The term “tax-free” ought to be the most prominent feature when contemplating a Roth Solo 401k. The ability to use a Roth 401k to more effectively manage your income taxes during retirement makes the difference between a tax-deferred and tax-free Solo 401k. The majority of new retirees’ income sources, including Social Security, traditional IRAs, and traditional 401(k)s, are still taxable, which surprises some of them. It might be too late once you retire to benefit from the tax-free income that comes with a Roth Solo 401k, which is something that Nabers Group offers at no additional cost.
Yes, you can absolutely have both a Roth IRA and a solo 401(k)! In fact, this combination can be a powerful strategy for maximizing your retirement savings and enjoying tax-free growth and withdrawals in retirement.
Here’s a breakdown of how these two accounts work together:
Roth IRA:
- Contribution Limit: $6,500 in 2023 ($7,000 if you’re 50 or older)
- Income Limits: There are income limits for contributing to a Roth IRA. For 2023, if your modified adjusted gross income (MAGI) is $153,000 or more as someone filing as single, married filing separately, or head of household, you can’t contribute to a Roth IRA. The limit is $228,000 for those who are married filing jointly or are qualifying widow(er)s.
- Withdrawals: Contributions to a Roth IRA can be withdrawn at any time without penalty. Earnings can be withdrawn tax-free after age 59 1/2, as long as the account has been open for at least five years.
Solo 401(k):
- Contribution Limit: $22,500 in 2023 ($30,000 if you’re 50 or older) plus the lesser of 25% of your compensation or $66,000.
- Income Limits: There are no income limits for contributing to a solo 401(k).
- Withdrawals: Contributions to a solo 401(k) can be withdrawn at any time without penalty. Earnings can be withdrawn tax-free after age 59 1/2, as long as the account has been open for at least five years.
Benefits of Combining a Roth IRA and Solo 401(k):
- Maximize Savings: With the combined contribution limits of a Roth IRA and solo 401(k), you can save a significant amount of money for retirement.
- Tax-Free Growth: Both Roth IRAs and solo 401(k)s offer tax-free growth on your investments. This means that your money can grow faster than it would in a taxable account.
- Tax-Free Withdrawals: In retirement, you can withdraw your contributions and earnings from both accounts tax-free. This can provide you with a significant tax advantage in retirement.
- Flexibility: You can choose how much to contribute to each account, giving you flexibility in how you save for retirement.
Things to Consider:
- Income Limits: While there are no income limits for contributing to a solo 401(k), there are income limits for contributing to a Roth IRA. If your income is above the limit, you may not be able to contribute to a Roth IRA.
- Contribution Limits: The combined contribution limit for a Roth IRA and solo 401(k) is $66,000 in 2023. This means that you can’t contribute more than this amount to both accounts combined.
- Fees: Some solo 401(k) plans have higher fees than Roth IRAs. Be sure to compare fees before choosing a plan.
Overall, having both a Roth IRA and a solo 401(k) can be a great way to maximize your retirement savings and enjoy tax-free growth and withdrawals in retirement. However, it’s important to consider your individual circumstances and choose the right combination of accounts for you.
Frequently Asked Questions
Can I contribute to both a Roth IRA and a solo 401(k) in the same year?
Yes, you can contribute to both a Roth IRA and a solo 401(k) in the same year. However, the total amount you can contribute to both accounts combined is limited to $66,000 in 2023.
Do I have to contribute to both a Roth IRA and a solo 401(k)?
No, you are not required to contribute to both a Roth IRA and a solo 401(k). You can choose to contribute to one or the other, or both.
Which account should I contribute to first?
The best account to contribute to first depends on your individual circumstances. If you are younger and have a long time until retirement, you may want to prioritize contributing to your Roth IRA. This is because the earnings in your Roth IRA will grow tax-free for a longer period of time. If you are older and closer to retirement, you may want to prioritize contributing to your solo 401(k). This is because you will be able to take advantage of the higher contribution limits.
Can I roll over my Roth IRA into my solo 401(k)?
Yes, you can roll over your Roth IRA into your solo 401(k). This can be a good option if you want to consolidate your retirement savings into one account.
Can I withdraw money from my Roth IRA or solo 401(k) before age 59 1/2?
Yes, you can withdraw money from your Roth IRA or solo 401(k) before age 59 1/2, but you will have to pay taxes and penalties on the earnings. There are some exceptions to this rule, such as for qualified education expenses or medical expenses.
Where can I find more information about Roth IRAs and solo 401(k)s?
You can find more information about Roth IRAs and solo 401(k)s on the IRS website or from a financial advisor.
What is a Roth Solo 401k?
