And, we aren’t talking about a Roth distribution after age 59 1/2!! Taking a distribution from your Solo-K tax free is possible. Now these plans (also marketed as Uni-K, Individual 401(k), self-directed 401(k) and self-administered 401(k) plans) are just like any 401(k) plan…which, generally, means that this might not be possible. Ah, the first thing you think:
“The person has to be over 59 1/2 and are taking out Roth funds as a distribution”…nope!
“The person is taking out their cost-basis on previous Roth contributions”….nope!
We ARE talking about after-tax contributions you make to your plan. After-tax contributions are not Roth contributions, they are after-tax contributions. What are after-tax contributions vs. Roth contributions?
Roth Contributions — In an employer-sponsored 401(k) plan, Roth contributions are elective deferrals that the participant still computes into their taxable, gross income. The plan must keep separate accounting records for all contributions, gains and losses in the Roth account. For more, see what the IRS says.
After-Tax Contributions — In an employer-sponsored 401(k) plan, after-tax contributions are contributions where the employee pays taxes on the contribution. It is included in their gross taxable income, and the participant, as a result of the after-tax contribution, has a cost-basis in the 401(k) plan. Unlike elective deferrals that have a limit of $18,000/$24,000 (under age of 50/over age of 50), the after-tax limits are up to $54,000 or 100% of the participant’s income. Now, there are some other rules that come into play, but to keep the concept simple for now, deferrals have set limits, that cannot be exceeded, which are far less (potentially) than what can be contributed to a plan with after-tax limits. Remember, keep in mind, we are speaking, potentially!
Similar to Roth 401(k) elective deferral contributions where you can take out your cost-basis, after-tax works in the same manner. You can always take out your cost-basis after-tax contributions at any time. Now, it is true that we are speaking of the cost-basis and not earnings on the cost-basis contributions, so keep this in mind. But, unlike the Roth elective deferrals that have annual limits of $18,000 or $24,000 (based on age brackets of under or over 50 years of age), after-tax contributions can, potentially, be made up to the participant’s 415 income limits of $54,000 or 100% of income, whichever is less.
One huge selling feature to the 401(k) plan is the ability (in most plan documents) to execute a 401(k) participant loan. But, as the saying goes, “with great freedom comes great responsibility.” So, why am I bringing up 401(k) plan loans. I’m sure you already know where I am going with this, but you have to pay back the loan. You must follow the IRS’ terms for repayment in order for it to be a non-taxable event. This takes discipline and, for some individuals, this may not be their strong suit.
if a participant has after-tax, cost-basis funds within the plan, they can simply take money out of the plan. It is their money. No 401(k) participant loans, no mess…the money can be distributed out of the plan. Of course, one would want to make sure they keep all appropriate records for the transaction, but the end result is that you have already paid taxes on that money, the after-tax contributions are not Roth dollars…it is your money.
Now, if you think this is the the best aspect of the after-tax contributions, it’s not. In fact, after doing three blogs on this on this topic, you probably think that I am singing all the praises of after-tax contributions…and, yes, I guess I am…to a point. The true potential beauty of after-tax contributions is not that you now have after-tax contributions in the plan, but rather transforming these after-tax contributions into Roth dollars!
Is it possible to convert your after-tax contributions to Roth dollars? Yes, with a couple of wrinkles to your plan, you can get there. Are there benefits to converting funds into Roth dollars? My guess is you know that answer already. And, remember, after-tax contributions are not Roth contributions. No additional taxes would be due, of course, as you already paid taxes on the after-tax contribution, so it is, more or less, a paper transaction to convert to Roth dollars. In the next post, we will review how you execute this conversion (it is easier than you think) and what some of the benefits might be in converting these funds to Roth dollars.
As always, this information is intended to be educational in nature. It is not intended, nor should it be interpreted as, any form of tax, legal, financial or investment advice. You must always review your actions with your respective professional.