Solo 401k for S-Corp: Traditional and/or Roth

Have a question about your personal investments? No matter how simple or complex, you can ask it here.
Post Reply
Topic Author
getmoneygetpaid
Posts: 24
Joined: Thu Oct 27, 2022 10:48 am

Solo 401k for S-Corp: Traditional and/or Roth

Post by getmoneygetpaid »

-Single Member S-Corp Owner, no other employees
-Net Income fluctuates: 200k-300k
-Back-Door Roth annually
-Max out HSA annually
-Monthly contributions into taxable account
-29, mfj

In review of my current investment strategy, I am considering two changes:

1. HSA - I currently use my HSA to pay for medical expenses. My wife and I just had our first child last year, and expect to pump out a 2-3 more over the next 1-7 years. If I can cash flow these expenses, should I move my HSA balance from money market funds and into more long-term oriented stock investments? Should I take the "tax free" benefit and just pay for these expenses out of my HSA?

2. Taxable Account Replacement - With some of my disposable income (currently 1k/mo), I contribute monthly to a taxable account. My CPA recently encouraged me to look into a "Solo 401k". It seems I could not only use these contributions to boost my W-2 earnings (a requirement of S-Corp's), but also reduce my current tax liability while contributing a significantly larger amount than $6,500 to my Roth.

Being self-employed, I'm honestly not sure what retirement may look like for me. Will I find a way to grow my business such that I can 1. Live semi-retired later in life, and 2. Stay in a higher tax bracket, or will I hang it all up at 60 and pull from my investment accounts to live off of?

I think the goal would be to find a way to stay in a higher tax bracket throughout retirement, though this isn't guaranteed.

With all this mind, is it ok to have both a Traditional and Roth account? What would this look like for me during retirement?
buy low, sell high
User avatar
retiredjg
Posts: 54082
Joined: Thu Jan 10, 2008 11:56 am

Re: Solo 401k for S-Corp: Traditional and/or Roth

Post by retiredjg »

Having both a traditional and a Roth account is a good and preferred choice. This gives you the flexibility to have both taxable and non-taxable income in retirement according to your needs and desires.

At your income level, using traditional 401k is the way to go to reduce your current taxable income. Supplement this with Roth IRA - tIRA would not be deductible for you and therefore is of little value other than as the first step in the backdoor Roth process.

Is spouse using backdoor Roth IRA as well? If not, that should also be done before putting retirement money into a taxable account.

As for your HSA - that is up to you whether you spend it now or save it until later. It does seem a lot of people, who have low medical bills, like to save it for later.

Not sure why a goal would be to be in a higher tax bracket in retirement though.
petulant
Posts: 3601
Joined: Thu Sep 22, 2016 1:09 pm

Re: Solo 401k for S-Corp: Traditional and/or Roth

Post by petulant »

As an S-corp owner, the W-2 portion of your income does not benefit from QBI, but your K-1 income does. Hence, reducing your W-2 income through maximum employee contributions makes sense. However, making more employer contributions will reduce K-1 income and also the QBI deduction. That means the marginal tax savings for employer contributions today is 20% less. Hence, absent a very specific tax analysis, I would recommend making maximum traditional employee contributions and not making employer contributions, or using some other maneuver for the space--Roth employer contributions if the plan allows it (post-Secure 2.0), or some kind of mega backdoor Roth if the plan allows it.
Topic Author
getmoneygetpaid
Posts: 24
Joined: Thu Oct 27, 2022 10:48 am

Re: Solo 401k for S-Corp: Traditional and/or Roth

Post by getmoneygetpaid »

retiredjg wrote: Tue May 30, 2023 8:27 am Having both a traditional and a Roth account is a good and preferred choice. This gives you the flexibility to have both taxable and non-taxable income in retirement according to your needs and desires.

At your income level, using traditional 401k is the way to go to reduce your current taxable income. Supplement this with Roth IRA - tIRA would not be deductible for you and therefore is of little value other than as the first step in the backdoor Roth process.

Is spouse using backdoor Roth IRA as well? If not, that should also be done before putting retirement money into a taxable account.

As for your HSA - that is up to you whether you spend it now or save it until later. It does seem a lot of people, who have low medical bills, like to save it for later.

Not sure why a goal would be to be in a higher tax bracket in retirement though.
That's a good idea for my wife... I could employ her through my business, give her a small W-2 so she could contribute to a Roth.

