If you have a solo 401k and are making voluntary after-tax contributions, you have a great opportunity to supercharge your retirement savings through a Mega Backdoor Roth Solo 401k. But when it comes time to transfer those funds, should you move them into a Roth IRA or Roth 401k?
Top Considerations in Deciding Where to Transfer Mega Backdoor Roth Solo 401k
- Withdrawal flexibility: With a Roth IRA, you can withdraw contributions anytime tax- and penalty-free. Roth 401ks require a triggering event like reaching age 59.5.
- Required minimum distributions (RMDs): Starting in 2024, neither Roth IRAs nor Roth 401ks have RMDs. Previously, only Roth IRAs avoided RMDs.
- Loans: You can’t borrow from a Roth IRA, but you may be able to take a loan from a Roth 401k if your plan allows it (like our Solo 401k plan does).
- Unrelated debt-financed income (UDFI) tax: If your Roth IRA uses debt to invest in real estate, that income may be subject to UDFI tax. Solo 401ks are generally exempt from UDFI on income debt-financed Solo 401k real estate investments.
| Factor | Roth IRA | Roth 401k |
|---|---|---|
| Withdrawals | Contributions can be withdrawn anytime | Triggering event like age 59.5 required |
| RMDs | Never required | No RMDs starting in 2024 |
| Loans | Not allowed | May be allowed if plan permits |
| UDFI tax | May apply to debt-financed real estate income | Exempt for debt-financed real estate |
Consider Different Use Cases
- Early Retiree: If you plan to retire before 59.5, having your funds in a Roth IRA provides more flexibility to access contributions if needed without worrying about triggering events.
- Real Estate Investor: If you want to use retirement funds to invest in debt-financed real estate, keeping the money in your solo Roth 401k generally avoids UDFI tax that may apply in a Roth IRA.
- Alternative Investments: With a self-directed Solo 401k plan that allows for alternative investments (such as real estate, private placements, cryptocurrency, precious metals, etc.), many will choose to transfer voluntary after-tax solo 401k funds to a Roth Solo 401k to preserve the ability to invest in such investments (as opposed to transferring after-tax solo 401k funds to a Roth IRA at a discount brokerage such as Vanguard, Fidelity, etc. that doesn’t allow for such investments).
