Backdoor Roth IRA for 2015, or wait and rollover IRA to solo 401k in 2016?

[pickles]

Hi everyone,

I was hoping to get your thoughts on what I should do in this situation.

For 2015, I received $200k on a W-2 and $15k from a 1099. I anticipate that in 2016, my W-2 income will be slightly higher, around $230k, and my 1099 income about the same. My employer does not provide a retirement plan for me.

Currently, I have about $20k in a Roth IRA and $5,500 in a Traditional IRA. I plan on contributing an additional $5,500 to my Traditional IRA It just occurred to me that because of my 1099 income, I could potentially open a solo 401k or SEP-IRA and put away more.

From what I understand, I can put away much more in a solo 401k, so that makes it more desirable than the SEP-IRA. Unfortunately, it is too late to establish a solo 401k for 2015, so I'll have to wait and do that for 2016.

My question is, what should I do for 2015?

1. Should I open a SEP-IRA for 2015? I can contribute about $3,750 (25% of my 1099 income). Then, I was hoping to do a backdoor conversion of the SEP-IRA and Traditional IRA funds (total $14,750) into my Roth IRA. To my understanding, I would be affected by the pro rata rule for $5,500 (amount in my Traditional IRA currently, that was a pre-tax contribution from 2013). The $3,750 + $5,500 SEP-IRA and Traditional IRA contributions for 2015 would NOT be affected by the pro rata rule because this was after-tax, is that correct?

OR

2. Should I open a SEP-IRA for 2015, contribute $3,750, but NOT do a backdoor Roth conversion for 2015? I would leave the money in the SEP-IRA and Traditional IRA for 2015. In 2016, I would open my solo 401k and rollover the $14,750 in the SEP-IRA and Traditional IRA into it.

Which of these two is better? With either plan, my goal starting in year 2017 is to do a backdoor Roth every year, in addition to putting away as much as possible from the 1099 to the solo 401k.

Any advice would be much appreciated!

[jfoxcpacfp]

First of all, you have a misunderstanding what a back-door Roth is. Very confusing if you are doing it for the first time, I realize, and you have several moving parts going on. A back-door Roth is a conversion of the contribution to a TIRA (Traditional IRA) that was nondeductible due to income limitations. It's a sneaky, but perfectly acceptable, way to get around the income limitations for a direct contribution to a Roth IRA. Since you do not have an employer plan, your contribution to a TIRA would actually be deductible if you didn't contribute to the SEP.

Now for your dilemma. Your priorities should be:

• Contribute as much as possible to retirement accounts for 2015. That means the SEP and a TIRA (which will be nondeductible). Be sure to file form 8606 for the TIRA to record basis with the IRS.


• Next, set up a SOLO 401k for 2016 and roll the SEP into it.


• Then convert the $5,500 you already have in your TIRA to your Roth (you'll have to pay tax on this if the account is pre-tax). This will open the door for your back-door Roth.


• Convert the 2015 nondeductible TIRA to your Roth. This is your back-door Roth conversion.


• Finally, you can convert as much of the 401k account as you want to the Roth. You'll pay tax on any amount converted so be sure and do a tax projection before you do so. If it pushes part of your taxable income into the next bracket, you may want to wait until the following year. I can't estimate where you'll fall in the brackets since I don't know your filing status.


• Now that you have the SOLO-k, you can contribute up to $18k per year to it, limited by your earned income. You may want to set up a Roth option to contribute directly to a Roth through your 401k.

Hope this makes sense - good luck!

[litovskyassetmanagement]

pickles wrote:

Hi everyone,

I was hoping to get your thoughts on what I should do in this situation.

For 2015, I received $200k on a W-2 and $15k from a 1099. I anticipate that in 2016, my W-2 income will be slightly higher, around $230k, and my 1099 income about the same. My employer does not provide a retirement plan for me.

Currently, I have about $20k in a Roth IRA and $5,500 in a Traditional IRA. I plan on contributing an additional $5,500 to my Traditional IRA It just occurred to me that because of my 1099 income, I could potentially open a solo 401k or SEP-IRA and put away more.

From what I understand, I can put away much more in a solo 401k, so that makes it more desirable than the SEP-IRA. Unfortunately, it is too late to establish a solo 401k for 2015, so I’ll have to wait and do that for 2016.

My question is, what should I do for 2015?

