Who is best suited for a Solo Roth 401k?
The Solo Roth 401k is a new salary deferral option which is useful for a wide variety of people. See if any of the scenarios below apply to you.
1) You anticipate being in a higher income tax bracket in retirement than your current income tax bracket
If this is the case then it may make sense to make after tax Roth 401k contributions and pay income taxes now while in a lower tax bracket. Then while in retirement the assets can be withdrawn tax free when you are in a higher tax bracket.
2) You are relatively young and earn a lower income now, but expect to earn a much higher income and expect to be in a higher tax bracket in the future
If you expect your income to increase dramatically over your career, you may find contributing to the Roth feature today to be very advantageous, as you are in a lower tax bracket now than you will be in the future. Also, if you are many years from retirement, you could choose a Roth 401k as your best option as you expect your retirement plan to grow tax-free to a significant nest egg that can be withdrawn tax-free, more than compensating for the taxes paid when young and lower paid.
3) You had an usual year and your income decreased considerably and as a result you are in a lower tax bracket this year than your expected tax bracket in retirement.
You may want to take this opportunity to make Roth 401k contributions since you are in an usually low tax bracket this year.
4) Retirement investors who feel federal income tax rates will increase in the future
If you believe the government will increase tax rates in the future, then you may be better off making Roth 401k contributions and paying income taxes now. That way you would be paying taxes now at a lower tax rate and receiving the distributions federal tax free in the future at retirement when income tax rates are higher. Current income tax rates are low by historical standards.
5) You already have considerable assets in traditional pre-tax retirement accounts
In that case you may want to diversify your future tax liability and invest salary deferral contributions into the Roth 401k. That way some of your retirement nest egg can be withdrawn tax free at retirement. That is especially beneficial if tax rates rise in the future.
6) You earn a high income and would like to make Roth IRA contributions, but can’t based on the Roth IRA income limits
- Roth IRAs have income limits, but Solo Roth 401k plans have no income limits.
- Everyone qualifies for a Solo Roth 401k. In 2015 you can’t contribute fully to a Roth IRA if your adjusted gross income exceeds $183,000 if you file a joint tax return with your spouse and $116,000 if you file as single or head of household.
- Higher contribution limits are permitted with a Roth Solo 401k than a Roth IRA regardless of income.
- In 2015 participants can contribute up to $18,000 to a Roth 401k ($24,000 if age 50 or older). The 2015 Roth IRA contribution limits are $5,500 and $6,500 if age 50 or older.
7) You wish to reduce future taxes on social security benefits
Qualified withdrawals from a Roth Solo 401k are excluded from taxable income when calculating taxes on Social Security benefits.
Currently half of Social Security benefits are taxable if AGI (adjusted gross income) plus one half of social security benefits exceeds $32,000 if married filing jointly or $25,000 if single. Note that the $32000 / $25000 threshold has never been adjusted since 1993. As a result, the value of tax savings via Roth accounts increases over time. Distributions from a Traditional 401k are included in AGI for determining Social Security benefit taxes, but distributions from a Solo Roth 401k are excluded, therefore saving taxes on Social Security benefits. Consult your tax advisor to verify your tax savings.
8) You want to avoid taking Mandatory Required Distributions (MRDs) at 70 ½ and you like the idea of passing assets tax free to your heirs
You can roll over a Solo Roth 401k to a Roth IRA and avoid the legal requirement to take withdrawals at age 70½. This can save significant taxes and be useful for estate planning because the taxes saved will increase your estate and your heir's distributions will be tax free in the future as well.
Learn more about the benefits of a Solo 401k.