The only distinction between a traditional Solo 401k and a Roth Solo 401k is the tax-deferred versus tax-free savings. As long as the total contribution amount stays below the aggregate maximum contribution limit, you are allowed to make contributions to both a Roth Solo 401k and a regular Solo 401k during the same tax year, and you can divide the contributions however you choose.
Many business owners are unaware of the retirement benefits that self-employed business owners can receive from a Solo Roth 401k. They might be unaware that they can create a Solo 401(k) that looks like the 401(k) plans provided by the majority of large employers. However, things get considerably better because a Solo 401(k) or Roth Solo 401(k) almost always offer higher contribution profit-sharing. Since you are in charge, you can decide to split your entire profit with your retirement account alone. Major corporations must distribute the majority of their profits to their hundreds of thousands of shareholders rather than their employees. Because of this, businesses set annual caps on employee savings, both for the employee and for profit sharing (employer).
In addition to being considerably more flexible than a corporate 401k, a Solo 401k can be established by a self-employed business owner. A portion of that flexibility comes from the Roth Solo 401(k), but it also comes from the ability to make alternative investments and completely manage your yearly contributions from 10% to 20%. And one of the ways Nabers Group offers flexibility is with a free Roth Solo 401k.
The fact that both the Solo 401k and the Roth Solo 401k are intended for companies without full-time employees is one of their commonalities. A significant employee exception is also included in both: spouses who receive revenue from the business may participate in either plan. Up to the legal maximums, including catch-up provisions, your spouse can make the same employee contributions as you as the business owner as a full-time worker. Up to the legal cap, an employed spouse is also eligible to receive the same percentage of the employer contribution. Due to this, your joint retirement contributions may be double what they would be if you were an individual employee. This is also significantly more than what is permitted by almost all corporate accounts.
The following is a crucial tax distinction between a solo 401(k) and a solo Roth 401(k). The Solo 401k is the tax-deferred version (aka pre-tax savings). To reduce your tax liability in the year that the contribution is made, you deduct it from your income. After that, the profits increase tax-deferred until you start taking withdrawals in retirement. When withdrawals are made, taxes become due. The idea is that when you make withdrawals, you’ll be in a lower tax bracket and won’t have to pay taxes on the contributions you made while you were employed and in a higher tax bracket.
A Roth Solo 401(k) approaches the tax benefits in a different way. It’s common to refer to Roth Solo 401(k) savings as post-tax savings with tax-free growth and withdrawals. This is why it is often referred to as tax-free. But in the year that the contributions are made, you do have to pay taxes on them. This explains why in retirement, 0% of the withdrawals are taxed.
The Roth Solo 401k is a very popular option in two scenarios. One is when you are experiencing a period of low income (usually in your early years of life). Paying taxes on that income while in a lower tax bracket, letting it grow tax-free for a number of years, and letting it remain tax-free in retirement can all make financial sense. Because the profits are tax-free upon retirement, this investment vehicle is also a very good choice if you anticipate an exceptionally high rate of return on your investment. For example, Nabers Group started investing in Bitcoin early in 2013 using a Roth Solo 401k because we anticipated amazing returns and tax-free gains for when we eventually cash out and take our retirement distribution.
Another thing to keep in mind when it comes to a Roth Solo 401(k) is that after the account has been open for five or more years, you can withdraw contributed funds at any time because the taxes have already been paid. After opening the account for five or more years and reaching the age of 59 1/2, you can start taking out the tax-free earnings.
But keep in mind that you don’t have to choose between a Solo 401(k) and a Roth Solo 401(k) right now. You are able to maintain both kinds of accounts and contribute to either at any moment.
The Mega Backdoor Roth Solo 401k
However, the Mega Backdoor Roth IRA offers a single, significant benefit to the Roth IRA. If you meet the income and savings requirements, you can use a Mega Backdoor Roth IRA to avoid the taxable event that typically results from converting a regular Roth IRA. With a Mega Backdoor Roth IRA, you can diversify your retirement income and receive tax-free income on your after-tax contributions in addition to tax-deferred income on your pre-tax contributions.
A Mega Backdoor Roth Solo 401k allows you to contribute more after-tax dollars than you would in a normal Roth IRA, based on IRS guidance in 2014. The result is that you can eventually take the funds out of the Roth 401k/IRA without tax penalty.
While this approach isn’t suitable for everyone, it can be a useful tactic for high earners who can’t make direct contributions to a Roth IRA or for those who wish to add more funds and assets to a Roth IRA structure. This is a complicated strategy that needs to be carefully calculated and well documented. The components required for the Mega Backdoor Roth strategy are all present in the Nabers Group Solo 401k plan.