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