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Add a Roth Contribution to Your Solo 401(k)
by William Brennan & Michael Byman (Write for us!)
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A good thing - the Solo 401(k) - just got a whole lot better.
A Solo 401(k) plan is already a great tax-advantaged retirement savings vehicle for a business (including corporations) where the owners and their spouses are the only employees. In 2006, tax- deductible retirement contributions can be as high as $49,000 per person (assuming you are over age 50 and have sufficient adjusted gross income to qualify for the maximum contribution). Amounts contributed to the plan grow tax-deferred until withdrawn, at which time regular income tax rates will apply.
Starting in 2006, 401(k) plans can be amended to include a Roth contribution option. This permits you to make all or part of the "employee deferral" portion of the plan contribution - up to $20,000 for people over 50 - on an after-tax basis. Even if you are self-employed, technically your 401(k) is funded by a combination of employer contributions and employee salary deferrals; only the employee deferrals can go into the Roth account. The subsequent distributions after you retire are not just tax- deferred; they are tax-free, putting more money in your pocket.
Because it's part of a 401(k) plan, the Roth 401(k) has some notable features that distinguish it from the Roth IRA:
Young people with low net income
They now have a way to make immediate Roth contributions (income limits on Roth IRA conversions are still in place until 2010).
If you have self-employed income and don't already have a 401(k) plan, consider setting one up. If you already have a 401(k), consider adding the "Designated Roth Account (DRAC)" option. The sooner you get started, the greater the benefit you will reap from tax-free growth of your retirement savings.
A Solo 401(k) plan is already a great tax-advantaged retirement savings vehicle for a business (including corporations) where the owners and their spouses are the only employees. In 2006, tax- deductible retirement contributions can be as high as $49,000 per person (assuming you are over age 50 and have sufficient adjusted gross income to qualify for the maximum contribution). Amounts contributed to the plan grow tax-deferred until withdrawn, at which time regular income tax rates will apply.
Starting in 2006, 401(k) plans can be amended to include a Roth contribution option. This permits you to make all or part of the "employee deferral" portion of the plan contribution - up to $20,000 for people over 50 - on an after-tax basis. Even if you are self-employed, technically your 401(k) is funded by a combination of employer contributions and employee salary deferrals; only the employee deferrals can go into the Roth account. The subsequent distributions after you retire are not just tax- deferred; they are tax-free, putting more money in your pocket.
Because it's part of a 401(k) plan, the Roth 401(k) has some notable features that distinguish it from the Roth IRA:
- High earners can contribute to a Roth 401(k) - unlike the Roth IRA where contributions phase out for incomes higher than $95,000 single / $150,000 joint (in 2006).
- You can contribute more to a Roth 401(k) - up to $20,000 vs. a maximum of $5,000 per year to the Roth IRA.
- If you need quick cash, you can borrow from your 401(k), but not your IRA.
- Roth 401(k)s have Required Minimum Distributions at age 70 1/2 . You can avoid these by rolling your Roth 401(k) over to a Roth IRA prior to age 70 1/2 . Just remember to setup the Roth IRA at least five years before you need to make a withdrawal, to avoid taxes and penalties.
- Contributing to a Roth 401(k) does not prevent you from also contributing to a Roth IRA - raising the annual potential Roth contribution to $25,000, depending upon your income level.
Young people with low net income
- Their current low tax bracket means they would get a relatively small benefit from the traditional 401(k)'s tax break now.
- Their long time horizon until retirement increases their tax-free growth potential.
They now have a way to make immediate Roth contributions (income limits on Roth IRA conversions are still in place until 2010).
If you have self-employed income and don't already have a 401(k) plan, consider setting one up. If you already have a 401(k), consider adding the "Designated Roth Account (DRAC)" option. The sooner you get started, the greater the benefit you will reap from tax-free growth of your retirement savings.
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