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In-plan Roth rollover (Solo 401k Roth Conversion) Explained
An in-plan Roth rollover is the movement of assets from a pre-tax Solo 401k (the funds or assets have not been taxed) to a designated Roth Solo 401k (also referred to as Roth account because the Roth option is part of the Self-Directed Solo 401k but a separate sub account/bucket is required to hold the Roth Solo 401k funds) within the employer’s Solo 401k plan from an account other than a designated Roth account within the same plan. Not only do both Solo 401k Plan participants (generally both spouses, or both business partners) may either roll over assets directly within a Solo 401k plan, or roll over a distribution within 60 days of receipt (indirect rollover), but so can the spouse beneficiaries (and spouse alternate payees).
The IRS Solo 401k regulations permit the Solo 401k participant to change (convert) the character of their Solo 401k plan assets from pretax—including basis—to Roth status within the Solo 401k plan. The IRS refers to this status change as an “in-plan Roth rollover” to a designated Rot account within the plan. Self-Directed Solo 401k in-plan rollovers were made possible by enactment of the Small Business Jobs Act of 2010.
Amounts eligible for in-plan Roth rollovers (Solo 401k Roth Rollovers)
Provided the Solo 401k plan document drafted by the Solo 401k provider that you established Solo 401k with allows for in-plan rollovers (i.e., for the conversion of Solo 401k funds to Roth Solo 401k), as the Solo 401k participant(s), any of your vested balance from elective deferrals and profit sharing as well as funds transferred from previous plans such as 401k, Profit Sharing, Money Purchase, Thrift Savings Plans, 403b, 457b, SIMPLE IRA, SEP IRA and Traditional IRA may be converted to Roth Solo 401k within the plan.
Tax consequences of an in-plan Roth Rollover (Solo 401k Roth Rollover)
An in-plan Roth rollover (Solo 401k Roth Rollover) is included in income and taxed for the plan year of the rollover, to the same extent that it would be taxed if the rolled over to a Roth IRA. Special rules apply for employer securities and loans. Net unrealized appreciation (NUA) in employer securities that are transferred to a designated Roth account in an in-plan Roth rollover will be taxed in the current year. A loan balance rolled over to a designated Roth account will be included in income, adjusted for basis (as any in-plan Roth rollover assets), but the loan will retain all of its previous provisions.
The 10 percent early distribution penalty tax may apply to in-plan rollovers
Similar to when rolling over (converting) non-Roth assets to a Roth IRA, following an in-plan Roth rollover (Roth Solo 401k conversion) there is a five-year “recapture” period during which a distribution attributable to that rollover cannot be distributed because it will subject the Roth Solo 401k to the 10 percent early distribution penalty tax on pre-59 ½ distributions. Note that the five-year recapture period begins on January 1 of the taxable year in which the rollover took place; therefore, if the Roth Solo 401k conversion (in-plan rollover) transpired in October it will be considered having commenced on January 1 for purpose of starting the 5 year clock. The five-year recapture period ends on December 31 of the fifth taxable year. If a distribution attributable to the Roth Solo 401k conversion (in-plan rollover) occurs before December 31 of that fifth year, the distribution amount is subject to the additional 10 percent tax, unless one of the qualified Solo 401k plan penalty exceptions applies.
Reporting in-plan Roth Rollovers (Roth Solo 401k Conversions)
While an in-plan Roth rollover (Roth Solo 401k conversion) is not subject to the mandatory 20 percent tax withholding, it is considered a taxable event reported using Code G (direct rollover) in box 7of Form 1099-R, the gross amount rolled over (converted) is reported in Box 1, the taxable amount in Box 2a, and applicable basis reported in Box 5 (employee contributions).
Lastly, for those that open Solo 401k with checkbook control (solo 401k checkbook control), you may want to open two checking accounts for the newly opened Solo 401k if you plan to process an in-plan rollover (Roth Solo 401k conversion) after you consolidate your other retirement accounts (e.g., SEP IRA, SIMPLE IRA, Thrift Savings Plan, former employer 401k, 403b, 457b, Traditional IRA, etc.). Reason being, the IRS Solo 401k rules require that Roth Solo 401k and Traditional Solo 401k funds be separately accounted for; hence the need for multiple Solo 401k checking accounts.