Can I tax-shelter money after maxing out 401(k) if I earn too much for an IRA?

[greenjb]

I have a slightly strange income situation and wondered if anyone had smart ideas about if/how I could put more money in tax-advantaged accounts. I'm married, work full time, and max out my 401(k) every year. My wife is a freelancer, so doesn't have 401(k) option, but my income is high enough ($300K) that our accountant says we can't do additional IRAs. With only me saving in a tax-advantage account, I feel like we're not saving nearly enough for retirement -- my $26K or so a year ($18.5K max plus employer match) is essentially trying to do the work for both of us. OK HERE'S THE TWIST: I also do some freelance writing. I don't make a ton of money doing it -- $5,000 last year -- but it's enough to take the home-office deduction, which is something. My question is, is there any way to turn the freelance income into some sort of legal business entity (or tax entity) that would allow me to then funnel additional money into a tax-advantage account? I should add, if it makes any difference, that I could conceivably work a little harder on the freelance stuff and maybe push it to $10K a year...but I only get paid $500 bucks a column, so it's actually quite a bit of work and I couldn't realistically get it up much higher than that without exhausting myself. If anyone has any thoughts or strategies -- or could point me to some pre-existing thread or article -- I'd be hugely appreciative. I just turned 44 and realized I'm basically half way to retirement, and need to kick it up a notch (several notches!). Thanks for any advice.

Oh -- and I should add that I put $10K per year into four 529 accounts (two accounts for each of our two kids -- Maryland, where I live, gives a fantastic state income tax break on the first $2,500 contributed to each account).

UPDATE: I'm new here, and after posting I noticed there's a separate "Taxes" forum -- if this seems like a post that's better suited to that board, would a more veteran member let me know? Thanks

[ender]

Oh -- and I should add that I put $10K per year into four 529 accounts (two accounts for each of our two kids -- Maryland, where I live, gives a fantastic state income tax break on the first $2,500 contributed to each account).

For what it's worth, my state does something like this too but I don't think it's really worthwhile. I guess you guys earn enough that it doesn't matter, at all, though.

529s are so restrictive for relatively minimal benefit (apparently Maryland maxes at a 5.75% state tax rate).

[seattlecyclone]

Your wife could start up a solo 401(k) for her freelance income. As long as you're declaring this as self-employment income I don't think the IRS would need you to "formalize" your business any further to be eligible for this.

She would be able to put away the first $18k of this income while wearing her "employee" hat, and then she can put on her "employer" hat and contribute an additional 25% of net after paying the self-employment tax.

You would be allowed to set up your own solo 401(k) for your freelance income, but since you're already maxing out the employee limit at your regular job you would only be able to do the employer part.

[greenjb]

Yeah, Maryland has a nice set- up -- you get a state tax deduction for contributions, which is pretty unique and saves us about $1,000 in taxes across all four accounts. Plus obviously the gains aren't taxed.

seattlecyclone: We were told by my wife's HR dept that we couldn't set up a solo 401(k)...though perhaps they're wrong? Even though she's a freelancer/independent contractor, she works only for this one company and still gets a W-2 with taxes withheld, rather than a 1099 like I get from my side gig. I was under the impression (perhaps wrongly?) that that foreclosed setting her up with a 401(k). Do you know where I could learn more about setting up a 401(k) for my freelance gig? Even if I could only contribute from the employer side, that would still tax shelter another $5-$10K which is totally worth it in my book. Thanks for the feedback.

[seattlecyclone]

Ah, yes if it's reported on a W-2 then she's an employee and can't use that for a solo 401(k).

Your total freelance income will be $5-10k, right? Since you already contribute your $18k employee side max to your other 401(k), it would be just a fraction of the income that you can shelter ($1-2k, roughly), not the full amount.

[Brokefuturedoctor]

I'm still new around here, but can't you still do a backdoor Roth IRA at that income level? It wouldn't be tax deferred of course, but it would still be $5,500 that you would only have to pay your taxes once on. That would still be better than funneling that money straight into a taxable account.

This doesn't really address your main question about a solo 401k, etc, but I thought it was worth throwing out there. Please let me know if I am thinking about this the wrong way.

