Max Funding 401(k) and Roth IRAs with $26k Earned Income

Submitted by Scott Jensen on Wed, 2018-05-02 15:46

Hello everyone. I searched for a while and have not found an answer for this.

Here’s the situation. We have a married couple in which the wife has $26k Net Business Income from an LLC and the husband is retired with no earned income. We manage an individual 401(k) with a Roth provision for her as well as Roth IRAs for both of them. With the $26k of earned income she deferred $24k (including catch up) into her Roth 401(k) and we max funded each of their Roth IRAs for $6,500.

Their accountant doesn’t think this is allowed because $24,000 + $6,500 + $6,500 = more than the $26k Net Business Income.

Our argument is (1) that ERISA plans are separate from IRA plans so you don’t have to add the values of the contributions together and (2) contributing to the Roth side of the 401(k) does not decrease your income like it does when you contribute to the pre-tax side.

Is this allowed or are we in error by allowing them to contribute to both?

Thanks!
Scott



Submitted by Alan - IRA critic on Wed, 2018-05-02 16:47

You are correct. Roth IRA contributions can be made using the same taxable compensation that was used to fund a designated Roth contribution. In fact, had the wife made employer contributions to a SEP or SIMPLE IRA instead of the Roth solo K, since those would have been employer contributions they would not have reduced the taxable comp available for Roth IRA contributions either. Has the accountant encountered  an issue with his professional software when entering these contributions, or hasn’t he entered them yet?

Submitted by William Tuttle on Wed, 2018-05-02 17:32

I realize this is actually off-topic, but this is for Alan. Your statement is true for W-2 employees, but self-employed employer contributions do reduce compensation.

Submitted by Scott Jensen on Wed, 2018-05-02 17:39

Thanks Alan.Spiritrider, you are referring to the SIMPLE/SEP contributions Alan mentioned, not the Individual 401(k) I had asked about, correct?  Self employed employer contributions to designated Roth plan do not reduce compendation, right? Thanks Again!Scott

Submitted by David Mertz on Wed, 2018-05-02 19:21

Employer contributions can only be to the traditional 401(k) account, not the designated Roth account.

Submitted by William Tuttle on Thu, 2018-05-03 03:01

  • I was nominally referring to the SEP/SIMPLE IRA employer contributions Alan was referring to. As indirectly implied by DMX’s comment this also applies to employer contributions to a one-participant 401k plan.
  • However, since you have no employer contributions, this does not apply. That is why I said my comment was for off-topic and for Alan.
  • I now regret even mentioning it and causing you confusion.

Submitted by Alan - IRA critic on Thu, 2018-05-03 03:28

Still want to get to the bottom of this question regarding reduction of compensation. My comment regarding the SIMPLE or SEP contributions were based on the following from p 41 of Pub 590 A:

This means that your contribution limit is the lesser of:

  • $5,500 ($6,500 if you are age 50 or older) minus all contributions (other than employer contributions under a SEP or SIMPLE IRA plan) for the year to all IRAs other than Roth IRAs, or
  • Your taxable compensation minus all contributions (other than employer contributions under a SEP or SIMPLE IRA plan) for the year to all IRAs other than Roth IRAs.

Submitted by William Tuttle on Thu, 2018-05-03 05:24

  • The Roth IRAs and traditional IRAs. paragraph is correct, because SEP and SIMPLE IRA employer contributions do not affect the Roth IRA contribution limit. Only contributions to a traditional IRA and employee contributions to a SEP IRA (if allowed) reduce the Roth contribution limit.
  • The first bullet is correct. Applying the contents of the paragraph to the full IRA contribution limit to determine the Roth cotribution limit.
  • The second bullet is saying that the Roth contribution limit is further limited to taxable compensation –  contributions to a traditional IRA and employee contributions to a SEP IRA. The phrase in parenthses is to exclude those contributions and to not reflect on their effect on compensation.
  • The effect of those contributions on compensation are addressed under What Is Compensation? on page 6
  • Self-employment income. If you are self-employed (a sole proprietor or a partner), compensation is the net earnings from your trade or business (provided your personal services are a material income-producing factor) reduced by the total of:
  • The deduction for contributions made on your behalf to retirement plans, and
  • The deduction allowed for the deductible part of your self-employment taxes.

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