Pretax Solo 401k Vs Roth Solo 401k: Contributions / Distributions

According to the Investment Company Institute, retirement assets totaled $28.3 Trillion in the second quarter of 2018, with $7.8 trillion held in defined contribution plans. The solo 401k plan falls under the defined contribution umbrella.

One of the many advantages of a solo 401k plan is that it allows for both pretax and Roth solo 401k contributions in addition to voluntary after-tax contributions.

The differences between pretax and Roth solo 401k contributions fall into two main groups: contributions and distributions

Contributions

Eligibility

There are no limits on your income in determining if you can make both pretax and Roth solo 401k contributions. The contribution eligibility requirements are the same for pretax vs Roth solo 401k contributions–that is in order to make both or either type earned income from self-employment income is required.

Roth Solo 401k Contributions

Only the employee (salary deferral) contribution source can be used to make Roth solo 4o1k contributions.  Therefore, profit sharing (employer) contributions cannot be applied to the Roth solo 401k.

The Roth solo 401k contribution limit is $19,000 in 2019 ($18,500 in 2018), plus an additional $6,000 in 2018 – 2019 if you are age 50 or older at the end of the year. These limits may be increased in later years to reflect cost of living adjustments.

Pretax Solo 401k Contributions

Both contribution sources–the employee and employer profit sharing contributions can be applied to the pretax solo 4o1k bucket.

You can contribute the employee contribution source up to the limits described above to both a pretax solo 4o1k and a Roth solo 401k account  in the same year in any proportion you choose.

Tax-Deductible Contributions

Pretax solo 401k contributions are popular because they are tax deductible (i.,e., they reduce your taxable earned income). On the other hand, Roth solo 401k contributions are never  tax deductible and are includible in gross income in the year of the contribution

Distributions

Once contributed, pretax and and Roth solo 401k assets both grow tax-deferred. How solo 401k assets are later distributed and taxed varies greatly between pretax and Roth solo 4o1k funds.

Roth Solo 401k Distributions  

You first have to determine if the Roth solo 4o1k distribution is qualified vs. non-qualified.

What is a qualified Roth solo 401k distribution?

A qualified  Roth solo 401k distribution is generally a distribution that is made after a 5-taxable-year period of participation in the Roth solo 401k plan and is made on or after the date you attain age 59½. The 5-taxable-year period of participation begins on the first day of your taxable year for which you first made designated Roth solo 401k contributions to the plan. It ends when five consecutive taxable years have passed.

What is a nonqualified Roth solo 401k distribution?

If you take a distribution from your Roth solo 401k account before the end of the 5-taxable-year period, it is a nonqualified distribution. You must include the earnings portion of the nonqualified distribution in gross income. However, the basis (or contributions) portion of the nonqualified distribution is not included in gross income. The basis portion of the distribution is determined by multiplying the amount of the nonqualified distribution by the ratio of  the Roth solo 401k contributions to the total Roth solo 401k account balance.

Pretax Solo 401k Distributions

Pretax solo 401k  generally are taxed in the year distributed. If distributed before the solo 401k participant attains age 59½, the 10 percent early distribution penalty tax generally applies unless the solo 401k  participant has a penalty tax exception.

Lastly, in order to process a distribution from both pretax solo 401k and Roth solo 401k funds a triggering even must be met, such as attainment of age 59 1/2. For a full list, VISIT HERE.

Side-by-Side

Understanding the differences between pretax solo 401k and Roth solo 401k funds will assist you in determining which type is more advantageous for you.

Solo 401k for the Gig Economy

The gig economy generally is viewed as those workers who are independent from an employer and who work jobs that are intended to be part-time. This environment consists of independent, temporary workers ranging from lawyers, accountants, doctors to construction, transportation and personal service. Many gig economy workers may not be aware that they can participate in a solo 401k plan even if they perform such work on a part-time basis.

Bureau of Labor Statistics

A 2017 survey by the Bureau of Labor Statistics (BLS) put contingent (jobs not expected to last more than one year) workers in 2017 at 3.8% of total employment and alternative employment arrangements (e.g., contractors, on-call workers, temp agency workers) at 10.1% of total employment.

Federal Reserve Board

A survey by the Federal Reserve Board late in 2017 estimates 31% of adults were engaged in gig work (defined as occasional work or side jobs, including nontraditional activities: offline services, offline sales, and online services) in the month before the survey.