To clarify, the goal of being in a higher tax bracket throughout retirement would be because I continued to own a business. Right now I have a good job, but maybe one day I'll passively own a business that pays me similarly.
buy low, sell high
User avatar
retiredjg
Posts: 54082
Joined: Thu Jan 10, 2008 11:56 am

Re: Solo 401k for S-Corp: Traditional and/or Roth

Post by retiredjg »

Your wife does not have to have her own income in order to contribute to IRA. She can contribute based on your income. :happy

https://www.irs.gov/retirement-plans/pl ... ion-limits
Topic Author
getmoneygetpaid
Posts: 24
Joined: Thu Oct 27, 2022 10:48 am

Re: Solo 401k for S-Corp: Traditional and/or Roth

Post by getmoneygetpaid »

petulant wrote: Tue May 30, 2023 8:39 am As an S-corp owner, the W-2 portion of your income does not benefit from QBI, but your K-1 income does. Hence, reducing your W-2 income through maximum employee contributions makes sense. However, making more employer contributions will reduce K-1 income and also the QBI deduction. That means the marginal tax savings for employer contributions today is 20% less. Hence, absent a very specific tax analysis, I would recommend making maximum traditional employee contributions and not making employer contributions, or using some other maneuver for the space--Roth employer contributions if the plan allows it (post-Secure 2.0), or some kind of mega backdoor Roth if the plan allows it.
That's a really good point about the 20% QBI deduction.

As a DYI investor, the downside to a mega-backdoor Roth appears to be that no major broker allow after-tax contributions. I would need to find a third party to help administer this. Beyond that, what if I did retire at 60 and had no other income? I'd only have my Roth's to pull from. As someone else mentioned, maybe having both a Traditional and Roth is advantageous, especially if I do not know what my income throughout retirement will look like.
buy low, sell high
Topic Author
getmoneygetpaid
Posts: 24
Joined: Thu Oct 27, 2022 10:48 am

Re: Solo 401k for S-Corp: Traditional and/or Roth

Post by getmoneygetpaid »

retiredjg wrote: Tue May 30, 2023 8:50 am Your wife does not have to have her own income in order to contribute to IRA. She can contribute based on your income. :happy

https://www.irs.gov/retirement-plans/pl ... ion-limits
Much love, retiredjg <3
buy low, sell high
User avatar
plutoblackhole
Posts: 180
Joined: Sat Feb 20, 2021 6:40 pm
Location: Kuiper Belt

Re: Solo 401k for S-Corp: Traditional and/or Roth

Post by plutoblackhole »

getmoneygetpaid wrote: Tue May 30, 2023 8:55 am
petulant wrote: Tue May 30, 2023 8:39 am As an S-corp owner, the W-2 portion of your income does not benefit from QBI, but your K-1 income does. Hence, reducing your W-2 income through maximum employee contributions makes sense. However, making more employer contributions will reduce K-1 income and also the QBI deduction. That means the marginal tax savings for employer contributions today is 20% less. Hence, absent a very specific tax analysis, I would recommend making maximum traditional employee contributions and not making employer contributions, or using some other maneuver for the space--Roth employer contributions if the plan allows it (post-Secure 2.0), or some kind of mega backdoor Roth if the plan allows it.
That's a really good point about the 20% QBI deduction.

As a DYI investor, the downside to a mega-backdoor Roth appears to be that no major broker allow after-tax contributions. I would need to find a third party to help administer this. Beyond that, what if I did retire at 60 and had no other income? I'd only have my Roth's to pull from. As someone else mentioned, maybe having both a Traditional and Roth is advantageous, especially if I do not know what my income throughout retirement will look like.
You could still max the employee deferral of $22,500 into traditional, and any amount over that into the MBDR. Also, barring any change in law, QBI will expire in 2025, and you could then plan to make higher traditional contributions then. Tax rates are also set to revert to their higher values in 2025, making now a better time to do Roth, and 2025 a better time to do traditional.
Topic Author
getmoneygetpaid
Posts: 24
Joined: Thu Oct 27, 2022 10:48 am

Re: Solo 401k for S-Corp: Traditional and/or Roth

Post by getmoneygetpaid »

plutoblackhole wrote: Tue May 30, 2023 9:00 am
getmoneygetpaid wrote: Tue May 30, 2023 8:55 am
petulant wrote: Tue May 30, 2023 8:39 am As an S-corp owner, the W-2 portion of your income does not benefit from QBI, but your K-1 income does. Hence, reducing your W-2 income through maximum employee contributions makes sense. However, making more employer contributions will reduce K-1 income and also the QBI deduction. That means the marginal tax savings for employer contributions today is 20% less. Hence, absent a very specific tax analysis, I would recommend making maximum traditional employee contributions and not making employer contributions, or using some other maneuver for the space--Roth employer contributions if the plan allows it (post-Secure 2.0), or some kind of mega backdoor Roth if the plan allows it.
That's a really good point about the 20% QBI deduction.

