Whether you select a Traditional andRoth Solo 401k or a combination of both, a Solo 401k gives self-employed business owners a tax and retirement boost. There are no other retirement accounts that provide higher contribution limits or more flexibility in how you can manage these accounts. The flexibility encompasses choices beginning the day you open your account, to deciding what alternative investments you want to make, how you want to manage your tax advantages, all the way to how you want to pass the tax savings on as an inheritance.
With Nabers Group, your Traditional Solo 401k automatically comes with a Roth Solo 401k as a subaccount for even more flexibility beginning on day 1 or any day in the future.
Traditional and Roth Solo 401k Accounts — Basic Options
Opening a Traditional and Roth Solo 401k for your small business makes a lot of sound financial sense. But you may be aware that you have different choices. Let’s begin with the basic that a Solo 401k allows you to save the most money versus all the other self-employed retirement plans (SEP-IRA, SIMPLE IRA, Keogh Plan). It is even better if you and your spouse run your business together because including your spouse can allow you to double your contribution amounts and tax savings.
Whether you are still exploring your options or are seriously looking into the details of opening your Traditional and Roth Solo 401k account, there are some important plan features to be considered upfront.
- Will you have both Traditional and Roth Solo 401k contributions?
- Will you allow loans from your solo 401k plan?
- Can you do rollovers into the plan?
- What are the fees for maintaining the plan?
- Do you want to invest in alternative investments, like real estate or cryptocurrency?
At Nabers Group, we offer the lowest noncustodial fees and give you the flexibility to say yes to every one of those important options. We believe in a flexible Solo 401k that you control. While you can always amend your plan documents, it makes sense to create a solo 401k plan with the most options up front.
The Roth Solo 401k should already be a basic option. Surprisingly, many brokerage firms currently don’t allow a Roth Solo 401k. When it comes to your Solo 401k, it’s important to remember that you have two aspects of contributions to your plan:
- You have your elective deferrals, which can either be Roth or Traditional.
- You have your profit-sharing contribution, which can only be Traditional.
The Roth option comes in handy when you’re looking for tax diversification. With Roth contributions, you are using post-tax money. So, you will pay more in taxes today, but you will pay fewer taxes in the future. However, if you’re putting large profit-sharing contributions into your solo 401k, then it might make sense to make Roth contributions as an employee. The reason? It will give you tax diversification in retirement. You can choose whether you use taxable or tax-free money in the future — options are always great. For instance, you may decide to use tax-free Roth funds for a major purchase after your retirement such as a motorhome. The reason is you won’t have to pay taxes on that major withdrawal. On the other hand, you might choose to withdraw Traditional Solo 401k funds that are tax-deferred to cover your month-to-month expenses. You might pay taxes on the Traditional withdrawal but only as ordinary income. The withdrawal for the major purchase won’t push you into a higher tax bracket for the year.
The important thing to remember is options. You want options to be able to invest how you want to invest and options to make withdrawals in the most tax-advantaged manner.
Traditional And Roth Maximize Contributions
Your ability to contribute in two ways to your Solo 401k plan (both Traditional or Roth) is at the heart of maximizing the largest contributions possible.
According to 2023 IRS 401(k) and Profit-Sharing Plan Contribution Limits, as an employee, you can make salary deferral contributions equal to the lesser of $22,500 or 100% of your compensation. If you’re at least 50 years old or will turn 50 years old in 2023, your savings options are even higher because you can add an extra $7,500 in catch-up contributions each year.
Then, as the employer, you can contribute up to 25% of your compensation each year. Total contributions to your account, not counting catch-up contributions for those age 50 and over, cannot exceed $66,000 for 2023. Here is a summary of the maximum allowed contributions.
- Employee Salary Deferral Contribution: $22,500 maximum.
- Catch-up Contribution: $7,500 maximum (for those age 50 or older).
- Total Solo 401k contribution:
- $73,500 for those age 50 or older.
If your spouse participates in the Solo 401k plan with you, those contribution numbers double:
- $132,000 total contribution between both spouses.
- $147,000 total contribution between both spouses, if both participants are age 50 or older.
Wondering how your contributions can add up? Check out our contribution calculator to run your numbers.
Having a Traditional and Roth Solo 401k account is about flexibility. Those are the total allowed contributions to both accounts, but you can decide to contribute zero one year and the maximum the next year or anything in between.
Combined, those contributions can add up to significant annual retirement savings. For example, if you’re an independent consultant (with no employees) and have wages in 2023 of $100,000, you could first contribute up to $22,500 as an employee. Then, as the employer, you could contribute $25,000 more based on your compensation minus business expenses and self-employment taxes. In total, you could set aside $47,500 in one year to help build your retirement nest egg.
Of course, if you make more money, you could combine the contributions to add up to the maximum of $66,000.
Traditional and Roth Solo 401k Accounts Minimize Taxes
Taxes is where you are going to find the biggest differences between the Traditional and Roth Solo 401k accounts. However, one place both have a similar effect is with your self-employment business taxes. The tax forms used, and the exact treatment can vary depending on your business structure (e.g., sole proprietor, LLC, S-Corp, etc.). If your business is not incorporated, you can generally deduct contributions for yourself from your personal income. If your business is incorporated, you can count the contributions as a business expense.
One way or another Uncle Sam wants the taxes due on your total income. Critical to a combined Traditional and Roth Solo 401k tax strategy is that you have the flexibility of when those taxes are collected and even how much tax is collected.
Traditional Solo 401k Reduces Taxes Now.
