CRNA 1099 Case Study: Solo 401(k) + Mega-Backdoor Contribution


Many of our clients, my wife included, are CRNAs. Be it a proxy of me having a vested interest to do a deep dive into any creative ways to keep Uncle Sam out of our pocket as much as possible with her unique compensation, or a proxy of me being a self-proclaimed nerd for anything related to tax planning, the results are the same = a great case study in tax savings. As the saying goes, “Tax evasion is illegal, tax avoidance is intelligent”.

WARNING: This case study does not include a sales pitch on permanent life insurance of any sort, often the go-to for advisors working with high-income individuals.

The Case: 1099 Work and Tax Advantage

I’ve learned many CRNAs possess a strong work ethic. Not surprising to me though, after first-hand witnessing the grueling process that is a Graduate Anesthesia program. Once completed, many CRNAs have options. Often, they will pick up a full-time gig with a salary eclipsing $200k/year of W-2 wages. Further capitalizing on their hard-earned education, many will supplement this great income with 1099 work. This 1099 work opens the door to a whole host of options, as they are essentially being compensated as an independent contractor (business owner) at that point, which the tax code heavily skews in favor.

Let’s side-by-side compare two CRNAs (call ‘em Bob & Cathy). First, a few assumptions: Bob & Cathy are 35 years old, single, and make $215k/year in W-2 Wages. They also pick up a few extra 1099 monthly shifts, amounting to an additional $35,000/year in net 1099 income (after deducting mileage and other business-related expenses). Without considering various possible deductions (and to keep this increasingly complex case study as simple as possible), let’s also assume they are in the 23.8% Long-term Capital Gains respective tax brackets. Whew! Now that we’ve got you overwhelmed with numbers let’s talk about the fun stuff = taxes (lol).

The Strategy: Creative Utilization of 1099 Income

Like most high earners, Bob & Cathy max out their employer-offered 401(k) or 403(b), deferring the maximum of $20,500 from their W2 income for 2022. The question arises – how should they handle their net 1099 income? That’s where this study gets exciting.

The question arises – how should they handle their net 1099 income? That’s where this case study gets spicy.

Creative Cathy decides to establish a Solo 401(k) plan that allows for after-tax contributions. She can contribute $33,688 to this plan (after subtracting 1/2 of the Self-employment tax). She puts this money away and converts this balance to her Roth IRA, colloquially known as a mega backdoor Roth IRA contribution. This one-time contribution grows tax-free now until she retires. For illustrative purposes, let’s assume this compounds at 8%/year for 30 years = amounting to $338,986 when she decides to take all the money out.

Boring Bob takes the same net 1099 income of $33,688 and responsibly saves & invests for the same 30 years, and owns the same investments at an 8% growth rate as Creative Cathy. Except, he saves within a different vehicle; he sets up a humdrum taxable brokerage account, whereby he owes long-term capital gains taxes at the end of the 30 years on any gains he has upon liquidation.

So, to make an apples-to-apples comparison for our case study, his balance also amasses to $338,986.

The Outcome: A Tale of Two Tax Liabilities

Upon retirement, both Bob and Cathy liquidate their respective investments. Bob, with a balance of $338,986, owes long-term capital gains taxes amounting to $72,661*. Cathy, with her Roth IRA, owes nothing, as all gains within a Roth IRA are tax-free.

*Bob’s Tax Liability = ($338,986 – $33,688) = $305,298 of long-term capital gains X 23.8% (top capital gains tax rate) = $72,661

Cathy and her creativity put her $72,661 ahead of Boring Ole’ Bob. And that’s only after one year of contributions; imagine if she did this her entire career?

I realize that I breezed over many definitions, but I’d also venture to guess many reading this article skimmed the article and went straight to the bottom line to see the results. Don’t worry – I get it. I sent this to my CRNA wife to review before I posted, and she confided that she did the same. So, to boil it down even further to one key takeaway: if you are picking up 1099 work in any amount and not taking advantage of this unique and complex savings vehicle, you are doing yourself a disservice.

