W2 & 1099 employment unknown - wait on Solo 401k employee contributions?

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Topic Author
ThankYouJack
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W2 & 1099 employment unknown - wait on Solo 401k employee contributions?

Post by ThankYouJack »

Say someone is a 1099 contractor (with a solo 401k) but may switch to W2 next year (possibly with a 401k match) and they'd like to max out their retirement accounts.

What would be the proper steps to make sure they don't leave any tax advantage space on the table?

As 1099 paychecks are deposited, I'm thinking:

1. Put the first $22,500 in a taxable account. Earmark this as the Solo 401k employee contribution.

2. Take (1099 income - $22,500) * 85% and contribute that towards the employer contribution up to the limit. I'm thinking 85% so the 401k employer contribution limit isn't exceed.

3. Do a backdoor Roth once the income limit is exceeded


After that it depends. If the person remains as a 1099 contractor for the year:

4. In Q4 sell the $22,500 from taxable and make the employee solo 401k contribution


However, if the person switches to a W2 employee:

4. Max out the new 401k with any match


5. Before the April 15, 2024 tax deadline, max out the employer contribution of the solo 401k


Does that make sense? Those are the only steps I can think that guarantee everything is maxed out.
FunOnABudget
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Re: W2 & 1099 employment unknown - wait on Solo 401k employee contributions?

Post by FunOnABudget »

The thing to keep in mind is that your solo 401k plan and the possible new employer's 401k plan are different plans. IRS limits apply to each plan separately with the exception of salary deferrals.

So if you are talking about switching on January 1 there is no issue whatever... put in as much as you want to each plan. If you are talking about switching in the middle of the year then your total deferrals from both plans can't exceed the max. ($22,500 plus $7500 catch up).

The employer side doesn't matter at all and voluntary after tax contributions don't matter at all as long as total plan contributions are no more that $66,000. ($73,500 if doing deferrals into that account with catch up).

Also remember that you can put money into a plan for a given tax year prior to the due date for that tax return. Your W2 company probably won't let you do this but your solo 401k should. The point being that you could put in exactly what you want in Q1 2024 for solo 401k. As long as you have the cash.
Topic Author
ThankYouJack
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Re: W2 & 1099 employment unknown - wait on Solo 401k employee contributions?

Post by ThankYouJack »

FunOnABudget wrote: Mon Nov 28, 2022 1:51 pm The point being that you could put in exactly what you want in Q1 2024 for solo 401k. As long as you have the cash.
But if I switch to W2 midyear, this could cost me down the road as it could prevent me from getting any W2 401k match for the year.

Also, I believe it could reduce the size of the Solo 401k employer contribution. For example say:

1: $100k 1099 income, $22.5k W2 401k would allow for $100k * 20% (not factoring SE tax) = approx. $20k employer contribution

2. $100k 1099 income, $22.5k solo 401k employee contribution would allow for ($100k - $22.5k) * 20% = approx. $15.5k employer contribution


Maybe the match is unlikely in the first year of employment, and the extra $4.5k of tax deferred space would be nice but definitely not the end of the world if I didn't get it
FunOnABudget
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Re: W2 & 1099 employment unknown - wait on Solo 401k employee contributions?

Post by FunOnABudget »

Here's what I would do.. this is just me.

Assume $100K in 1099 income (gross) and $100K in W2 income. Job switches in June 2023.
Assume you have no Voluntary after tax feature in either plan.

Put NOTHING into your solo 401k plan during calendar year 2023.
Contribute 6% (or whatever it takes to get matching) to your W2 job 401k.
Get the matching. Get bonuses, whatever.
In january of 2024 Look at your W2 401k Plan. See how much you contributed. Say it's $6000. (6% of 100K)
Now do your schedule C for your business. Based on turbo tax or whatever get the exact amount maximum for the EmployER side of your solo 401k.
Put that money into the employer bucket of the solo 401k. This is like $20K or so.
Now take the maximum for 2023 deferrals: $22,500.00 and subtract the $6000 you contributed as deferral to the W2 401k = $16,500. So put the $16.5K into the EmployEE side of the solo 401k.
Now you are done.

If it's important to earn deferred interest or growth on the money from the business then you could put some in at mid year, but again that's extra work. I'm lazy and I do all my business retirement at the beginning of the next year when I know all the numbers exactly.
Topic Author
ThankYouJack
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Re: W2 & 1099 employment unknown - wait on Solo 401k employee contributions?

Post by ThankYouJack »

That’s what I was thinking too. But the employee contributions (if any) would need to made by Dec 31, not April 15.

I was also looking up how many employers give a match within the first year of employment and it’s a pretty low percentage. So that’s unlikely.

I’m torn, I may just go ahead and front load the employee contribution as the only thing I’d likely be giving up is a little extra tax advantage space.
FunOnABudget
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Re: W2 & 1099 employment unknown - wait on Solo 401k employee contributions?

Post by FunOnABudget »

ThankYouJack wrote: Mon Nov 28, 2022 5:17 pm That’s what I was thinking too. But the employee contributions (if any) would need to made by Dec 31, not April 15.

I was also looking up how many employers give a match within the first year of employment and it’s a pretty low percentage. So that’s unlikely.

