Retirement accounts are a great vehicle for saving money, but what happens if you need to take money out of your retirement plan? Some avenues can be tax-free, others will incur taxes. Taking money out of your retirement plan can even be part of your estate planning, if done in advance. Read on for the 7 most common ways to get money out of the Solo 401k:
1. Participant Loan
Our first way to get money out of the Solo 401k is tax-free. This immediately makes it very attractive to accountholders since you don’t have to pay taxes for removing these funds from the Solo 401k plan. The reason you don’t pay taxes on removing these funds is…because you have to put them back into the plan.
Once of the most attractive features of the Solo 401k plan is the highly beneficial Participant Loan. The solo 401k participant loan allows you to withdraw 50% of your 401k account value up to $50,000 per participant. The loan is tax free. These funds can be used for any reason, including home improvement, a cash infusion into your business, paying down bills and expenses, etc. The participant loan can even be used to pay for your primary residence.
Participant loan funds must be paid back within 5 years. If the funds are being used to purchase a primary residence, the payback period can be extended to 15 years.
The participant loan interest rate must be a “reasonable” rate of interest, generally determined to be the prime rate plus 1-2%. The loan repayments are made monthly or as infrequently as quarterly and loan repayments go right back into the Solo 401k. If you have a need for cash and have liquid funds in the Solo 401k, a participant loan is a great way to get funds out tax-free.
2. Rollover to Another Retirement Plan
The second way to get funds out of the Solo 401k may also be tax-free, depending on how you execute removal of money. Funds inside the Solo 401k can roll over to other retirement accounts including Roth IRA, Traditional IRA, Simple IRA, SEP-IRA, 457(b), 403(b) or other qualified plan. Generally, rolling over funds from one retirement plan to another is not a taxable event, so long as the tax treatment is the same of each plan (pre or after tax).
If you plan to roll funds from the traditional (pre-tax) portion of the Solo 401k into a Roth IRA, taxes will be due. If you are rolling funds from the Roth 401k to a Roth IRA, there are no taxes due.
Anytime you roll funds out of a Solo 401k plan, you and your CPA will prepare form 1099-R to document the rollover. Depending on the tax treatment and type of rollover, you may also be required to document the rollover on your personal income tax return. Taking money out of the Sol 401k plan to roll it into another retirement plan may not always incur taxes if it is done as a direct rollover. Be sure to work with your CPA or tax advisor to determine if this type of removal of funds from the Solo 410k plan will be a taxable event.
3. Hardship Distribution/Withdrawal
The rest of our ways to get money out of the Solo 401k plan will incur paying some taxes. The first taxable event to discuss on removing funds from a Solo 410k plan is a hardship distribution.
A hardship distribution occurs when you have to take money out of your Solo 401k due to an immediate, urgent financial need. The Nabers Group Solo 401k allows for hardship distributions.
The IRS has determined that hardship withdrawals can only be made if the distribution is:
A) because of an immediate and heavy financial need, B) limited to the amount necessary to satisfy that financial need, and C)limited to the participant’s total elective deferrals as of the date of distribution, reduced by the amount of previous distributions of elective deferrals. (Source)
Examples of hardship distributions may be:
- Prevent eviction or foreclosure of your primary residence
- Post-secondary education expenses for the next 12 months for you, your spouse, or your children
- Medical expenses not covered by insurance for you, your spouse or your children
- Funeral expenses
- Expenses to repair damage or to make improvements to your primary residence
In the case of each hardship distribution/withdrawal, you will have the burden of proof to explain the expense was urgent and immediate. If you take a hardship withdrawal, you will need to document removing those funds.
Hardship withdrawals are generally a taxable event. Work with your CPA or tax advisor to calculate the taxes owed for amounts you’re distributing. If the hardship withdrawal is made before the participant reaches age 59 ½, a 10% early withdrawal penalty will also apply.
Further hardship distribution and withdrawal resources from the IRS:
Issue Snapshot – Hardship Distributions from 401(k) Plans
Retirement Topics – Hardship Distributions
Do’s and Don’ts of Hardship Distributions
Retirement Plans FAQs regarding Hardship Distributions
4. Early Withdrawal
Generally, you can take an early withdrawal from your Solo 401k plan. Withdrawals are taxed as ordinary income. This means the amount you remove from your Solo 401k plan is added to your annual income and taxes will be owed.
An early withdrawal means you are removing funds before age 59 ½. You can take a withdrawal from your Solo 401k before age 59 ½ by paying taxes due at the time of withdrawal as well as a early withdrawal penalty. This is generally 10% of the withdrawal.