Upwork and Freelancers Union

The 2017 study by Upwork and the Freelancers Union estimates that 36% of the U.S. workforce are freelancers. This study takes a very broad approach to include anyone who has engaged in supplemental, temporary, project-based work and contract-based work within the past 12 months. The study also predicts that if the current growth rate continues, more than half of the U.S. workforce will be freelancers (if even on a small scale) by 2027.

Retirement Account Solution: Solo 401k Plan

Those in the gig economy are not covered by a retirement plan at work so they may want to consider opening a solo 401 plan. A solo 401k plan  is owner-only version of a 401(k) plan. It is ideal for gig workers  looking to make high annual contributions in lucrative business years.  It allows for higher contributions than SEP and SIMPLE IRAs, for example.  Pretax, Roth and voluntary after-tax contributions can be made to a solo 401k  plan.  For more on the solo 401k contribution limits, CLICK HERE.

 

Can I contribute to a solo 401k, Roth IRA and Traditional IRA for 2019?

  1. Contributions to IRAs and Roth IRAs are aggregated. This means that you cannot contribute $6,000 to each type (i.e., traditional and Roth IRA); however, you can contribute some to each up to the $6,000 combined limit. If you are aged 50 or older in 2019, your IRA contribution increases to $7,000.
  1. TRADITIONAL IRA CONTRIBUTIONS: While the IRS rules allow for contributions to both Solo 401k plan and IRAs, since you are participating in a solo 401k plan, your traditional IRA contributions may not be deductible. See the chart listed on the following IRS link for these  limits:

https://www.irs.gov/retirement-plans/2019-ira-deduction-limits-effect-of-modified-agi-on-deduction-if-you-are-covered-by-a-retirement-plan-at-work

2019 IRA Deduction Limits – Effect of Modified AGI on Deduction if You Are Covered by a Retirement Plan at Work

If you are covered by a retirement plan at work, use this table to determine if your modified AGI affects the amount of your deduction. See IRAs for more information.

If Your Filing Status Is…And Your Modified AGI Is…Then You Can Take…
single or
head of household
$64,000 or lessa full deduction up to the amount of your contribution limit.
more than $64,000 but less than $74,000a partial deduction.
$74,000 or moreno deduction.
married filing jointly or qualifying widow(er)$103,000 or lessa full deduction up to the amount of your contribution limit.
more than $103,000 but less than $123,000a partial deduction.
$123,000 or more no deduction.
married filing separatelyless than $10,000 a partial deduction.
$10,000 or more no deduction.
If you file separately and did not live with your spouse at any time during the year, your IRA deduction is determined under the “Single” filing status.

 

  1. ROTH IRA CONTRIBUTIONS: While you can also contribute to Roth IRAs and solo 401k plans, not everybody qualifies if their modified AGI is over a certain limit. For these limits, please see the following chart.

https://www.irs.gov/retirement-plans/amount-of-roth-ira-contributions-that-you-can-make-for-2019

Amount of Roth IRA Contributions That You Can Make For 2019

This table shows whether your contribution to a Roth IRA is affected by the amount of your modified AGI as computed for Roth IRA purpose.

If your filing status is…And your modified AGI is…Then you can contribute…
married filing jointly or qualifying widow(er)

 < $193,000

 up to the limit

> $193,000 but < $203,000

 a reduced amount

 >  $203,000

 zero
married filing separately and you lived with your spouse at any time during the year

 < $10,000

 a reduced amount

 > $10,000

 zero
singlehead of household, or married filing separately and you did not live with your spouse at any time during the year

 < $122,000

 up to the limit

 > $122,000 but < $137,000

 a reduced amount

 > $137,000

 zero

Can I contribute to a solo 401k, Roth IRA and Traditional IRA for 2018?

  1. Contributions to IRAs and Roth IRAs are aggregated. This means that you cannot contribute $5,500 to each type (i.e., traditional and Roth IRA); however, you can contribute some to each up to the $5,500 combined limit. If you are aged 50 or older in 2018, your IRA contribution increases to $6,500.
  1. TRADITIONAL IRA CONTRIBUTIONS: While the IRS rules allow for contributions to both Solo 401k plan and IRAs, since you are participating in a solo 401k plan, your traditional IRA contributions may not be deductible. See the chart listed on the following IRS link for these  limits:

https://www.irs.gov/retirement-plans/plan-participant-employee/2018-ira-contribution-and-deduction-limits-effect-of-modified-agi-on-deductible-contributions-if-you-are-covered-by-a-retirement-plan-at-work

If you’re covered by a retirement plan at work, use this table to determine if your modified AGI affects the amount of your deduction.