I’m torn, I may just go ahead and front load the employee contribution as the only thing I’d likely be giving up is a little extra tax advantage space.
If that's true someone will come along and confirm it. :happy
HomeStretch
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Re: W2 & 1099 employment unknown - wait on Solo 401k employee contributions?

Post by HomeStretch »

ThankYouJack wrote: Mon Nov 28, 2022 5:17 pm That’s what I was thinking too. But the employee contributions (if any) would need to made by Dec 31, not April 15. …
If you elect S-Corp status for your self-employed business, yes the employee elective deferral must be made through payroll withholdings from Jan. 1-Dec. 31.

If your business will be a Sole Proprietorship, you can make a written deferral election by Dec. 31, but you have until your tax return filing deadline (including extension) the following year to make the plan contribution.
Topic Author
ThankYouJack
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Re: W2 & 1099 employment unknown - wait on Solo 401k employee contributions?

Post by ThankYouJack »

HomeStretch wrote: Mon Nov 28, 2022 5:58 pm
ThankYouJack wrote: Mon Nov 28, 2022 5:17 pm That’s what I was thinking too. But the employee contributions (if any) would need to made by Dec 31, not April 15. …
If you elect S-Corp status for your self-employed business, yes the employee elective deferral must be made through payroll withholdings from Jan. 1-Dec. 31.

If your business will be a Sole Proprietorship, you can make a written deferral election by Dec. 31, but you have until your tax return filing deadline (including extension) the following year to make the plan contribution.
Thanks for the correction :beer

In the scenario above, am I correct in thinking that making the full $22,500 contribution on the W2 side would be better because it would allow for a larger solo 401k employer contribution?
Plus there's the QBI deduction to factor in, essentially I'd get a larger QBI deduction going with the W2 401k.
HomeStretch
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Re: W2 & 1099 employment unknown - wait on Solo 401k employee contributions?

Post by HomeStretch »

ThankYouJack wrote: Mon Nov 28, 2022 6:59 pm … In the scenario above, am I correct in thinking that making the full $22,500 contribution on the W2 side would be better because it would allow for a larger solo 401k employer contribution?
Plus there's the QBI deduction to factor in, essentially I'd get a larger QBI deduction going with the W2 401k.
I don’t know if you posted your projected net self-employed business earnings for the year. Your Solo 401k employER contribution is limited to 20% of your net business earnings minus the employER portion of self-employment taxes. Your Solo 401k employEE elective deferral does not reduce your net business earnings. But the total of your employEE and employER contributions cannot exceed your self-employment compensation.

With QBI in the equation, I think it makes sense to model the scenarios out to see what is best for you. But, if you miss filling a bit of tax deferred space and instead save the extra in a Taxable account, I don’t think you can go wrong.
Topic Author
ThankYouJack
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Re: W2 & 1099 employment unknown - wait on Solo 401k employee contributions?

Post by ThankYouJack »

HomeStretch wrote: Mon Nov 28, 2022 7:13 pm
ThankYouJack wrote: Mon Nov 28, 2022 6:59 pm … In the scenario above, am I correct in thinking that making the full $22,500 contribution on the W2 side would be better because it would allow for a larger solo 401k employer contribution?
Plus there's the QBI deduction to factor in, essentially I'd get a larger QBI deduction going with the W2 401k.
I don’t know if you posted your projected net self-employed business earnings for the year. Your Solo 401k employER contribution is limited to 20% of your net business earnings minus the employER portion of self-employment taxes. Your Solo 401k employEE elective deferral does not reduce your net business earnings. But the total of your employEE and employER contributions cannot exceed your self-employment compensation.

With QBI in the equation, I think it makes sense to model the scenarios out to see what is best for you. But, if you miss filling a bit of tax deferred space and instead save the extra in a Taxable account, I don’t think you can go wrong.
Thanks makes sense.

For the QBI part, back of the napkin is my deduction would likely be reduced by $22,500 * 20% = $4,500. Say I'm in the 29% tax bracket (federal + state), I'd be paying an extra $4,500 * .29 = $1,305 in taxes for the year.
HomeStretch
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Re: W2 & 1099 employment unknown - wait on Solo 401k employee contributions?

Post by HomeStretch »

ThankYouJack wrote: Mon Nov 28, 2022 7:50 pm … For the QBI part, back of the napkin is my deduction would likely be reduced by $22,500 * 20% = $4,500. Say I'm in the 29% tax bracket (federal + state), I'd be paying an extra $4,500 * .29 = $1,305 in taxes for the year.
Agree, it makes more sense to make Traditional 401k employee elective deferrals to your W-2 401k plan. Or make Roth 401k deferrals to your Solo 401k plan as they don’t affect QBI.
Topic Author
ThankYouJack
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Re: W2 & 1099 employment unknown - wait on Solo 401k employee contributions?

Post by ThankYouJack »

HomeStretch wrote: Mon Nov 28, 2022 10:05 pm Or make Roth 401k deferrals to your Solo 401k plan as they don’t affect QBI.
That's exactly what I did that this year as it's a lower income year. But for higher income years (most likely next year) I'll want to stick with pre-tax contributions because of tax arbitrage. I'll be saving about 30% on the money going in and pay less than 20% on the money coming out. So $22,500 * 10% = $2,2500 which is greater the savings from the QBI deduction if I went the Roth route.
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