You first need to open a designated Roth solo 401k brokerage or bank account as Roth solo 401k funds are required to be separately tracked under a defined contribution plan such as a solo 401k plan.
Note: opening a separate bank/brokerage account to hold the Roth solo 401k funds does not mean you are opening an additional solo 401k but rather an additional holding account under the existing self-directed solo 401k to hold the Roth solo 401k funds. The IRS refers to this additional solo 401k holding account as a Roth Designated Account.
If Using Solo 401k Bank Accounts- In-Plan Pretax Solo 401k Roth Conversion
Step 1-Open Bank Account: Make sure to open up a bank account to hold the Roth solo 401k funds.
Step 2. The Roth solo 401k bank account needs to be titled in the name of the solo 401k followed by the word ROTH in parenthesis (ROTH), and use the same employer identification number for the solo 401k.
EXAMPLE: If the name of your solo 401k is “Futuristic Times Trust”, then the bank account to hold the Roth solo 401k funds would be titled as follows: Futuristic Times Trust (ROTH)
Important Note: If each participant (e.g., both spouses) are converting funds, separate solo 401k bank accounts are required for each.
Step 3. Move the funds from the pretax solo 401k bank account to the Roth solo 401k bank account. You will work with your bank in moving the fund by check or electronically.
Step 4: Report the Taxable In-Plan Conversion on Form 1099-R. We will issue the Form 1099-R by February of 2023 as long as the following on-line conversion form[CLICK HERE to complete the form] is received by 12/31/2022, so make sure to fill it out once you have moved the funds to the Roth solo 401k bank account.
If using Solo 401k Brokerage Accounts (e.g., Fidelity, Schwab, E-TRADE or TD AMERITRADE- In-Plan Pretax Solo 401k Roth Conversion
Step 1. Open the Brokerage Account: Make sure to open a brokerage account to hold the Roth solo 401k funds if you have not already done so. Please send us an email to: [email protected] if you have not yet opened the additional brokerage account to hold the Roth solo 401k funds so that we can assist. Make sure to reference your plan name. Also, if both participants (e.g., both spouses) will process a conversion, they each need separate Roth solo 401k brokerage accounts.
Step 2. The Roth solo 401k brokerage account needs to be titled in the name of the solo 401k followed by the word ROTH in parenthesis (ROTH), and use the same employer identification number for the solo 401k.
EXAMPLE: If the name of your solo 401k is “Futuristic Times Trust”, then the brokerage account to hold the Roth solo 401k funds would be titled as follows: Futuristic Times Trust (ROTH)
Step 3. Move the funds from the pretax solo 401k brokerage account to the Roth solo 401k brokerage account. You will work with your broker in moving the funds by check or electronically.
Step 4: Report the Taxable In-Plan Conversion on Form 1099-R. We will issue the Form 1099-R by February of 2023 as long as the following on-line conversion form[CLICK HERE to complete the form] is received by 12/31/2022, so make sure to fill it out once you have moved the funds to the Roth solo 401k bank account.
Taxable Conversion
The amount converted from the pretax solo 401k to the Roth solo 401k is considered a taxable conversion so is includible in gross income in the year of the conversion, but going forward eligible distributions from the Roth solo 401k account (including earnings) are generally tax-free. This is why the self-employed business owner must separately account for all contributions, gains and losses to this designated Roth solo 401k account until this account balance is completely distributed.
You may be considering converting your traditional (pretax) solo 401k to a Roth solo 401k (designated Roth account) in 2022. Following are key items to understand prior to proceeding.
December 31, 2022 is the Deadline
- Conversions must be processed by December 31, 2022 in order to count for 2022.
- This means that the funds and/or assets must be deposited from the solo 401k pretax bank/brokerage account to the Roth solo 401k bank/brokerage account by 12/31/2022.
- Don’t confuse the contribution deadline rules with the conversion deadline. Unlike contributions where you can make them the following year (2023) by the self-employed business tax return due date plus extension, the Roth solo 401k conversion rules require the funds and or asset converted by 12/31/2022.
- Don’t forget that your solo 401k provider may need more time than you think to complete the conversion including assisting in opening the Roth solo 401k bank or brokerage account if that has not yet been done. Waiting until the last minute can be a nail biter.
Don’t Forge About Taxes
The conversion of pretax solo 401k funds to the Roth Solo 401k designated account is considered a taxable event but not subject to the 10% early distribution penalty.
The pretax solo 401k conversion will increase your ordinary income for 2022 – potentially causing the loss of exemptions, credits tax deductions, taxation of Social Security, and increased premiums for Medicare Part B and Part D premiums – but this only happens for the year of the conversion. The trade-off is that all future qualified distributions from your Roth solo 401k will be distributed completely tax-free.
Reasons to Process a Conversion
Should you convert solo 401k funds to the Roth solo 401k bucket? Some factors in favor of converting include not needing your money soon, or even at all and expecting your future tax rates to be higher. Being younger can favor conversion as younger people generally are in a lower bracket, have not yet accumulated large sums in their solo 401k, and have long retirement savings timelines to work with.
Reasons not to Processing a Conversion
Conversion may make sense for some but is not for everyone. Why may you not want to process an in-plan solo 401k conversion? Conversion may not be for you if:
are older and will need the money soon;
you think you will be in a lower tax bracket at retirement; and
not having available, non-retirement assets to pay the tax due on the in-plan solo 401k conversion.
No Do Over
Just like Roth IRA conversions, you cannot change your mind once the in-plan solo 401k conversion has been processed. To learn more about the in-plan Roth solo 401k conversion rules, VISIT HERE.
