When people hear the word “Roth,” they often think of an IRA, or individual retirement account. The terms “Solo Roth 401(k)” and “Roth Solo 401(k)” can be confusing. Both refer to a Solo 401(k) plan with a Roth component. Although the Roth Solo 401(k) combines many features of IRAs and 401(k)s, it is its own plan type.
There are many retirement plan options for small business owners, and it can be difficult to determine which one best fits your needs. SIMPLE 401(k), Individual 401(k), Traditional 401(k), safe harbor 401(k), Roth Solo 401(k), self-directed 401(k), and other name variations can feel overwhelming. However, it is important to find the Solo 401(k) account that best supports your investment strategy.
There are important differences between IRAs and 401(k)s. Knowing what they are and how they can affect your retirement plans can help you make more informed decisions. Here are the top questions regarding these plans to make your research easier.
What is a Solo Roth 401(k)?
A Solo Roth 401(k) is a standard Solo 401(k) with an activated Roth savings feature. With this plan type, you can have both Roth savings and tax-deferred savings housed in the same plan. However, the two types of savings are kept in separate accounts for proper recordkeeping. To establish a Solo Roth 401(k), you must be a business owner with no employees.
A Solo Roth 401(k) is initially funded with after-tax funds, meaning the contribution to the Roth portion does not reduce your taxable income. However, future gains and distributions may be tax-free if certain requirements are met. Although paying taxes upfront may not sound appealing, it may be beneficial over the long term, especially for high-yield investments.
One advantage of having a Solo Roth 401(k) is that there are no earned income limits imposed on the individual making the Solo Roth 401(k) annual contributions for the tax year. For a regular Roth IRA, if you file your taxes as a single person, your modified adjusted gross income must fall below $168,000, and $252,000 for a married couple filing jointly.
Who is a Solo Roth 401(k) Good For?
The Solo Roth 401(k) can be a good option for people who work for themselves and want to accrue tax-free income. These plans are designed for business owners and their spouse who works for the business.
Self-employed people can make contributions to the plan as both employer and employee. These contributions may be made to the Roth feature, the traditional 401(k) feature, or a combination of the two.
A Solo Roth 401(k) can also be useful for people who want to make large annual contributions. These plans may also allow catch-up contributions if you are age 50 or older.
Are Solo 401(k) Contributions Tax Deductible?
In a Solo 401(k) plan, the contributions you make as an employer may be tax-deductible up to the maximum allowed by the IRS for that year. You do not pay taxes on earnings until you take distributions at retirement.
For the Roth portion of the Solo 401(k), you do not receive a tax deduction. However, your distributions at retirement may be tax-free if certain requirements are met.
What are the Disadvantages of a Solo Roth 401(k)?
While there are many advantages to having a Solo Roth 401(k), there are a few rules that may be important to consider.
- You cannot roll over an existing Roth IRA to your Roth 401(k). However, rollovers from previously existing Roth 401(k)s may be allowed into a Roth IRA or another employer’s Roth 401(k) program.
- You cannot change your mind if you want to switch your 401(k) contribution back to tax-deferred status. This differs from an IRA recharacterization.
- You must keep good accounting of the different types of contributions for tax purposes. Contributions to each feature, Roth and traditional Solo 401(k), are taxed differently when you take a distribution. There are only a few online products in the market that do this well.
What is a Self-Managed Account vs. Self-Directed Account?
Large financial institutions may offer a service known as “self-managed.” This allows retirement customers to select and oversee investments such as mutual funds, stocks, bonds, and ETFs online. These accounts typically do not allow alternative assets.
Self-directed accounts are directed by you, the investor, and allow a wider range of assets that are not available in many self-managed accounts, such as real estate.
These accounts include Traditional IRAs, Roth IRAs, SEP IRAs, SIMPLE IRAs, and Solo 401(k)s. They are established and managed through a regulated or approved provider. For an IRA, you need an IRA custodian. To establish a self-directed Solo 401(k) plan, you need an approved provider that allows alternative assets.
While self-directed accounts give investors more freedom, they also come with more responsibility. To make informed investment decisions, it is important for the account holder to perform proper due diligence.
What Else Should be Considered?
The laws and regulations that govern various investment products can be complex. Due diligence is important when considering potential investment opportunities. Part of performing your due diligence may include consulting with accountants, financial advisors, and other financial services professionals.
How Can IRAR Help?
IRAR Trust Company has been providing self-directed IRA and alternative investment services for self-employed individuals, small business owners, and investors since 1996. Our mission is to provide retirement plan options and education to our clients.
Our Solo Roth 401(k) also allows for alternative investments, meaning clients can use their retirement savings to invest in assets that are not typically available through traditional 401(k) plans. This gives clients the flexibility to diversify their retirement portfolio with assets they understand. The plan also allows a Roth option if you would like to add tax-free growth potential to your retirement savings. Learn more about our Solo 401(k) plan.
At IRAR Trust Company, we strive to be your trusted self-directed retirement partner. We pride ourselves on providing client service to help you meet your individual needs.
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