Work with your CPA to document the early withdrawal. Your early withdrawal will need to be documented on you personal income tax form (generally Line 16b of form 1040). Additionally, the amount of the withdrawal is reported on form 1099-R in box 2a. The amount specified in box 2a is what is added to your taxable income for that year. Finally, you’ll document the early withdrawal on IRS Form 5329 (form found here)
Find more help from the IRS regarding Early Withdrawals here
5. Normal Taxable Distribution
Once you reach age 59 ½, you can start to take distributions from your Solo 401k with no early withdrawal penalties. To document a taxable distribution, you will need to complete and file form 1099-R. You will also need to document the distribution on your personal income taxes (generally line 16b on your form 1040).
Work with your CPA or tax advisor to accurately calculate, document, and pay taxes owed.
For further help, please see the 401(k) Resource Guide – Plan Participants – General Distribution Rules
6. Required Minimum Distribution
Because the Solo 401k and retirement plans grow funds tax-deferred, the IRS will eventually want to collect on those taxes. Required Minimum Distributions are the way the IRS mandates you remove funds from your retirement plan in order to pay taxes.
Required Minimum Distributions begin at age 70 ½, regardless of whether or not you are still active in your business. In general, your first RMD is due on April 1st of the next calendar year following the day you reach 70 ½.
For example, If you turn 70 on July 17th, 2018, you would turn 70 ½ (your half birthday) on January 17th, 2019. Your first RMD would be taken on April 1st , 2020.
The Solo 401k has Required Minimum Distributions like any other Qualified Retirement Plan. Additionally, Required Minimum Distributions apply for Roth Solo 401k funds as well, though there is no taxation due when the funds are removed from the Roth portion of the Solo 401k, assuming they are qualified when taken out in a Required Minimum Distribution.
This article from the Nabers Group Knowledge Base contains more information on calculating your Required Minimum Distribution. Work with your CPA or tax advisor to ensure you are properly calculating and paying the correct amount on your Required Minimum Distribution.
You or your CPA will file form 1099-R to document removing the funds from your Solo 401k for the Required Minimum Distribution. Additionally, your personal income tax return will reflect the amount of funds added to your annual income in the Required Minimum Distribution. If the RMD is taken from pre-tax (traditional) 401k funds, it will be a taxable event. You will pay taxes on RMDs for the Solo 401k from pre-tax funds.
This IRS article on Required Minimum Distributions can offer more assistance.
7. Death Distribution
When a Solo 401k participant passes away, the beneficiary of the Solo 401k has several options as to how to take control of the funds. Beneficiaries are designated at the time of establishing the Solo 401k, so there is an estate plan in place for where the funds are distributed after the participant dies.
If the beneficiary is a spouse, that individual can do the following with the inherited funds:
A) Take a full taxable distribution of the plan assets and calculate and pay taxes for any non-Roth funds
B) Roll funds over to an Inherited IRA
C) Roll funds over into the beneficiary’s IRA
D) Leave the funds in the 401k
If the spousal beneficiary chooses A-C above, form 1099-R will be filed to document the removal of funds from the Solo 401k plan.
If the participant was over the age of 70 ½ at the time of death, the beneficiary will need to continue to take Required Minimum Distributions (RMDs).
If the spousal beneficiary is under age 59 ½, (s)he may take distributions from the 401k without incurring a 10% early withdrawal penalty. To avoid paying taxes on the distribution, the spousal beneficiary will generally roll the inherited funds into another retirement plan, such as an Inherited IRA.
If the beneficiary is not a spouse, that individual can do the following with the inherited funds:
A) Take a full taxable distribution of the plan assets and calculate and pay taxes for any non-Roth funds
B) Roll funds over into a beneficiary IRA
Either option above will require the non-spouse beneficiary to file form 1099-R will to document the removal of funds from the Solo 401k plan. If the non-spouse beneficiary chooses Option A, taxes will be due upon removal of funds from the deceased’s retirement account. If the non-spouse beneficiary chooses Option B, taxes may not be due if the rollover is a direct rollover to another retirement plan with the same tax treatment.
For further resources from the IRS, please see the article on Retirement Topics – Death
Now that you have the methods for getting funds out of your Solo 401k, you’re ready to get going!
2 Responses
What happens to the RMD requirement for a Roth 401(k) when I attain 70.5 years of age, but the Roth 401(k) funds have been in the account for less than 5 years?
SECURE Act 1.0 removed RMDs for Roth 401k plans so this may not be applicable for you!