and the criteria for eligible employees (attached), here are the highpoint

                    You will become eligible to make Elective Deferral Contributions and Voluntary Contributions and receive Non-Elective Contributions on the a) first day of the first month of the Plan Year or b) first day of the seventh month of the Plan Year, next following the date you attain age 21 and you complete one (1) Year of Eligibility Service, provided that you are an Eligible Employee on that date.

                    Computing Service: With respect to eligibility to make Elective Deferral Contributions and Voluntary Contributions and to receive Non-Elective Contributions, "Year of Eligibility Service" means an Eligibility Computation Period during which you complete at least 1,000 hours of service.

                    So I should be good to contribute to the solo 401k this year. I am wondering the best way to approach next year, I officially opened in 2020 (no employee saw one patient by myself in December), 2021 Hired employee but none meeting qualification in 401k. Now I am looking for best option for 2022. Thanks so much for your help. If it means I pay taxes on my Backdoor roth 2021 I am ok with that.
                    Attached Files


                    • #11
                      I posted on bogleheads,
                      But here is my plan, and I would value any input

                      1) Fund solo 401k for 2021
                      2) Close solo 401k at the end of December in 2021 and file form 5500-EZ. Specifically targeting end of December because the transfer to the IRAs will not be complete until January 2022
                      3) I then could still put $0 on line 2 of form 8606 (so I would not be subject to pro-rata)
                      4) Open a 5305 SEP IRA at some point in 2022 elect 2 of 5 years eligibility criteria (I started in 2020), in 2023 change to 3 of 5 years. If employee is still with me in 2024 go with guideline 401k.

                      Does this make sense? Any suggestions appreciated!