[greenjb]

I'm not familiar with backdoor Roths, but I've seen them mentioned here and there, so maybe I should read up on that. Ideally, I'd like to find a way to tax shelter on the front end, because I have a Roth 401(k) through work -- but I suppose I could switch to traditional Roth. I'll do some googling on backdoor Roths, unless anyone has a link to a good explainer.

[jjandjab]

https://www.bogleheads.org/wiki/Backdoor_Roth_IRA

Although I know you are looking to make tax-deductible retirement contributions, at your income you should still be maxing out your IRAs - $11k per year, $5500 for both you and your wife - every year to benefit from the tax-free income growth. Ideally you will do the backdoor Roth...

The major question - do you have any money at this point in any IRA or SEP or SIMPLE plan? If the answer is no, you should absolutely be doing a "backdoor Roth". I have been doing them for 6 years.

How it works - open two accounts at a brokerage, one for each of you (I use Fidelity),  and create both a traditional IRA and a Roth IRA. Takes only a few minutes. Next, make the $5500 contribution to the traditional IRA, once for each of you. (Because you make too much, you can't deduct the tax break. But in this case, that's a good thing since that is what allows you to roll it into the Roth without a tax penalty.) When that money clears into your traditional IRA account in a few days, you just click the button to transfer the cash to the Roth IRA. That's it.

This is a loophole of sorts. As a high earner you can't deduct the traditional IRA contribution, but you  make too much to fund a Roth directly. But for some reason the IRS allows this little trick. So now that 11k per year grows tax-free and can be withdrawn tax free in retirement (or you can get at the contributions if you need them)

If you have any money in an IRA, SEP, SIMPLE you will have to roll that into the Roth and pay the taxes on it - I did that and it was still worth it in my opinion - which can complicate matters a bit. Good luck

[Vagabond76]

You can put an unlimited amount in a variable annuity contract or whole life insurance. You don't get an immediate tax deduction but you do get to defer taxes until withdrawal.

Many of these plans are expensive, but not all.

[greenjb]

Thanks jjandjab -- I spent the afternoon reading about backdoor Roths, but as far as I can tell I'm stuck because I have $130K in a Rollover IRA (in addition to an existing Roth with $36K). Converting that to a Roth would entail a huge tax hit I'm not eager to pay. I think I may be stuck.

[Gronnie]

Check if you can roll the IRA into your 401k, thus opening up the backdoor Roth IRA without running into the pro-rata rule.

Also, check if you can do after-tax (different than Roth) contributions in your 401k, as well as in-service withdrawals. These are the ingredients of the "mega back-door Roth". Contribute to after tax 401k, and then periodically do a rollover to a Roth IRA.

[Scandium]

Yeah, Maryland has a nice set- up -- you get a state tax deduction for contributions, which is pretty unique and saves us about $1,000 in taxes across all four accounts. Plus obviously the gains aren't taxed.

[fixed pet peeve]
I also live in MD. The problem is that the ER on the 529s is something like 0.80%+, been a few years since I looked. I went with the NY plan with a 0.17% ER instead. And as pointed out above, deducting a progressive tax that maxes out at <6% doesn't get you a whole lot. If you get the full 5.75% deducted from $2500 *4 that's $575. And you pay $63 more in fees, per year, than you would with the NY plan. Which of course goes up as the plan grows.

[greenjb]

Thanks Scandium -- I'm working through my accounts and haven't gotten to the 529s yet, but I'll have to check what our expense ratio is. Still seems like the combination of income-tax deduction plus untaxed gains makes the overall proposition worthwhile....but maybe if I'm going to save college money over and above the $10K it'd make more sense to just stick it in a Vanguard index fund with low ER? If you don't mind my asking, how have you liked the NY funds? And is there anything to stop me from rolling my MD 529 over to a NY fund every year? Seems to me I could just take the MD deduction, then a year later roll it over to a lower ER NY fund -- best of both worlds (or, states).

[DavidAnnArbor]

If your wife makes substantially less than you do, maybe you can file your taxes, "married filing separately", and maybe that would enable her to qualify for a traditional IRA.

