What is a Solo Roth 401k?
Participants in a Solo 401k can elect to make after-tax or Roth contributions with the salary deferral portion of the Solo 401k.The 2022 salary deferral contribution limit is $20,500 and $27,000 if age 50 or older (2021 limit is $19,500 and $26,000 if age 50 or older). If a participant elects to make Solo Roth 401k contributions then the salary deferral contribution is not tax deductible, but withdrawals are tax free after age 59 ½ provided the “five year rule” is satisfied.
What is the “five-year rule” and when can I withdraw from my designated Solo Roth 401k?
Assets may be withdrawn tax-free from a Solo Roth 401k provided the Roth 401k account has been established for five or more years and you are age 59 ½ or older. The 5-year holding period begins with the first contribution to a Roth 401k account.
An exception to the age 59 ½ rule occurs in the event of disability or death. If you should become disabled, you may be able to access your Roth 401k assets tax free prior to age 59 ½ and prior to satisfying the 5 year rule. In the case of death, the Roth 401k assets are tax free to your heirs.
How much can I contribute to a Solo Roth 401k and how is it calculated?
Annual Solo 401k contributions consist of two parts 1) a salary deferral contribution and 2) a profit sharing contribution.
- Roth 401k Salary Deferral – Participants in a Solo 401k can elect to make Roth 401k contributions only with the salary deferral portion of the Solo 401k. In 2022 the Roth 401k salary deferral contribution limit is $20,500 ($27,000 if age 50 or older). Solo Roth 401k salary deferral contributions are not tax deductible, but withdrawals are tax free after age 59 ½ provided the 5 year rule is satisfied.
- Profit Sharing – A profit sharing contribution of up to 25% of compensation can also be made into a Solo 401k. The profit sharing portion of the Solo 401k contribution is not eligible to be made as a Roth contribution. Profit sharing contributions are made pre-tax and are tax deductible.
Note: The combined 2022 salary deferral and profit sharing contributions in a Solo 401k cannot exceed $61,000 or $67,500 if age 50 or older.
Roth 401k versus Traditional 401k comparison
Solo 401k salary deferral contributions can be made as Roth 401k (after tax) or Traditional 401k (pre-tax).
The basic difference between a Roth 401k and a Traditional 401k is that the Roth 401k is funded with after-tax contributions while the Traditional 401k is funded with pre-tax contributions. In other words, with a Roth 401k you pay taxes today in return for a tax-free withdrawals in retirement. Traditional 401k contributions are tax deductible and are made pre-tax so you save taxes today, but withdrawals are taxed in retirement. As a result, the choice between the two 401k options comes down to whether you believe your income taxes rates will be higher or lower in retirement.
This chart compares the features of both salary deferral options.
| Roth 401k (after tax contributions) | Traditional 401k (pre-tax contributions) | |
|---|---|---|
| Maximum annual contribution (under age 50) | $20,500 – 2022 | $20,500 – 2022 |
| Maximum annual contribution (age 50 or older) | $27,000 – 2022 | $27,000 – 2022 |
| Tax treatment of contributions | After tax (not tax deductible) | Pre-tax (tax deductible) |
| Tax treatment of distributions | Distributions are tax free if five years have passed since the first contribution and must begin at age 70½ unless rolled to a Roth IRA. If rolled over to a Roth IRA then the money is not subject to RMD rules until the death of IRA owner there is a qualifying event (attainment of age 59½, death or disability) | Distributions are taxed as ordinary income and can be withdrawn after age 59 ½ without IRS penalty. |
| Required minimum distributions (RMDs) | Must begin at age 70½ unless rolled to a Roth IRA. If rolled over to a Roth IRA then the money is not subject to RMD rules until the death of IRA owner | Must begin at age 70½ |
| Rollovers | Can rollover to another Roth 401k or a Roth IRA | Can rollover to another traditional 401k or a Traditional IRA or Rollover IRA |
Solo Roth 401k Rules
- The 2022 Solo Roth 401k contribution limit is $20,500 and $27,000 if age 50 or older.
- Solo Roth 401k contributions are made after-tax and are not tax deductible.
- Solo Roth 401k distributions are received tax free from federal income taxes provided there is both a 5-year holding period and there is a qualifying event. The 5-year holding period begins with the first contribution to a Roth 401k account and there are 3 qualifying events: the attainment of age 59 ½, disability or death.
- After-tax contributions cannot be combined with pre-tax contributions. As a result, within your Solo 401k there will be two separate accounts; one account will be designated for after-tax Roth contributions, the other for pre-tax contributions such as the profit sharing portion of your Solo 401k. You will need to segregate tax deductible versus non tax deductible (Roth) account activity when reporting to the IRS.
- Roth 401k accounts from a previous employer can be rolled over to a Solo Roth 401k. If rolled over to a Solo 401k, the 5-year holding period begins with the earlier of the date the rolled over account was established, or the date the receiving Roth account was established.
- Solo Roth 401k accounts can be rolled over to a Roth IRA or to another identically designated Solo Roth 401k. Otherwise the previously untaxed earnings will be treated as an early distribution from a qualified plan (liable for taxes and penalties for any such early distribution) unless you have had this Roth account established for more than five years.