Voluntary After-Tax and Roth Contributions in the Solo 401k

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If you’ve never heard of voluntary after-tax contributions for a Solo 401k, you aren’t alone. Although they have been in existence for many years , they haven’t been a very popular choice for retirement savers. Voluntary after-tax contributions are different from Roth contributions. With voluntary after tax contributions, you have to pay taxes on the growth and withdrawals. Therefore, they’ve long been ignored.

Then, back in 2014, IRS Notice 2014-54 simplified things by separating the pre-tax and after-tax portions of a 401(k) distribution. The section was called Guidance on Allocation of After-Tax Amounts to Rollover.  And, it opened the door for participants to roll their voluntary after-tax contributions into a Roth Solo 401(k).

Mega “Back Door” Roth Solo 401(k) Conversion

Roth solo 401k contributions are bound by the same distribution triggering events as pre-tax contributions. Those events include:

  • The death of the participant
  • Reaching the age of 59 ½
  • Disability
  • Termination of employment

Voluntary after-tax solo 401k contributions can be distributed and converted without these restrictions.

Contributions into a Solo Roth 401(k) are typically limited to $19,000 per year in 2019. That number increases to $25,000 if you are 50 years of age or older. Solo 401k voluntary after-tax contributions, however, offer yet another way to contribute more into your retirement plan. Solo 401k voluntary after-tax contributions allow you to add up to $56,000 annually. If you are age 50 or older, you can contribute $62,000 to your retirement account.

That’s because Voluntary after-tax contributions fall into the bucket of “employee salary deferral” contributions. The IRS allows you to contribute up to 100% of your net self-employment earnings into this bucket as an after-tax contribution.

Keep in mind that you can only contribute as much as you make. Therefore, it’s important to know your numbers and earnings from your business. A contribution calculator can be a helpful tool to know exactly what you can contribute. You cannot contribute more than you earned in your business. Additionally, it’s important to factor in any employee salary deferral contributions you are making to another employer plan as the aggregate comes from all plans.

Where does the “back door” part come in?

The term “back door” sounds a bit sketchy and could give the impression that it would raise red flags with the IRS. But it is entirely compliant with their regulations. Your voluntary after-tax solo 401k contributions are subject to the higher annual overall limits, and if your plan provider allows it, you can convert those voluntary after-tax contributions to Roth funds with a Roth conversion within the plan.

Since rollovers have no monetary or income restrictions, you can turn the more substantial accumulations in the voluntary after-tax contributions into a Roth Solo 401(k) and bypass the lower limits of contributing directly into the Roth. Thus, the rollovers became known as the “mega back door Roth conversions”

Choose Your Plan Provider Wisely

For a plan participant to make after-tax contributions, the plan provider must allow them. Even though a solo 401(k) may allow for after-tax contributions, there is nothing that says they must offer this option.

As a result, many solo 401k plan providers will not allow voluntary after-tax solo 401k contributions. That’s because there are more reporting requirements associated with these contributions. For instance, whenever the voluntary after-tax solo 401k contributions are converted to the Roth Solo 401k, the plan administrator must document it with a conversion form.  The IRS might request this documentation. Further, your CPA will need to file form 1099-R to document the conversion.

The Solo 401k at Nabers Group allows for both voluntary after-tax contributions and in-plan Roth conversions. In other words, you can successfully execute a Mega Backdoor Roth Conversion with the Solo 401k plan. You may contribute up to 100% of your net compensation as a voluntary after-tax contribution, which means you could set aside up to $56,000 ($62,000 if you are 50 or over).. Max out your contributions even more by having your spouse participate in the plan with you.

Why Use After-Tax Funds?

With typical retirement funds, you have to pay taxes when you withdraw the money. The IRS presumes you’ll be making less money as you reach your 70’s, and therefore will be in a lower tax bracket. Because you’re in a lower tax bracket when you’re withdrawing funds, the overall tax penalty isn’t as intense as it would be if you were withdrawing at the peak of your earning career.

Making voluntary after-tax and Roth contributions gives you the opportunity to grow your money tax-free. Because you don’t get a tax deduction when the money goes in, you don’t have to pay taxes when the money comes out. However, keep in mind that in order for the money to be truly tax free, it must be qualified.

A qualified Roth distribution must fulfill two things:

  • Reaching the age of 59 ½
  • Have the funds in the account for five calendar years or more

Having some exposure to Roth and after-tax funds is a great idea to lessen your taxes in retirement. Keep in mind that while the contribution part of the voluntary after-tax contribution grows tax free, the growth is taxable. Therefore, if you want the entire voluntary after-tax bucket to be tax-free as well, you’ll need to convert those funds to Roth.

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