[Scandium]

Thanks Scandium -- I'm working through my accounts and haven't gotten to the 529s yet, but I'll have to check what our expense ratio is. Still seems like the combination of income-tax deduction plus untaxed gains makes the overall proposition worthwhile....but maybe if I'm going to save college money over and above the $10K it'd make more sense to just stick it in a Vanguard index fund with low ER? If you don't mind my asking, how have you liked the NY funds? And is there anything to stop me from rolling my MD 529 over to a NY fund every year? Seems to me I could just take the MD deduction, then a year later roll it over to a lower ER NY fund -- best of both worlds (or, states).

I looked into the rolling over strategy. Get the tax deduction in MD then roll to NY. I believe you can do it, but don't quote me on that. But they charge something like a $75 fee so my savings were pretty minor, if any. And with the added hassle I gave up on the idea. You earn more so would stand to gain a bit more from it. Would have to run the exact numbers to find out.

The NY plan (www.nysaves.org) is pretty great. It's basically all Vanguard index funds. The aggressive age-based option give you a 70/30 US/international split, and bonds are added as the child age. All for a 0.16% ER. The only advantage is of course just avoiding cap-gains tax on growth. Which I don't think is that huge over this time frame, for the price of flexibility. I put a few thousand in as front-loading, but have slowed down to only do minor monthly auto-investing for now.

[jjandjab]

I would second the idea of seeing if you can roll your "rollover IRA" into your current 401k. That would be my first choice.

Second choice, at your salary, and depending on your age, you might think about rolling over the rollover IRA into a Roth IRA anyway. If you are young and going to be earning a good salary for a while, then the Roth conversion might be worth it

[greenjb]

Thanks guys -- I ain't young (44), so I don't think I'm going to roll the rollover IRA to a Roth -- it'd also be a big cap gains tax hit I don't want to take. But I'm curious whether rolling a Maryland 529 into a NY 529 is feasible. It would be a wonderful hack if I could take the Maryland state tax deduction of $575 each year, then roll over to New York's low ER Vanguard fund the following year. But my eldest is 9 and youngest in 6, so I'm not sure how much I'd really gain in that narrow (9-12) year time horizon from the .64% difference in fees. Probably not a ton since I don't have much money in the accounts yet. Still, I will call Vanguard and T.Rowe Price and see what the fees are. If anyone here is interested in the results, I'll report back.

[BlueHouse]

I third the suggestion for back door Roth.

I earn similar income and am a few years older. Last year, I rolled my rollover traditional IRA into my company 401k, then I put 5500 into a newly opened traditional Ira.   I waited 30 days on the advice of vanguard, then converted all $5500 to a Roth IRA. No taxable event.

Best move I ever made. It sounded complex so it took me longer to get the nerve, but then I just called vanguard and the guy on the phone explained exactly how he would do it and it matched up exactly with the advice I received on this forum.
Easy peasy! 

[greenjb]

But just to clarity, BlueHouse, doing a backdoor Roth would first entail me switching my current Rollover IRA ($130K) to a Roth and paying a big slug of capital gains taxes in the process, right? My impression from reading the thread is that I can't have any pre-existing Traditional or Rollover IRAs if I'm going to do this maneuver -- am I reading that right? Thanks.

[BlueHouse]

But just to clarity, BlueHouse, doing a backdoor Roth would first entail me switching my current Rollover IRA ($130K) to a Roth and paying a big slug of capital gains taxes in the process, right? My impression from reading the thread is that I can't have any pre-existing Traditional or Rollover IRAs if I'm going to do this maneuver -- am I reading that right? Thanks.

First step:  look at your current company 401k plan. See if rollovers INTO the 401k are allowed. (Almost always).
You want to move (pre-tax) money from traditional IRA to you (also pretax) 401k account. all the money is pretax and stays that way, so no taxable events are occurring.

Only after that part is done do you put new money into a new traditional IRA account. (This will already be post-tax and due to your income, you can't get a tax benefit).
Then you can convert the 5500 in your new tIRA into a Roth. No taxable event on this step either. 

