QUESTION:

For solo 401k, are we allowed to invest in annuities? 

ANSWER:

Yes, a solo 401k may be invested in annuities whether fixed or variable annuities.

Owner:

When a solo 401k plan invests in an annuity, the annuity is owned by the solo 401k plan. This means the annuity policy is required to reflect the solo 401k as the owner, so as follows:

If the name of the solo 401k is Palm Tree Trust and the trustee’s name is Jane Do, then the annuity policy will reflect the owner as follows: jane Do, Trustee of Palm Tree Trust

Beneficiary

The beneficiary of the annuity will also be the solo 401k. Reason being, upon the death of the annuitant, the proceeds from the annuity will need to flow back to the solo 401k before distributions can be made to the annuitant.

Annuitant

The annuitant of the annuity is the trustee of the solo 401k, so John Do, in our example above. 

QUESTION:

I have an outstanding loan with the current 401k. Can it be transferred as well to the self-directed solo 401k, or does it need to be paid off ?

ANSWER:

Yes, if the participant loan in your former employer’s 401k plan is in good order and the former employer allows you to transfer it. However, former employer’s generally won’t allow you to transfer-out the existing participant loan; therefore, you will need to ultimately check with your former employer’s 401k plan administrator. You will want to communicate to them that you now have a solo 401k plan for your self-employed business which accepts the transfer of the outstanding 401k loan to the solo 401k plan. If they say yes, then the transfer of the participant loan will be requested when completing the transfer forms. 

On the other hand, if they say no, then you may want to consider asking them to process the loan as a “loan offset” which is a way of ultimately indirectly transferring the loan to the new plan. For more on these specific loan offset rules, please see the following page: https://www.mysolo401k.net/former-employer-plan-participant-loan-offset-vs-deemed-distribution/

ANSWER:

The rent payments for the solo 401k owned property have to flow directly to the solo 401k account NOT first to your personal account and then to the solo 401k. The funds not flowing to the solo 401k account directly can result in a taxable distribution as well as a prohibited transaction.

If you are self-employed your self-employed business can sponsor both a defined benefit plan (DBP) and a defined contribution solo 401k plan. This will allow you to maximize annual plan contributions.

Contributions to a defined benefit plan (DBP) are always treated as employer contributions;therefore, your employee contributions to the solo 401k are not impacted by your contributions to the DBP, but your employer contributions to the solo 401k are impacted by your DBP contributions. Also contributions to a solo 401k plan can be made on an employee and employer basis.We have also previously published the following two blog posts on this topic:

1: https://www.mysolo401k.net/contribute-to-both-a-defined-benefit-plan-dbp-a-self-directed-solo-401k-plan/

2: https://www.mysolo401k.net/making-voluntary-after-tax-contributions-to-combined-hybrid-401k-and-defined-benefit-plan-dbk-plan/

Making Employee Solo 401k Contributions & Employer Contributions Even if You Contribute to a Defined Benefit Plan

Employee Contributions:

Let’s assume your self-employed business is taxed as an S-corporation and that you receive W-2 wages from it.  You have also maximized your DBP plan contribution for the year and now also want to  maximize your solo 401k contributions.  Since DBP contributions don’t impact employee contributions to the solo 401k plan, for tax year 2023 you could contribute $22,500 as an employee contribution to the solo 401k which can be applied as a pre-tax or a Roth contribution or in combination. If you are age 50 or older in 2023, you could also contribute an additional catch-up amount of $7,500 which can also be treated as a pre-tax or Roth contribution or in combination. 

Employer Contributions

Unlike employee contributions, employer contributions (aka profit sharing) to the solo 401k plan are impacted by your DBP contributions. The maximum employer contribution to a solo 401k is 6%  of your W-2 wages from the S-corp self-employed business if you also contribute to your DBP. 

Voluntary After-Tax (mega backdoor Roth) Contributions

Voluntary after-tax contributions are employee contributions; as a result. they are not impacted by DBP contributions which are always deemed employer contributions. For 2023, the overall contribution limit to a defined contribution plan such a solo 401k plan is $66,000. If you have the required W-2 wages from your self-employed business you could contribute the entire $66,000 amount as a voluntary after-tax solo 401k contribution. 

