- With a solo 401k, you contribute as both the employee and employer. While employers can only contribute to a pre-tax solo 401k, employees can choose whether to contribute as pre-tax or Roth.
- Pre-tax contributions give you a tax advantage when you make a contribution (tax deduction) and Roth contributions give you a tax advantage when you withdraw in retirement (tax-free withdrawals).
- For 2023, the contribution limit for a Roth solo 401k is $22,500 ($30,000 if age 50+).
- Not all solo 401k plan providers offer a Roth option. You can compare providers and their specific offerings here.
What is a Roth solo 401k?
When you open a solo 401k plan, many plan providers will give you two different accounts: A traditional (pre-tax) solo 401k account and a Roth (post-tax) solo 401k account. The traditional solo 401k gives you a tax break when you contribute, and the Roth solo 401k gives you a tax break when you make withdrawals in retirement.
- With a traditional solo 401k, contributions are tax-deferred until retirement. You get a tax deduction on the contribution, but qualified distributions in retirement are taxed as regular income.
- With a Roth solo 401k, contributions are taxed as income today. You don’t get a tax deduction for your contribution, but qualified distributions in retirement are entirely tax-free.
The Carry Solo 401k Plan is a fully managed solo 401k plan with a Roth option, fully managed set up and tax filings, and zero fees on your assets under management. Learn more.
Roth solo 401k eligibility
Because a Roth solo 401k is only one part of a solo 401k plan, you need to meet the eligibility requirements of a solo 401k plan in order to have a Roth solo 401k.
You’re eligible for a Roth solo 401k if:
- You have any form of self-employment activity.
- You have no employees (other than your spouse).
- Your plan provider offers a Roth option within their plan.
The last point is an important one. Many plan providers do not offer a Roth option with their solo 401k plan, and only let you contribute to a pre-tax account. If you want to contribute to a Roth solo 401k, you need to find a plan provider that also offers a Roth option. You can compare solo 401k plan providers that offer a Roth option here.
Whether you have a full-fledged business or just a weekend side hustle, there are no income limits with a Roth solo 401k. It doesn’t matter if you make a $100 per week, or six-figures per month. All income levels are eligible. However, per solo 401k rules, you must not have any employees, including part-time employees who are at least 21 years of age, and have worked over 500 hours per year for 3 consecutive 12-month periods. The only exception to this rule is your spouse.
All business entities are eligible whether you’re a sole proprietorship, LLC, partnership, C corporation, or S corporation.
Are all business entities eligible?
Yes, all business structures qualify for a solo 401k. Whether you run your business as a sole proprietorship, LLC, partnership, C corporation or S corporation, all entities are eligible for a Roth solo 401k.
Benefits and tax-advantages of a Roth solo 401k
Because a Roth solo 401k is a part of a regular solo 401k account, most of the benefits and tax-advantages are essentially the same. Investing through a Roth solo 401k gives you the highest Roth contribution limits, tax-free compounding, freedom to invest in any asset class, and loan and rollover options.
The main benefit of a Roth solo 401k, the same as with any Roth retirement account, is that withdrawals in retirement are completely tax-free.
For example, let’s say you contribute a total of $50,000 into a Roth solo 401k and, over the years, your account value grows to $5 million. Because you contributed with income that you’ve already paid taxes on, you can withdraw the entire $5 million in retirement without owing any taxes to the IRS.
In comparison, with a pre-tax traditional solo 401k, your $50,000 contribution would have been made with income that you haven’t paid taxes on, but you would end up owing taxes when you withdraw the $5 million in retirement.
How much can I contribute into a Roth solo 401k?
The total contribution limit of a solo 401k is $66,000 ($73,500 if age 50+) for 2023. The contribution limit is separated between employer and employee contributions, which each have their own limits and rules.
Out of the $66,000 limit, employees can contribute up to 100% of their income up to $22,500 ($30,000 if age 50+) in 2023. While employers can only contribute to a pre-tax traditional solo 401k, employees can choose whether to contribute to a traditional solo 401k or Roth solo 401k.
In comparison, a Roth IRA plan has a total contribution limit of just $6,000 ($7,000 if you’re over the age of 50) for 2022. A Roth retirement account can provide huge tax savings at the time of withdrawal. The ability to contribute over three times as much to a Roth solo 401k plan over a Roth IRA plan is one of the biggest tax advantages of a solo 401k.
Want to contribute even more money into a Roth solo 401k? Learn about the mega backdoor Roth solo 401k conversion, which would allow you to contribute up to $66,000 entirely into a Roth solo 401k for 2023.
You can contribute the full amount into a Roth solo 401k, a traditional solo 401k, or divide it up into both.
You don’t only have to choose one or the other. You can allocate a certain percentage into a Roth solo 401k, and then put the rest towards a traditional solo 401k. This could be especially useful if it can help lower your taxable income enough to drop you a tax bracket for the year.
Learn more: Solo 401k Contribution Limits and Deadlines.
Contributing to both the traditional solo 401k and Roth solo 401k
Another benefit of growing a large nest egg in both accounts is that you can choose which account to withdraw from during retirement. If your income tax bracket is going to be high for the year, you might want to withdraw from your Roth solo 401k and pay zero taxes. If your income drops, you might choose to take advantage of the lower tax bracket and make a withdrawal from your traditional solo 401k account.