If you have discretionary taxable income from your 1099 work, I urge you to consider this strategy as compared to a Variable Universal Life Insurance Policy (VUL) or Annuity, or even saving to a Taxable Brokerage account. Delegating the establishment of this plan is easier than you think- shoot me an email, and we can talk turkey on the specifics if this appeals to you.

Frequently Asked Questions (FAQ)

  • What is a Solo 401(k) and how does it differ from a traditional 401(k)?
    • A Solo 401(k), also known as a one-participant 401(k) or self-employed 401(k), is designed for self-employed individuals or business owners with no employees other than a spouse. It has the same rules and requirements as a traditional 401(k), but offers higher contribution limits because you contribute as both an employer and an employee.
  • What is a Mega-Backdoor Roth IRA?
    • A Mega-Backdoor Roth IRA is a strategy that allows you to contribute an additional amount (over and above the normal contribution limit) to your Roth IRA. It involves making after-tax contributions to a 401(k) plan, then converting those contributions to a Roth IRA.
  • Are there any risks involved in the Mega-Backdoor Roth IRA strategy?
    • Yes, there are some risks, including legislative changes that could alter the rules, the possibility of incurring taxes during the rollover process if not done correctly, and the potential for penalties if withdrawals are made from the Roth IRA before age 59½.

Understanding Contribution Limits with a 403(b) and Solo 401(k)

When it comes to optimizing your tax-advantaged retirement savings, things can get a little complex if you’re simultaneously contributing to a 403(b) and a Solo 401(k) due to your dual status as an employee and a self-employed individual. It’s important to understand how contribution limits work in this scenario to avoid over-contributing, which can result in penalties.

The IRS has rules around “aggregating” contributions. In simple terms, this means that your contributions to all your retirement plans — in this case, your 403(b) and Solo 401(k) — cannot exceed the IRS limit for that year.

For instance, in 2022, the contribution limit for an individual to a 403(b) or 401(k) is $20,500. If you’re also contributing to a Solo 401(k) due to your 1099 work, your total employee deferral contributions across both accounts can’t exceed this limit. However, keep in mind that the overall limit for a Solo 401(k) for 2022 is $61,000, inclusive of both employee deferrals and employer profit-sharing contributions. Therefore, if you’ve maximized your deferral limit through your 403(b), you could still make an employer contribution to your Solo 401(k), as long as the total doesn’t exceed the overall limit.

In sum, it’s crucial to keep track of all your contributions across multiple plans. While it can be an effective strategy for maximizing retirement savings, it does require careful planning and record-keeping to ensure compliance with IRS rules.

As always, consulting with a tax professional or financial advisor can provide you with personalized advice tailored to your specific situation.

The Pros and Cons of Mega-Backdoor Roth IRA Contributions

Before jumping into the Mega-Backdoor Roth IRA strategy, it’s vital to weigh the pros and cons.

  1. Tax-Free Growth and Withdrawals: The main advantage of the Mega-Backdoor Roth IRA strategy is the tax-free growth and withdrawals in retirement, as highlighted in our case study with Cathy. This strategy allows for significant potential tax savings, particularly for high earners.
  2. Higher Contribution Limits: This strategy also offers higher contribution limits than regular IRAs, allowing you to potentially save much more for retirement.
  3. No Required Minimum Distributions: Unlike Traditional IRAs and 401(k)s, Roth IRAs do not require minimum distributions in retirement, providing more flexibility for your retirement income strategy.
  1. Complexity: The Mega-Backdoor Roth IRA strategy involves multiple steps and some complexity, including the requirement to have a 401(k) plan that allows for after-tax contributions and in-service withdrawals or rollovers.
  2. Legislative Risk: The rules for this strategy could change in the future, potentially impacting your retirement savings strategy.
  3. Tax Implications: If not executed correctly, the rollover process could incur unexpected tax liabilities.
  4. Availability: Not all 401(k) plans allow for after-tax contributions or in-service withdrawals, which are necessary for this strategy.