Does that make sense? 

MDM explained all this to me and I still fretted over it. But once I picked up the phone to vanguard and explained the circumstances, they knew exactly what I wanted and also suggested the easiest way to do it.
Pick up the phone and walk through the steps with vanguard. They'll lay it all out so it makes sense. I also had to make a flowchart because I was so cautious! 

[dandarc]

If your wife makes substantially less than you do, maybe you can file your taxes, "married filing separately", and maybe that would enable her to qualify for a traditional IRA.

There is a lot of confusion about MFS.  One of the big downsides of MFS is that your phase-out-range for tIRA deduction and Roth IRA contributions is 0-$10,000.  So unless the wife is not earning much at all, this won't work.  And even if she is, by not filling her half of the lower tax-brackets, together they're probably paying more in taxes - probably more than she would save in the tIRA.

Backdoor Roth.  Self-employed retirement accounts (although it sounds like there isn't much room to be had there, every little bit helps).

[dandarc]

But just to clarity, BlueHouse, doing a backdoor Roth would first entail me switching my current Rollover IRA ($130K) to a Roth and paying a big slug of capital gains taxes in the process, right? My impression from reading the thread is that I can't have any pre-existing Traditional or Rollover IRAs if I'm going to do this maneuver -- am I reading that right? Thanks.

No, not capital gains taxes if you convert from traditional to Roth.  Ordinary Income tax.  On the whole amount.  Way bigger hit than capital gains taxes.  So your best bet is to roll your tIRA into your 401K, as BlueHouse has said.

[greenjb]

dandarc and BlueHouse -- thanks for the pointers. I took the first step in doing this and called my 401(k) administrator -- Empower Retirement -- to see about rolling my Rollover IRA into my 401(k). The Empower person I spoke with said I can't do this. I'm skeptical -- the guy did not sound too sure of himself, so I may just call again tomorrow and hope to get someone better. But does anyone have experience with Empower (I think they used to be JP Morgan) or know of any reason I wouldn't be able to do this?

[Gronnie]

But just to clarity, BlueHouse, doing a backdoor Roth would first entail me switching my current Rollover IRA ($130K) to a Roth and paying a big slug of capital gains taxes in the process, right? My impression from reading the thread is that I can't have any pre-existing Traditional or Rollover IRAs if I'm going to do this maneuver -- am I reading that right? Thanks.

Nope. Like I posted a long time ago, roll it into your 401k.

[seattlecyclone]

dandarc and BlueHouse -- thanks for the pointers. I took the first step in doing this and called my 401(k) administrator -- Empower Retirement -- to see about rolling my Rollover IRA into my 401(k). The Empower person I spoke with said I can't do this. I'm skeptical -- the guy did not sound too sure of himself, so I may just call again tomorrow and hope to get someone better. But does anyone have experience with Empower (I think they used to be JP Morgan) or know of any reason I wouldn't be able to do this?

This has less to do with the plan administrator (Empower) and more to do with the specifics of your employer's plan. The plan administrator is just following the instructions set up by the employer. It's quite possible for the same company to administer certain 401(k) plans that allow these rollovers and other 401(k) plans that do not.

[SuperSecretName]

I can't speak to your main issue, but regarding MD and 529:

I too am in MD and tax advantage of the state tax break.  However, I was not too thrilled with the fund choice's and their high ER.  A little research later, and MD does not recapture the state tax deduction if you roll over into another plan.  You can only rollover once every 12 months.

So, contribute to MD, and once a year or so, rollover to Vanguard for the lower ER.

Also, you say "Oh -- and I should add that I put $10K per year into four 529 accounts (two accounts for each of our two kids -- Maryland, where I live, gives a fantastic state income tax break on the first $2,500 contributed to each account)."

I hope you mean that you have an account for you and your spouse to which you are contributing and will later change the beneficiary.  The MD max is 2500 per beneficiary, not per account.

[greenjb]

SuperSecretName -- Thanks for the intel on MD 529 rollovers -- it's great to know that you can hack a 529! As soon as the first year is up (December, I believe), I will roll our MD 529s to a "Vanguard state" like NY or NV. And yes, the $10K is allotted among 4 accounts.