As a DYI investor, the downside to a mega-backdoor Roth appears to be that no major broker allow after-tax contributions. I would need to find a third party to help administer this. Beyond that, what if I did retire at 60 and had no other income? I'd only have my Roth's to pull from. As someone else mentioned, maybe having both a Traditional and Roth is advantageous, especially if I do not know what my income throughout retirement will look like.
You could still max the employee deferral of $22,500 into traditional, and any amount over that into the MBDR. Also, barring any change in law, QBI will expire in 2025, and you could then plan to make higher traditional contributions then. Tax rates are also set to revert to their higher values in 2025, making now a better time to do Roth, and 2025 a better time to do traditional.
How would this work? The same way my current back-door Roth works? Leave 22.5k in Traditional and any excess (from employer contributions) transfers into a Roth from Traditional? If so, then based on tax law I could either choose to keep in in Traditional or transfer to Roth?
buy low, sell high
User avatar
plutoblackhole
Posts: 180
Joined: Sat Feb 20, 2021 6:40 pm
Location: Kuiper Belt

Re: Solo 401k for S-Corp: Traditional and/or Roth

Post by plutoblackhole »

getmoneygetpaid wrote: Tue May 30, 2023 9:12 am
plutoblackhole wrote: Tue May 30, 2023 9:00 am You could still max the employee deferral of $22,500 into traditional, and any amount over that into the MBDR. Also, barring any change in law, QBI will expire in 2025, and you could then plan to make higher traditional contributions then. Tax rates are also set to revert to their higher values in 2025, making now a better time to do Roth, and 2025 a better time to do traditional.
How would this work? The same way my current back-door Roth works? Leave 22.5k in Traditional and any excess (from employer contributions) transfers into a Roth from Traditional? If so, then based on tax law I could either choose to keep in in Traditional or transfer to Roth?
To be clear, I mean that you'd defer $22,500 into the traditional part of the 401(k) from your salary, and contribute up to $43,500 more into the voluntary after tax account and roll that over to either the Roth 401(k) or a Roth IRA. This is just the mega backdoor Roth strategy.

My main point was that due to QBI, employER contribution are not that beneficial at this point in time, due to only being 80% deductible federally.

Come Jan 1 2026, you can revise this strategy assuming QBI has expired and tax rates have risen as they are planned to.
User avatar
retiredjg
Posts: 54082
Joined: Thu Jan 10, 2008 11:56 am

Re: Solo 401k for S-Corp: Traditional and/or Roth

Post by retiredjg »

You must have a special plan to do mega-backdoor Roth with a Solo 401k. That requires you to hire a third party plan administrator or do the plan administration yourself (for which few people are prepared). Employee Fiduciary will do it for you with their documents, but many people do not want to pay for the plan administration.

Mega-backdoor is sprinkles on the icing on the cake. It is not necessary for successful investing. Only go there with a Solo if you are fully committed to figuring it out.
Topic Author
getmoneygetpaid
Posts: 24
Joined: Thu Oct 27, 2022 10:48 am

Re: Solo 401k for S-Corp: Traditional and/or Roth

Post by getmoneygetpaid »

Thanks everyone. I think I'll work toward the following:

1. Setup Roth for my wife
2. Enjoy the benefits of the HSA along the way (can't just defer everything till I'm 60; until of course I read something else about why HSA is superior again)
3. Contribute up to 22.5k in Traditional until tax law changes and then consider increasing with employER contributions (MBDR doesn't seem worth hassle bringing in 3rd party).
4. Lastly, choose to either invest into a taxable account or save for real estate (previously undisclosed is that I do own some rental properties - as part of my diversification strategy - the goal is to have a mix of investment accounts and debt-free rentals come 60 years of age).
5. Continue to increase income. Hopefully this turns into 300-400k over the next few years.
buy low, sell high
User avatar
illumination
Posts: 3173
Joined: Tue Apr 02, 2019 6:13 pm

Re: Solo 401k for S-Corp: Traditional and/or Roth

Post by illumination »

I use MySolo401k.net for a MegaBackDoor Roth option. I think it's a great way for a one-owner business like mine to be able to unlock this. Very reasonable fees imo. The cheapest "actual" TPA I could find was going to be around $5,000 a year for me in fees.