1. Should I open a SEP-IRA for 2015? I can contribute about $3,750 (25% of my 1099 income). Then, I was hoping to do a backdoor conversion of the SEP-IRA and Traditional IRA funds (total $14,750) into my Roth IRA. To my understanding, I would be affected by the pro rata rule for $5,500 (amount in my Traditional IRA currently, that was a pre-tax contribution from 2013). The $3,750 + $5,500 SEP-IRA and Traditional IRA contributions for 2015 would NOT be affected by the pro rata rule because this was after-tax, is that correct?

OR

2. Should I open a SEP-IRA for 2015, contribute $3,750, but NOT do a backdoor Roth conversion for 2015? I would leave the money in the SEP-IRA and Traditional IRA for 2015. In 2016, I would open my solo 401k and rollover the $14,750 in the SEP-IRA and Traditional IRA into it.

Which of these two is better? With either plan, my goal starting in year 2017 is to do a backdoor Roth every year, in addition to putting away as much as possible from the 1099 to the solo 401k.

Any advice would be much appreciated! " />

Click to expand...

If you have a consistently high 1099 income and you are older than 35, I'd consider doing a solo Defined Benefit plan together with a solo 401k:

http://quantiamd.com/player/ygvmhdmbm?cid=1467

By the way, a solo 401k at Vanguard will not allow you to roll over your SEP unless you have a customized plan document (and use a VRIP account):

https://www.whitecoatinvestor.com/improving-the-vanguard-individual-401k-with-a-customized-plan/

So you'd have to go someplace else.  This won't be a problem if you are doing a solo DB plan though (at that point you can open two VRIP accounts because as far as I know, none of the solo 401k plan documents allow for a DB plan.

This might not be the best solution for you unless you can consistently contribute about double the 401k plan maximum (~$100k or so).  And I would also suggest giving yourself a W2 for your 1099 income by creating an LLC taxed as S corp (this is a must if you want to have a DB plan if you want to max out your contribution).

[jfoxcpacfp]

Kon Litovsky wrote:

If you have a consistently high 1099 income and you are older than 35, I’d consider doing a solo Defined Benefit plan together with a solo 401k:

Click to expand...

Per pickles' original post, his 1099 income is $15k and expected to remain about the same.

[litovskyassetmanagement]

jfoxcpacfp wrote:

Kon Litovsky wrote:

If you have a consistently high 1099 income and you are older than 35, I’d consider doing a solo Defined Benefit plan together with a solo 401k: 

Click to expand…

Per pickles‘ original post, his 1099 income is $15k and expected to remain about the same.

Click to expand...

I actually read this as '1099 income about the same as W2', doh!

 

[litovskyassetmanagement]

I read this as 'having the same 1099 income as W2', my bad.  The bit about solo 401k at Vanguard still stands - don't do it if you want to roll the SEP into it.  Go someplace else like Schwab or Fidelity that allows incoming rollovers.

[RadDoc6876]

Just asking this since some people inclduing myself are wondering about this.  Except my W-2 employer does have a 401K equivalent plan (Thrift Savings Plan--which does allow incoming SEP-IRA transfers).  Could pickles do the following:

1. Assuming pickles' W-2 employer did offer a 401K plan, contribute $18K (*employee* contribution) to that, and

2. Contribute to a SEP IRA plan with 25% of net 1099 income (SEP IRA is always considered *employer* contribution per my understanding) and roll it over to the W2 employer's 401K plan to zero it out and enable the back-door Roth conversion, and

3. Contribute $5500 to a TIRA and do the back-door Roth conversion, and

4. Contribute some amount to an Individual 401K plan (this would have to be an *employer* contribution since $18K employee contribution already made).  If this is allowable, how much could be put into the Individual 401K under these circumstances?

Can all the above items 1-4 be done, without running afoul of IRS rules?

Thank you.

 

 

 

[litovskyassetmanagement]

It's not 25% but close to 20%.  Yes, you can certainly roll your SEP into your employer plan, that's always an option.  Yes, you can use a solo 401k as a SEP pretty much.

[s2km]

@pickles, I'm in a very similar situation, no 401k offered by employer, made some 1099 income in 2015 and have contributed to T-IRA (deductible) for few years.  I'm going to be making more 1099 income this year. I was planning on doing your option 2 this year minus opening the SEP b/c my 2015 1099 income was not too significant.  I did not want to deal with doing a T-IRA to ROTH conversion as I do not want to pay the taxes on the conversion.

as for your option 1, i'm a fan of keeping things simple and personally would not want to deal with which portion is considered pro-rata and all.

as for opening a SEP, would that make your 2015 T-IRA contribution non-deductible? you could then do a backdoor conversion like jfoxcpacfp suggested for 2015, but you would have to roll over the SEP and the prior T-IRA (deductible) into the solo 401k first (make sure you choose a solo401k that accepts roll overs, i'm planning using TD-ameritrade as I already have other accounts through them, but Fidelity is good too).