[BlueHouse]

dandarc and BlueHouse -- thanks for the pointers. I took the first step in doing this and called my 401(k) administrator -- Empower Retirement -- to see about rolling my Rollover IRA into my 401(k). The Empower person I spoke with said I can't do this. I'm skeptical -- the guy did not sound too sure of himself, so I may just call again tomorrow and hope to get someone better. But does anyone have experience with Empower (I think they used to be JP Morgan) or know of any reason I wouldn't be able to do this?

This has less to do with the plan administrator (Empower) and more to do with the specifics of your employer's plan. The plan administrator is just following the instructions set up by the employer. It's quite possible for the same company to administer certain 401(k) plans that allow these rollovers and other 401(k) plans that do not.

Yes to the above and I also suggest trying different terms.  Sometimes I use the wrong words and am told "that can't be done" because I asked the wrong way and the other party isn't experienced enough to differentiate between what I really want and what I say I want. 

Try starting out by saying that you want to rollover a previous employer's 401K into your current 401K.  If they say yes to that, then say "oh, and my previous employer's 401K has already been rolled over into an IRA".  That may shake them into realizing that it can be done. 

But then again, there is a possibility that the plan doesn't allow it.  So I like your plan to call back and get a different person.  If they keep saying no, then ask for the "Plan documentation" so that you can read it for yourself.  Or have them show it to you. 

I think they're so used to doing a small subset of possible actions, that when we ask for something a little bit different, they just don't know. 

[MustacheAndaHalf]

Investing in taxable is going to be nastier for you than most posters, because of the higher tax on capital gains (20%) plus the net investment income tax for high earners.  Since you're already over $250k, I'll use 3.8% for the entire dividend.  So in total I'm guessing you'd be paying 23.8% on qualified dividends.

So if you invest $10,000 in Vanguard Total Stock Market, with a dividend yield of 2%, what do you pay in tax?
The $10,000 investment spits out $200 of dividends, and you pay about $48.  In other words, to invest in taxable you'll pay about $50 tax on each $10,000 invested.

While I agree with your search for better tax treatment, I'd suggest you start investing in taxable.  You could figure out what $16k/year invested will do in retirement, but it's unlikely to be anywhere near your current spending (which can change).  If you instead peel off 20% of your income and invest $60,000 per year in a taxable account it will add up much faster than the retirement account.

Ultimately having a much higher income than average it's a good idea to not limit yourself to the lower limits of 401(k) plans.  Take a look at investing in taxable, and especially how it could change your retirement by doing so versus not doing so.  Good luck.

[greenjb]

BlueHouse: Thanks, that's great advice. I'm also going to enlist my company's HR department to help me figure this out -- squeaky wheel, etc. It seems like if this is a pretty standard financial maneuver, my company ought to offer a plan that allows it.

MustacheAndaHalf: Yikes, I hadn't fully appreciated the tax math you've pointed out. I also realize I'm probably exposing myself to a higher tax bill than necessary. A couple years ago, I found out my employer offered a Roth 401(k) -- I was doing traditional at the time. Given my age (42) and the fact that I had a decent amount in my traditional 401(k), I switched over and did the full $18K per year in Roth, my thinking being that that way, when I retire, I'll have a nice balance of Roth and traditional money to draw on. I figured I'd draw on the traditional funds right up to the point that income taxes kicked in, and then take Roth $$ if I need more. But the problem, I'm now realizing, is that going full-Roth right now exposed that extra $18K a year to income tax, and I'm in the 33% bracket (plus another 6% state tax). I'm almost certain my tax rate will be lower in retirement, as I won't have mortgage/tuition payments. So I think I may switch the 401(k) back to traditional, and maybe take another look at my wife's 401(k) plan -- it's absolutely terrible; no match, absurdly high fees. But it'd shelter an additional $18K from taxes (more with state tax), and I could roll it over to a Vanguard IRA when she leaves the job at some undetermined point in the future. While it doesn't save my taxes on the front end, I guess I could also pour that extra money into my kids' 529 accounts, too.