I know there's people that feel very strongly that it's "dangerous" because it's not a real TPA, but any questions are promptly answered and they set everything up for me. I regret not doing it a long time ago.
fyre4ce
Posts: 2544
Joined: Sun Aug 06, 2017 11:29 am

Re: Solo 401k for S-Corp: Traditional and/or Roth

Post by fyre4ce »

Other posters are correct that employer contributions will probably reduce QBI and have 20% less value. That doesn't necessarily mean they aren't better than Roth though, if you are in a high bracket now. For example, say you are in the 24% bracket in California. Normally you would save 33.3% (24% + 9.3% state) on deferrals, but due to loss of QBI deduction that drops to 28.5% (= 24%*0.8 + 9.3%). But, the California S-corp tax is 1.5% on profits, which takes the rate back up to 30%. Not quite as good as 33.3% but still not bad, especially if you're planning on retiring in a tax-free state in the 22% or 24% bracket. If you are in one of the top three federal brackets (32%, 35%, 37%), deferring with loss of QBI probably makes sense, absent some unusual tax situation.
pizzy
Posts: 4339
Joined: Tue Jun 02, 2020 6:59 pm

Re: Solo 401k for S-Corp: Traditional and/or Roth

Post by pizzy »

illumination wrote: Tue May 30, 2023 6:17 pm I use MySolo401k.net for a MegaBackDoor Roth option. I think it's a great way for a one-owner business like mine to be able to unlock this. Very reasonable fees imo. The cheapest "actual" TPA I could find was going to be around $5,000 a year for me in fees.

I know there's people that feel very strongly that it's "dangerous" because it's not a real TPA, but any questions are promptly answered and they set everything up for me. I regret not doing it a long time ago.
At what income would you switch from MBR to the full $66k being tax deferred via employee/employer deferral?
Vanguard/Fidelity | 76% US Stock | 16% Int'l Stock | 8% Cash
petulant
Posts: 3601
Joined: Thu Sep 22, 2016 1:09 pm

Re: Solo 401k for S-Corp: Traditional and/or Roth

Post by petulant »

fyre4ce wrote: Tue May 30, 2023 7:11 pm Other posters are correct that employer contributions will probably reduce QBI and have 20% less value. That doesn't necessarily mean they aren't better than Roth though, if you are in a high bracket now. For example, say you are in the 24% bracket in California. Normally you would save 33.3% (24% + 9.3% state) on deferrals, but due to loss of QBI deduction that drops to 28.5% (= 24%*0.8 + 9.3%). But, the California S-corp tax is 1.5% on profits, which takes the rate back up to 30%. Not quite as good as 33.3% but still not bad, especially if you're planning on retiring in a tax-free state in the 22% or 24% bracket. If you are in one of the top three federal brackets (32%, 35%, 37%), deferring with loss of QBI probably makes sense, absent some unusual tax situation.
Note that in my previous post I stated the following caveat: "absent a very specific tax analysis." It is entirely possible that a poster with low/no tax-deferred, advanced age, and no residual income from the business would be better off making traditional contributions even with a loss of QBI. But I would not recommend that as the default position due to the variety of circumstances that can make that not true. If OP wants a specific tax analysis, it would require at least the following: 1) state of residence and planned moves, 2) existing tax-deferred balances, 3) fair estimate of future retirement age, 4) nature of business, specifically whether any residual income would be earned after stopping working or through a sale, 5) the existence of other sources of taxable income, such as rental properties with higher future rents and depreciation exhaustion during retirement, 6) marital status, 7) approximate sustainable income received from business when working, 8) expected retirement spending, 9) tax status of heirs or other legacy goals.
User avatar
plutoblackhole
Posts: 180
Joined: Sat Feb 20, 2021 6:40 pm
Location: Kuiper Belt

Re: Solo 401k for S-Corp: Traditional and/or Roth

Post by plutoblackhole »

petulant wrote: Tue May 30, 2023 7:20 pm Note that in my previous post I stated the following caveat: "absent a very specific tax analysis." It is entirely possible that a poster with low/no tax-deferred, advanced age, and no residual income from the business would be better off making traditional contributions even with a loss of QBI. But I would not recommend that as the default position due to the variety of circumstances that can make that not true. If OP wants a specific tax analysis, it would require at least the following: 1) state of residence and planned moves, 2) existing tax-deferred balances, 3) fair estimate of future retirement age, 4) nature of business, specifically whether any residual income would be earned after stopping working or through a sale, 5) the existence of other sources of taxable income, such as rental properties with higher future rents and depreciation exhaustion during retirement, 6) marital status, 7) approximate sustainable income received from business when working, 8) expected retirement spending, 9) tax status of heirs or other legacy goals.
Definitely all of this. I've run the numbers several times over the years, and I keep concluding that MBDR is the best at this point in time. I do plan to re-evaluate in 2026, and I expect traditional will come out ahead at that point. In any case, I'll still be contributing to the MBDR since my salary isn't high enough to max traditional through employer contributions.
fyre4ce
Posts: 2544
Joined: Sun Aug 06, 2017 11:29 am