2018 IRA Contribution and Deduction Limits – Effect of Modified AGI on Deductible Contributions If You ARE Covered by a Retirement Plan at Work

If Your Filing Status Is…

And Your Modified AGI Is…Then You Can Take…
single or
head of household

$63,000 or less

a full deduction up to the amount of your contribution limit.

more than $63,000 but less than $73,000

a partial deduction.

$73,000 or more

no deduction.

married filing jointly or qualifying widow(er)

$101,000 or less

a full deduction up to the amount of your contribution limit.

 more than $101,000 but less than $121,000

  a partial deduction.

 $121,000 or more

 no deduction.

married filing separately

 less than $10,000

  a partial deduction.

 $10,000 or more

 no deduction.

If you file separately and did not live with your spouse at any time during the year, your IRA deduction is determined under the “single” filing status.

 

  1. ROTH IRA CONTRIBUTIONS: While you can also contribute to Roth IRAs and solo 401k plans, not everybody qualifies if their modified AGI is over a certain limit. For these limits, please see the following chart.

This table shows whether your contribution to a Roth IRA is affected by the amount of your modified AGI as computed for Roth IRA purpose.

https://www.irs.gov/retirement-plans/plan-participant-employee/amount-of-roth-ira-contributions-that-you-can-make-for-2018

Amount of Roth IRA Contributions That You Can Make for 2018

If your filing status is…And your modified AGI is…Then you can contribute…
married filing jointly or qualifying widow(er)

< $189,000

up to the limit

> $189,000 but < $199,000

a reduced amount

> $199,000

zero

married filing separately and you lived with your spouse at any time during the year

< $10,000

a reduced amount

> $10,000

zero

singlehead of household, or married filing separately and you did not live with your spouse at any time during the year

< $120,000

up to the limit

> $120,000 but < $135,000

a reduced amount

> $135,000

zero

Program Letter Published on October 3, 2018 by the Commissioners of IRS’s Tax Exempt & Government Entities Division

When making a distribution from a 401k plan including a solo 401k plan it is important to make sure you qualify to take a distribution as triggering events apply.

Types of Solo 401k Contributions and Distribution Rules

  •      After-Tax Contributions and Rollover Contributions. The solo 401k plan participant may withdraw at any time (after completing a distribution form), all or any portion of her account balance attributable to “rollover contributions” and/or “after-tax contributions.”
  •    Employer Contributions: Employer contributions are subject to more stringent distribution rules and may be distributed upon the solo 401k participant’s severance from employment, death, or disability. In addition, employer contributions may be withdrawn upon the occurrence of any of the following events:

1) The occurrence of a Hardship,

2) The attainment of age 59 ½

3) The employer contributions being withdrawn have been accumulated in the solo 401k plan for at least 2 years; or

4) The participant has participated in the solo 401k plan for at least 5 years.

  •   Salary Deferrals (employee contributions): Any employee contribution (including any earnings on such amounts) may not be distributed prior to the solo 401k participant’s severance from employment, death, or disability. However, the solo 401k plan permits an in-service distribution of such amounts upon attainment of age 59 ½ or upon a Hardship.

On October 3, 2018, the Commissioners of IRS’s Tax Exempt & Government Entities Division published a “Program Letter” describing “where we are heading in the new fiscal year” that included a discussion on “executing compliance strategies.” One of the compliance strategies with respect to employee plans the letter identified for 2019 was:

Distributions: verify that plans are following correct distribution processes and procedures and that participants are receiving correct distribution amounts.

IRS Advisory Council releases its 2018 annual report

The full 2018 IRSAC Public Report is available on IRS.gov.

WASHINGTON — The Internal Revenue Service Advisory Council (IRSAC) today issued its annual report for 2018, including recommendations to the IRS on new and continuing issues in tax administration.

The IRSAC is a federal advisory committee that provides an organized public forum for discussion of relevant tax administration issues between IRS officials and representatives of the public. IRSAC members offer constructive observations regarding current or proposed IRS policies, programs and procedures.

“As I saw firsthand, IRSAC provides a valuable role for the tax community to provide insight and recommendations for the nation’s tax system,” said IRS Commissioner Charles Rettig, a former member and chair of the IRSAC. “The IRS appreciates the work of the members, and we look forward to reviewing the report.”

