Self-employed? Seeking to ramp up your retirement savings? You should look at the potential of the Roth Solo 401(k). If you are a high-earning solopreneur, this savings vehicle may be a great choice, because it allows you to make both employee and employer contributions to a 401(k) account in the same year.
How does a Roth Solo 401(k) work? This is a Roth variation of the standard Solo 401(k). In the standard or “traditional” Solo 401(k), employer and employee account contributions are made with pre-tax dollars. In the Roth version, the employer still contributes pre-tax dollars but the employee contribution is made with after-tax dollars.
There is a very nice tradeoff for doing this. If you abide by IRS rules, the Roth contributions you make, and the earnings they generate, can be eventually be withdrawn tax-free.
You can make an employee contribution of up to $18,000 to a Roth Solo 401(k) in 2015. This amount will rise in future years, as it is indexed for inflation. Yearly catch-up contributions of up to $6,000 are currently allowed for those 50 and over.
Your business may also contribute 20-25% of your yearly net earnings to the plan. If you have incorporated your company, this profit-sharing contribution limit is set at 25%; if you have not, the limit is 20%. Total employer & employee contributions to a Roth Solo 401(k) are capped at $53,000 for 2015, $59,000 if you are old enough to make the $6,000 catch-up contribution. (The maximum amount of employee elective deferrals and employer non-elective contributions should be calculated via the methods detailed in IRS Publication 560.)
How can you invest the Solo Roth 401(k) assets? You can invest them in myriad ways. This is truly a self-directed retirement plan, and that means you aren’t limited to a dozen or two dozen investment options as you might be with a 401(k) sponsored by a large employer.4
What are the restrictions on a Roth Solo 401(k)? As the name implies, this is truly a retirement plan for the smallest businesses. To have any kind of Solo 401(k), you must work for yourself and have a maximum of only one other full-time employee (and that other FTE needs to be your spouse). If you foresee hiring people as your business evolves, then this is not the retirement account for you.
Once the Roth Solo 401(k) contains more than $250,000 in assets at the end of a year, you must file Form 5500 annually with the IRS. The plan is also subject to non-discrimination testing if you have common-law employees. (If you have an employee and you can control what will be done by that worker and how it will be done, that is a common-law employee under the IRS definition.)
If by chance you also contribute to a 401(k) at another employer, your total Roth and traditional employee contributions to all 401(k)s will be capped at the common employee limit – $18,000 in 2015, $24,000 if you are 50 or older. Participation in another 401(k) plan does not limit employer profit-sharing contributions to a Roth Solo 401(k).
As you can’t deduct after-tax dollars, you can’t deduct your employee contributions to a Roth Solo 401(k). Your business, however, can still make traditional, tax-deductible contributions.
December 31 is the annual deadline. If you want to contribute to a Solo 401(k) for the current tax year, you must create the account by that date or earlier. Many self-employed people need to establish a retirement plan, and through a Solo Roth 401(k), you could go a long way toward fixing a retirement savings shortfall.
Todd Pouliot, AIF may be reached at 1 (844) 592-9888 or Tpouliot@sigmarep.com.