Re: Solo 401k for S-Corp: Traditional and/or Roth

Post by fyre4ce »

petulant wrote: Tue May 30, 2023 7:20 pm
fyre4ce wrote: Tue May 30, 2023 7:11 pm Other posters are correct that employer contributions will probably reduce QBI and have 20% less value. That doesn't necessarily mean they aren't better than Roth though, if you are in a high bracket now. For example, say you are in the 24% bracket in California. Normally you would save 33.3% (24% + 9.3% state) on deferrals, but due to loss of QBI deduction that drops to 28.5% (= 24%*0.8 + 9.3%). But, the California S-corp tax is 1.5% on profits, which takes the rate back up to 30%. Not quite as good as 33.3% but still not bad, especially if you're planning on retiring in a tax-free state in the 22% or 24% bracket. If you are in one of the top three federal brackets (32%, 35%, 37%), deferring with loss of QBI probably makes sense, absent some unusual tax situation.
Note that in my previous post I stated the following caveat: "absent a very specific tax analysis." It is entirely possible that a poster with low/no tax-deferred, advanced age, and no residual income from the business would be better off making traditional contributions even with a loss of QBI. But I would not recommend that as the default position due to the variety of circumstances that can make that not true. If OP wants a specific tax analysis, it would require at least the following: 1) state of residence and planned moves, 2) existing tax-deferred balances, 3) fair estimate of future retirement age, 4) nature of business, specifically whether any residual income would be earned after stopping working or through a sale, 5) the existence of other sources of taxable income, such as rental properties with higher future rents and depreciation exhaustion during retirement, 6) marital status, 7) approximate sustainable income received from business when working, 8) expected retirement spending, 9) tax status of heirs or other legacy goals.
Agreed, and I actually created a software tool for exactly this purpose:

viewtopic.php?t=352921

One situation where deferrals are very likely best is those in the phase-out range for the QBI deduction. You get a smaller deduction, but you get a bigger percentage of it, and the marginal rates usually work out in favor of deferrals.
User avatar
illumination
Posts: 3173
Joined: Tue Apr 02, 2019 6:13 pm

Re: Solo 401k for S-Corp: Traditional and/or Roth

Post by illumination »

pizzy wrote: Tue May 30, 2023 7:15 pm
illumination wrote: Tue May 30, 2023 6:17 pm I use MySolo401k.net for a MegaBackDoor Roth option. I think it's a great way for a one-owner business like mine to be able to unlock this. Very reasonable fees imo. The cheapest "actual" TPA I could find was going to be around $5,000 a year for me in fees.

I know there's people that feel very strongly that it's "dangerous" because it's not a real TPA, but any questions are promptly answered and they set everything up for me. I regret not doing it a long time ago.
At what income would you switch from MBR to the full $66k being tax deferred via employee/employer deferral?
I put the full employEE contribution into tax deferred ($22,500) and I then put the "rest" into the Roth side.

I file as an S-Corp and have the ability pay myself a reasonable, fair salary on the lower side and the MBR allows me to put more into a retirement account than I otherwise would.

I like hedging my bets with a good amount in both pre and post tax and my reading is this is the best way to still maximize the QBI deduction.

https://www.kitces.com/blog/199a-qbi-de ... ions-roth/
Topic Author
getmoneygetpaid
Posts: 24
Joined: Thu Oct 27, 2022 10:48 am

Re: Solo 401k for S-Corp: Traditional and/or Roth

Post by getmoneygetpaid »

Wanted to circle back on this after having spoken with a local TPA (annual estimated fees 1-1.5k) and my CPA. Apparently, to take advantage of the MBDR, the plan needs to allow the following:
1. Allows after tax contributions
2. Allow in service distributions (the rollover)

Additionally, my CPA helped me visual contributions to this plans by presenting 3 buckets:
1. Employee deduction contributions (capped at $23,500)
2. Employer Match
3. Personal Contributions to the plan (rather than having an employer match, I could write a personal check to the plan for $42,500)

So all in all, I could contribute $6,500 personal Roth, $6,500 wife's Roth, $7,500 HSA, $63,000 MBDR, for an annual total of $86,500 that would grow tax free. That's crazy.

Now I just have to stomach letting go of that much money that I can't touch for a long time :)
buy low, sell high
Post Reply