The 2018 Annual Report covers a broad range of topics and concerns including:

  • The IRS Budget
  • Electronic Third-Party Authentication
  • Transfer Pricing Documentation
  • Tax Pro Account
  • Updating Circular 230

 

Commissioner Rettig and IRS executives also thanked six members of the council whose terms end this year:

  • Dennis J. Ventry, Jr., IRSAC Chair – University of California Davis School of Law, Davis, Calif.
  • Brenda Bianculli – Brenda M. Bianculli, CPA, LLC, Charlton, Mass.
  • Stuart Hurwitz – Stuart M. Hurwitz, CPA Law Offices, San Diego, Calif.
  • Shawn O’Brien – Mayer Brown LLP, Houston, Texas
  • Stephanie Salavejus – PenSoft, Newport News, Va.
  • Dave Thompson, Jr. – Alabama State University, Montgomery, Ala.

 

The IRSAC is administered under the Federal Advisory Committee Act by the Office of National Public Liaison and draws its members from the taxpaying public, the tax professional community, small and large businesses and the payroll community.

 

Restating Existing Solo 401k Plan to Full-Time Employer 401k Plan

Once you hire full-time W-2 employees in your self-employed business, you will need to either transfer the solo 401k plan to an IRA, or convert/restate the solo 401k plan to a full-time employer 401k plan.

If you choose to restate the existing solo 401k plan to a full-time employer 401k plan, the following applies.

  1. Choose: Select a new full-time employer 401k plan provider.
  2. Provider: A common provider of full-time employer 401k plans is The Stadard.
  3. Communicate: You need to let the new full-time 401k provider know that you currently have a self-employed solo 401k plan that you want to “restate” to a full-time employer plan.
  4. No Reporting: Note that we won’t have to issue a Form 1099-R or a final Form 55000-ez since you are restating the plan to a full-time employer 401k plan. In other words, your business is not shutting down, rather it is growing so it now needs to offer a full-time employer 401k plan to the full-time W-2 employees since a solo 401k plan is for owner-only businesses with no full-time employees.
  5. Moving the Funds: To move the funds from the existing solo 401k plan, simply make the check payable in the name of the new 401k plan, write “restatement of solo 401k plan to full-time employer 401k” on the memo section of the check, and deposit the funds directly into the new 401k plan.
  6. 401k Loan: Lastly, if you have an outstanding solo 401k participant loan, the loan payments will continue pursuant to the original payment schedule but made into to the new full-time employer 401k plan.

 

Transfer/Restate PAI Retirement Services Solo 401k to a Self-Directed Solo 401k

Existing clients of PAI Retirement Services that want to convert their existing solo 401k plan to a self-directed solo 401k that will allow for checkbook control for investing in alternative investments such as bitcoin, real estate, metals, tax liens, and private equity can do so by restating their Ascensus solo 401k plan to a self-directed solo 401k from My Solo 401k Financial.

When an existing solo 401k plan from a provider such as PAI Retirement Services is restated to a self-directed solo 401k plan from My Solo 401k Financial, the following PAI forms apply, which we will fill-out as part of the self-directed solo 401k setup process:

  • PAI Transfer Form (2 pages)

The above form gets submitted to PAI by fax once you setup the self-directed solo 401k with us which starts by you completing our on-line self-directed solo 401k application.

We will then assist you in opening a bank account or brokerage account for your self-directed solo 401k. To learn more about the differences and similarities between the bank account and the brokerage account, VISIT HERE.

ROTH Solo 401k Contributions vs Voluntary After-Tax Solo 401k Contributions

Both Roth solo 401k contributions and voluntary after-tax solo 401k contributions fall under the employee (salary deferral) contribution umbrella.  In other words, both of these contribution types are not considered employer (profit sharing) contributions, so the contributions are not tax deductible because they are considered made with post-tax dollars.

Not all solo 401k plan document providers will allow for either Roth solo 401k or voluntary after-tax solo 401k contributions, while some will allow for just Roth solo 401k but not voluntary after-tax solo 401k contributions. However, a self-directed 401k plan document provider like MySolo401k.Net allows for both types.

The reason many solo 401k plan providers do not allow for voluntary after-tax solo 401k contributions is because of the added reporting requirements that come with this type of contribution. For example, when voluntary after-tax solo 401k contributions are converted to a the ROTH IRA or the ROTH Solo 401k, the conversion has to be documented in writing by completing a conversion form ( the IRS will expect to see a copy of this form upon request), and a Form 1099-R has to be issued to report the conversion whether taxable or not.