 

[pickles]

Thank you everyone for the helpful responses!

jfoxcpacfp,

-----My tax status for 2015 & 2016 - single, no dependents. My income level for 2015: W2 - $200k, 1099 - $15k; 2016: W2 - $230k, 1099 - $15k. Do you think I should convert the amount in my solo 401k (~$3k rolled over from my 2015 SEP-IRA contribution, plus ~$15k from 2016 solo 401k distribution, so ~$18k total) in 2016 or wait?

-----You wrote, "convert the $5,500 you already have in your TIRA to your Roth (you’ll have to pay tax on this if the account is pre-tax). This will open the door for your back-door Roth. Convert the 2015 nondeductible TIRA to your Roth. This is your back-door Roth conversion."

Sorry if this is a dumb question, but can I do the conversion of the total amount in my TIRA ($11k - $5.5k from before, and $5.5k marked as a 2015 contribution but deposited in the same account Feb 2016) all at the same time? I understand I have to pay taxes on the $5.5k that was in there from before, and that I need to file form 8606, but I'm not clear if I have to do it sequentially, ie 1) Transfer taxable amount in TIRA, then 2) do backdoor Roth next?

-----You wrote, "Now that you have the SOLO-k, you can contribute up to $18k per year to it, limited by your earned income. You may want to set up a Roth option to contribute directly to a Roth through your 401k."

Can you elaborate on this? How would I contribute directly to a Roth through a solo 401k?

Thank you so much!

[pickles]

I thought I posted a reply, but for some reason it isn't here. Here's round 2!

Thank you everyone for the helpful responses!

jfoxcpacfp,

-----My tax status for 2015 & 2016: single, no dependents. My 2015 income: W2 - $200k, 1099 - $15k; 2016 income: W2 - $230k, 1099 - $15k. Not sure about 2017. Do you think I should convert the amount in my solo 401k (~$3k rolled over from my 2015 SEP-IRA contribution, plus ~15k directly contributed in 2016) to my Roth in 2016 or wait?

-----You wrote, "Convert the $5,500 you already have in your TIRA to your Roth (you’ll have to pay tax on this if the account is pre-tax). This will open the door for your back-door Roth."

Sorry if this is a dumb question, but can I convert the total amount in my TIRA ($5.5k from before, and $5.5k marked as a 2015 contribution but deposited in Feb 2016) at the same time? I understand that I have to pay taxes on the $5.5k from before and must file form 8606, but do I have to convert sequentially, ie 1) Convert old TIRA amount, then 2) do backdoor Roth?

-----You wrote, "Now that you have the SOLO-k, you can contribute up to $18k per year to it, limited by your earned income. You may want to set up a Roth option to contribute directly to a Roth through your 401k."

Can you explain how I would be able to directly contribute to a Roth through my solo 401k? I have not heard of this before.

 

Thank you so much!

 

[pickles]

I thought I posted a reply, but for some reason it isn't here. Here's round 2!

Thank you everyone for the helpful responses!

jfoxcpacfp,

-----My tax status for 2015 & 2016: single, no dependents. My 2015 income: W2 - $200k, 1099 - $15k; 2016 income: W2 - $230k, 1099 - $15k. Not sure about 2017. Do you think I should convert the amount in my solo 401k (~$3k rolled over from my 2015 SEP-IRA contribution, plus ~15k directly contributed in 2016) to my Roth in 2016 or wait?

-----You wrote, "Convert the $5,500 you already have in your TIRA to your Roth (you’ll have to pay tax on this if the account is pre-tax). This will open the door for your back-door Roth."

Sorry if this is a dumb question, but can I convert the total amount in my TIRA ($5.5k from before, and $5.5k marked as a 2015 contribution but deposited in Feb 2016) at the same time? I understand that I have to pay taxes on the $5.5k from before and must file form 8606, but do I have to convert sequentially, ie 1) Convert old TIRA amount, then 2) do backdoor Roth?

-----You wrote, "Now that you have the SOLO-k, you can contribute up to $18k per year to it, limited by your earned income. You may want to set up a Roth option to contribute directly to a Roth through your 401k."

Can you explain how I would be able to directly contribute to a Roth through my solo 401k? I have not heard of this before.

Thank you so much!