Once the you have had the Roth solo 401k for 5 years and are age 59 1/2 or oler, you can take tax free distributions of both the contributions and the earnings that have accumulated in the Roth Solo 401k.   The 5 year clock on the Roth solo 401k starts when funds were first contributed to the Roth Solo 401k as described on the following page: https://www.mysolo401k.net/daily-solo-401k-question-when-does-the-5-year-clock-start-for-qualified-roth-solo-401k-distributions/   

If you make a distribution prior to meeting both qualified distribution requirements (i.e., the 5 year rule and the age 59 1/2 or older rule) , then the distribution will be deemed non-qualified and subject to the pro-rata rules where a potion will be tax free and a portion will be taxable. Pro-Rata Rule Applies A distribution that is not a qualified distribution is subject to the pro-rata rule. A portion of every distribution taken will be considered taxable and a portion will be considered nontaxable. The non-taxable amount of the distribution is generally determined by dividing the employee’s deferrals (basis) by the balance in the Roth solo 401(k) account and multiplying the amount distributed by the result. Unfortunately, the favorable ordering rules used to determine the taxation of a distribution from a Roth IRA do not apply to Roth 401(k)s.

Example:  Fred has deferred a total of $30,000 to his Roth Solo 401(k) and has a total balance in the account of $40,000. He then takes a nonqualified distribution of $12,000. $9,000 of the distribution will be tax free. ($30,000 / $40,000 = .75) ($12,000 x .75 = $9,000).

QUESTION:

My understanding is that it is not permitted to transfer a Roth IRA into a Roth Solo401(k).    Recognizing this, I was planning on transferring the Roth 401(k) that I have from a previous employer to my new Roth Solo401(k) once I’ve set it up.

My question is related to options for directing funds from the pre-tax portion of the 401(k) from my previous employer to a Roth Solo401(k).    My understanding is that both of the options shown below are available

1. Convert the pre-tax to the Roth account within the 401(k) from my prior employer prior to transferring to the new Roth Solo401(k)
2. Convert some or all of the pre-tax balance to the pre-tax portion of the the Solo401(k) and then do conversion(s) within the Solo401(k)

On a related note to #2, I understand that if I transfer all or a portion of the pre-tax balance in the 401(k) from my previous employer to a Traditional IRA, I would later have the option to transfer a portion of the Traditional IRA to the pre-tax account of the Solo401(k) and would be able to then do a conversion to the Roth account in the Solo 401(k).

Could you please confirm or correct my understanding?

ANSWER:

Here are items to consider when deciding to convert pretax funds from your former employer 401k to a Roth 401k, including a Roth solo 401k if you are self-employed.

Option 1: Process an In-Plan Conversion Under the Former Employer 401k

Under this option, you would process the in-plan conversion (i.e., convert pretax 401k to Roth 401k) within the former employer 401k where that plan’s administrator would move the funds internally from the pretax 401k to the Roth 401k (aka designated Roth account), and subsequently perform the Form 1099-R reporting with the IRS to report the taxable conversion. Finally, you would then transfer the Roth 401k to the Roth solo 401k when ready.

Option 2: Convert Former Employer Pretax 401k Funds to the Roth Solo 401k

Under this option, the administrator of your former employer’s 401k plan still performs the required IRS reporting for the conversion of the pretax 401k funds to the Roth solo 401k and issues the Form 1099-R; however, they also make the check payable in the name of the Roth solo 401k and mail it to you as the trustee of the solo 401k and you then deposit the check directly into the Roth solo 401k bank or brokerage account.

Option 3: Directly transfer the Former Employer 401k Petax Funds to the Pretax Solo 401k

Here the former employer 401k pretax funds are transferred to the pretax solo 401k. The former employer plan’s administrator will report the movement of the funds as a non-taxable direct rollover from the pretax 401k to the pretax solo 401k using a code “G” in box 7 of the Form 1099-R. Then, once the funds are inside your pretax solo 401k, you can then work with your solo 401k plan provider in processing the in-plan conversion of pretax solo 401k funds to the Roth solo 401k. The solo 401k plan provider will also document the conversion and issue the Form 1099-R to report the taxable conversion. For client’s of My Solo 401k Financial, see the following form: https://www.mysolo401k.net/pretax-to-roth-solo-401k-in-plan-conversion-form/

And see the following for items to consider prior to deciding to process the in-plan conversion of pretax solo 401k funds. https://www.mysolo401k.net/items-to-consider-if-you-plan-to-process-a-self-directed-roth-solo-401k-pretax-in-plan-conversion-in-2023/

Note: under all of the options described above where pretax 401k funds are ultimately converted to the Roth 401k including the Roth solo 401k, not only is conversion taxable but you will pay the taxes due on the conversion with funds outside the 401k plan and they are due by your personal business tax return (generally April 15) of the following year for conversions processed by 12/31 of the prior year. For example, any pretax conversions processed in 2023 would have taxes due on the conversion by April 15, 2024.