Difference #1 Between Roth Solo 401k and Voluntary After-Tax Solo 401k Contributions

Roth solo 401k contributions are subject to the same pretax distribution triggering events. Therefore, in order to distribute Roth contributions, one of the following events apply:

Death of the participant;

termination of employment;

disability; or

attainment of age 59 1/2.

On the other hand, voluntary after-tax solo 401k contributions can be distributed and thus converted at any time. This is why the the conversion of voluntary after-tax solo 401k contributions has been dubbed the “mega-backdoor Roth solo 401k.”

Difference #2 Between Roth Solo 401k and Voluntary After-Tax Solo 401k Contributions

Roth solo 401k annual contributions are capped at the employee (salary deferral) limit of $18,000 for 2017, or $24,000 if age 50 or older. For 2018, the Roth solo 401k contribution limited increased to $18,500, or $24,500 if age 50 or older.

However, and not commonly known, voluntary after-tax solo 401k contributions are subject to the annual overall limit (“The 415 Limit) of $54,000 for 2017, or $55,000 for 2018.

Top 10 Business Financing 401k (ROBS 401k) Items to Know

  1. Neither nondeductible (after-tax) IRAs nor Roth IRA funds can be transferred to the Business Financing 401k (ROBS 401k).
  2. While Roth 401k, Roth 457 and Roth 403b can be transferred to the “Roth Designated Account” bucket of the Business Financing 401k (ROBS 401k), this bucket cannot be invested in your C-Corporation business.
  3. As a rule of thumb, in order to transfer an employer plan such as a PSP, 401k, 403b and 457b plan to the Business Financing 401k (ROBS 401k), you either have to be no longer employed (separated from service) with the employer that sponsors the retirement plan or be age 59 ½ or older (retirement age). However, some exceptions apply. Or only if you transferred funds from a previous employer plan or IRA you generally will be able to transfer these funds from the plan to the ROBS 401k plan prior to separating from service.
  4. The Business Financing 401k (ROBS 401k) setup fee cannot be paid with retirement funds or the C-corporation funded business. Also, once the business has been funded, business funds cannot be used to pay off your personal credit card that was used to pay the ROBS 401k setup fee.
  5. The purpose of the Business Financing 401k (ROBS 401k) is to fund your own business; therefore, you have to (don’t have a choice other than being) be a W-2 employee of the retirement funded business.
  6. The use of the Business Financing 401k (ROBS 401k) strategy requires a C-corporation entity (no exception).
  7. All  the revenue generated by the ROBS 401k funded C-corporation business will simply flow in and out of the corporation’s business account.  If at the end of the year after the company has paid expenses & taxes, the company has earned an after-tax profit company could decide to distribute that profit. In that case, the C-corporation would pay out dividends (profits) to the stockholders in which case it must pay all stockholders dividends in accordance with the ownership percentages (i.e., the 401k for you benefit and you personally). For example, if the only two stock investors in the C-corporation are you and your ROBS 401k, profits/distributions attributable to the shares in the 401k would flow to the 401(k) account on a tax-deferred basis and the remaining profits would be distributed to you personally; you would have to pay capital gains on your personal amount on your personal taxes.
  8. You should wait to receive w-2 compensation (e.g., salary, bonuses, etc.) until the C-corporation is generating income to justify your salary and then your salary should not be unreasonably high (i.e., no more than what the company would have to pay someone else to do all of the things that you do).  Any compensation that you receive should be paid to you as W-2 wages (i.e. not as 1099 income).  As such, it will be prudent to coordinate with your business tax adviser.
  9. Your ROBS 401k cannot guarantee a business loan to your ROBS 401k funded C-corporation.
  10. Your ROBS 401k funded business cannot do business with any other business that you or disqualified persons own. Disqualified persons include you, your spouse, child, grandchild, for example.

More Items to Know

  • Inherited IRAs or inherited qualified plans such as a former employer 401k plan cannot be transferred to the ROBS 401k plan if the funds were inherited from a non-spouse.
  • You cannot loan personal funds to the ROBS 401k funded business. This same rule also applies to disqualified parties such as your parents, children, spouse, etc.
  • The ROBS 401k funded business can be operated via/through a subsidiary LLC that is wholly-owned by the C-corporation.
  • The ROBS 401k funded business must be a C-corporation and Can NOT be an S-corporation.

 

 

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