Roth Solo 401(k)
What is a Roth Solo 401(k)?
The Roth Solo 401(k) combines some of the best features of a Roth IRA and a 401(k) plan. The result is a great opportunity to build significant tax-free wealth. Like a Roth IRA, the Roth 401(k) is initially funded with post-tax dollars, but all earnings and future distributions are tax-free. Because it is a Solo 401(k) plan, it comes with the ability to make high contributions to the plan, without the income limits that apply to a Roth IRA.
A Roth Solo 401(k) is not actually a distinct type of retirement plan, but rather just a standard Solo 401(k) plan for which the Roth feature has been enabled. One can have both tax-deferred savings and Roth savings in the same Solo 401(k) plan. Each type of savings is held in a separate account under the umbrella of the plan.
Pay Taxes Now. No Taxes Later
The key benefit of a Roth retirement account such as a Roth IRA or Roth Solo 401(k) is the ability to create tax-free income. Unlike a traditional IRA or 401(k) where contributions are tax-deferred, contributions to a Roth account are taxed in the year they are earned. However, while future distributions from a tax-deferred account are taxed, the distributions you take from your Roth Solo 401(k) in retirement will not be taxed. All the earnings you create by investing your Roth 401(k) are tax free. This can be a huge benefit for investments that produce high return, or for younger investors with a long time to compound the growth of their savings.
High Contribution Limits
Safeguard’s Solo 401(k) plan allows for employee deferrals to be made as either tax-deferred, Roth, or a combination of the two. Only the employee contributions can be made on a Roth basis. Employer profit-sharing contributions must be made on a tax-deferred basis. For those under age 50, that means up to $19,500 can be contributed to the Roth account. For those age 50 or older, the catch-up provision allows for an additional $6,600 and a maximum of $26,000.
No Income Limits
Those with high earnings have generally not been able to take advantage of the Roth IRA, as contributions are prohibited above $139,000 in earnings for single-filers and $206,000 for married taxpayers filing jointly. A Solo 401(k) is not bound by these income limits.
In-Plan Roth Conversions
Not only does the Roth Solo 401(k) plan provide an option to create significant new Roth savings, it also allows for existing tax-deferred funds to be converted to Roth status within the plan. If you have rolled over capital from a prior IRA or employer 401(k) plan, or made contributions to your Solo 401(k) on a tax-deferred basis in the past, you can convert those funds to Roth tax treatment. The amount converted becomes taxable income in the year of the conversion. All future growth, however, will have the tax-free status of the Roth account after a 5-year seasoning period.
No Roth IRA Rollovers
While the Solo 401(k) offers some fantastic Roth features, it cannot, however, accept a rollover from an existing Roth IRA. Only new contributions, a rollover from a prior Roth 401(k) account, or in-plan conversions are allowed.
Unlike a Roth IRA, contributions made to a Roth Solo 401(k) cannot be re-characterized back to tax-deferred status if you change your mind.
A Roth 401(k) is still subject to Minimum Required Distributions starting at age 72. An easy solution is to rollover the Roth funds to a separate Roth IRA, where such distributions will not be required.
The decision to pursue a Roth savings strategy is complex and specific to each investor’s individual situation. Age, income, current vs. predicted future tax rates, and investment goals are just a few of the key factors that can determine whether there is a benefit. You should always seek the guidance of a licensed CPA or tax advisor when evaluating whether the Roth approach is right for you.
This page has been updated to reflect law changes implemented with the SECURE Act of 2019.
All contribution limits reflect 2020 tax year values.