Can I change my allocations each year?
Yes, just because you decide to go full Roth this year, it doesn’t mean that you’re locked into your choice for the life of your account. You get to choose your allocation year by year. If you prefer to ignore the Roth option in order to reduce a hefty income tax bill for this year, you still have the option to make maximum contributions to your Roth solo 401k the next year. It all depends on what makes sense for any given year.
What can I invest in with a Roth solo 401k?
A solo 401k account gives you complete control over your investments. You can invest in any asset class you want, minus a small list of exceptions. You can invest in traditional assets like stocks, bonds, mutual funds, and ETFs. And, you can invest in alternative assets like real estate, crypto, NFTs, and private equity.
The only things the IRS doesn’t let a Roth solo 401k invest in are:
- Collectibles (like art, antiques, and stamps)
- S corporation stock
- Life insurance investments
If your investments do not fit into these classifications, you’re allowed to invest in them through a Roth solo 401k.
Can I invest in crypto with a Roth solo 401k?
Yes, crypto is classified as property by the IRS and is allowed to be invested in through a Roth solo 401k. In fact, a Roth solo 401k could be an ideal account to invest in volatile assets like crypto since you get tax-free compounding and tax-free withdrawals.
Can I invest in NFTs with a Roth solo 401k?
Yes, you can invest in NFTs with a Roth solo 401k. NFTs used to be a risky investment since the IRS never provided any clear guidelines whether they were collectibles or an asset class. However, in October of 2022, the IRS updated their tax guidelines to include NFTs as digital assets. They are treated the same as cryptocurrencies and stablecoins.
Can I invest in real estate with a Roth solo 401k?
Yes, investing in real estate through a Roth solo 401k can provide major tax savings. Because a Roth solo 401k has tax-free compounding, you don’t pay any taxes on gains and income earned. For example, if you purchase a rental property with a Roth solo 401k, you won’t have to pay any taxes on rental income or when you sell the property for a profit. All profits go straight back into your Roth solo 401k account.
However, keep in mind that any real estate purchased through a Roth solo 401k must be as investments. You cannot purchase real estate through your plan for personal use. There are strict rules around prohibited transactions for real estate investments.
Roth Solo 401k vs Traditional Solo 401k Plan
The biggest difference with the two plans is how and when you get taxed. To make things easier, just think of it as pre-tax (traditional) vs post-tax (Roth).
- With the traditional solo 401k, you don’t pay taxes now, but you pay taxes when you make withdrawals in retirement.
- With a Roth plan, you pay taxes now, but you don’t pay any taxes when you withdraw in retirement.
In a traditional solo 401k plan, you contribute money to your account with PRE-TAX dollars. You get a tax-deduction for the year by reducing your taxable income. However, you’re going to have to pay taxes when you withdraw the money in retirement.
In a Roth solo 401k plan, you contribute money to your account with POST-TAX dollars. You won’t get get any tax breaks for the year you contribute, but you pay zero taxes when you withdraw the money in retirement.
For example, let’s say you made $80,000 this year and decide to put in $10,000 into your solo 401k account.
- With a Roth solo 401k plan, your taxable income for the year would still be $80,000.
- With a traditional solo 401k plan, your taxable income for the year would be $70,000 ($10,000 tax-deduction).
Which one you choose depends on if you want to pay taxes now, or later in retirement.
Which one’s better?
There’s no right answer, and it entirely depends on your given situation each year and if you think you’ll be in a higher tax bracket in the future. In general, having your money grow for years with tax-free compounding, and then getting to keep the entire thing when you withdraw usually works out to be the better choice, by a significant margin.
Let’s go through a simple example (with a BIG number just for fun).
Let’s say at retirement, the total assets in your solo 401k is $10 million.
- If you invested through a Roth solo 401k, you’ll pay zero taxes.
- If you invested through a traditional solo 401k, you could end up owing millions of dollars in taxes, depending on tax rates at the time and what tax bracket you fall under.
For some people, going the Roth route is a no brainer. For others, getting a tax-deduction now could be more important. It all depends on your circumstances each year, and whether you think your tax bracket will be lower or higher in retirement.
When can you withdraw?
With both the pre-tax solo 401k and the Roth solo 401k, you have to wait until you’re 59½ in order to withdraw from your account without any penalties. If you withdraw early, you’re subject to a 10% fee and you have to pay taxes on however much you take out.
As mentioned earlier, the only difference in withdrawal rules is how they’re taxed. Roth withdrawals won’t be taxed, since you contributed with after-tax dollars. Withdrawals from your traditional solo 401k will be taxed according to your tax bracket and the tax rates at the time of withdrawal.
Breaking It Down
The only thing you need to remember is that there are two kinds of solo 401k accounts available: A pre-tax account (traditional) and a post-tax account (Roth).
With a solo 401k, you have access to both as long as your plan provider offers them. And, you can choose to allocate to either one, or both. Which one you choose depends on what makes the most sense for you for a given year.
If your income is high, and getting a tax-deduction would help you, then contributing towards a traditional solo 401k account would make more sense. If you don’t necessarily mind paying taxes on the income, and want to maximize your tax-free nest egg for retirement, then a Roth solo 401k might be the better option.
The Carry Solo 401k Plan comes with a Roth option, easy account setup, managed tax filings, and zero fees on your assets under management. Learn more.