The Traditional 401k is tax-deferred. You do not pay taxes on the employee part of your income that is contributed — in the tax year it was earned. The tax deferral may even place you in a lower tax bracket for the income that you do earn that year. However, a tax-deferred Solo 401k does not mean you never pay taxes. You pay taxes when you withdraw both the earnings and contributions.
One way you minimize traditional and roth taxes is if your taxable income drops in retirement. This can put you in a lower tax bracket than you were as an employee in the year you earned the income. The money you take from a Traditional 401k during retirement years can get taxed at a rate lower than what you would pay while fully employed. Withdraw money early, though, and you will usually pay taxes plus a 10% penalty. The Traditional Solo 401k can help you here also. Instead of withdrawing money early, you can often meet unexpected financial emergencies or other needs with a participant loan. Not only can you take money out of your retirement account early without paying taxes and penalties, but you also repay the loan and a small interest rate back into your Solo 401k retirement account.
The IRS lets you begin to withdraw without a penalty at age 59 1/2 and requires you to begin withdrawing by April 1 the year after you turn 72.
Roth 401k Reduces Taxes Later
You pay the taxes on your contributions in the year it is earned. You do not get the tax deferral that you get with the Traditional Solo 401k. The big tax break here is that you will not pay taxes on any of the earnings that your large contributions have been accumulating for years and years. That is the tax-free beauty of a Roth Solo 401k.
The Roth Solo 401k earnings aren’t taxable when you keep them in the account until you’re 59 1/2 and you’ve had the account for five years. Because you are paying taxes as you contribute, you won’t have to pay taxes on the funds or their earnings when you withdraw the money.
One example of how you can gain a tax benefit is the major purchase after retirement mentioned above. Other examples include.
- Younger participants will have many years and decades to grow substantial earnings that will never be taxed.
- Any participant that predicts they will have more income and a higher tax rate when they retire.
- Any participant with an alternative investment that is expected to have extraordinary earnings may want to use Roth Solo 401k funds to make the investment so that taxes are never paid on those substantial earnings.
This is why having the flexibility of a Naber Group Solo 401k that includes a Roth Solo 401k as a subaccount is so important. Each and every year you have the option of which account you contribute to and how much you contribute to each account.
The Solo 401k Inheritance Benefits
When someone inherits a Roth Solo 401k, distributions should be tax-free if the deceased first began making contributions to their Roth account at least five years before the survivor begins inherited withdrawals. That is a huge benefit for people inheriting a Roth Solo 401k but not the only benefit that comes when a Solo 401k inheritance is passed on.
Inheriting a Solo 401k as a Spousal Beneficiary. A spouse inheriting a Solo 401k (Traditional or Roth) has several options depending on his or her age. They can generally do one of three things:
- If younger than age 59½ the spouse can leave the money in the plan and take distributions from the account without triggering the 10% early withdrawal penalty. They will still pay regular income tax on any distributions they take (unless it is a Roth). If the deceased spouse was already taking the Required Minimum Distributions from their 401k when they passed away, the surviving spouse has the choice to continue taking them or delaying them until he/she turns 72. However, if the spouse is already age 72 or older, they will have to generally take the RMD no matter which option they choose.
- Transfer the funds to an Inherited IRA. An inherited IRA is an individual retirement account that’s designed to hold rollover funds from an inherited retirement plan, including Solo 401ks. The spouse can make withdrawals without triggering an early withdrawal penalty. This kind of account requires you to take minimum distributions but the amount would be based on the surviving spouse’s life expectancy, not the amount the deceased spouse would have been required to take.
- Transfer the money to their own IRA. If the surviving spouse already has an IRA in place, they could roll an inherited Solo 401k into it with no tax penalty. The catch is that if they are under age 59 1/2 when they execute the rollover, the withdrawal will be treated like a regular distribution. That means they’ll pay income tax on the full amount, along with the 10% early withdrawal penalty. This is seldom a preferred option.
Traditional And Roth Withdrawal Age
If they are over age 59 1/2, they won’t have to worry about paying the early withdrawal penalty with any of these options. If the deceased spouse was taking required minimum distributions from their Solo 401k when they passed away, the surviving spouse has the option to continue taking them or delay taking them until they turn 72. If the surviving spouse is already 72 or older, they’d be required to take minimum distributions — regardless of whether they leave the money in the Solo 401k, transfer it to an inherited IRA, or roll it over to their existing IRA.
- inheritance. The spouse receiving the inheritance has the most flexibility and options. However, a nonspouse inheritance also has options. They can take a lump-sum distribution, but this may push them into a higher tax bracket. As an alternative, they can leave the 401k as-is and take distributions over time, whenever they want, and in any amount they want, as long as they withdraw all the funds from the account by the end of the 10th calendar year after the original owner’s death. They could also transfer the assets from the Solo 401k into an inherited IRA, but again, they would need to empty the account by the end of 10 years.
Individual circumstances may apply here such as other estate planning strategies. You need to talk with a qualified financial planner about your specific circumstances.
A Solo 401k is a fantastic way to save for retirement if you’re self-employed. A Roth Solo 401k adds even more flexibility to your potential retirement savings.
The Nabers Group Solo 401k Unlimited® platform brings simplicity to self-directed investing. Ongoing fluctuations in the stock and bond markets along with a breakdown of investor confidence in corporate America are driving the demand for alternative investments with a greater choice for retirement accounts. Investors now realize they can invest in real estate and other non-traditional assets using their retirement accounts.
Setting up a Solo 401k retirement plan is easy and allows for tax-advantaged contributions much larger than an IRA or employer 401k. Importantly, it puts you in control with access to a world of alternative investment options and tax strategies.Book a Free Call with a Specialists at Nabers Group to Begin Participating in Alternative Investments with a Solo 401k or Self-Directed IRA