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Roth solo 401(k): What it is and who should get one

A small business owner at her coffee shop
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A Roth solo 401(k) is a retirement plan that allows contributions by a business owner and their spouse who is involved in the business. Plus, any business partners and their involved spouses can participate in their own Roth solo 401(k) plans. The plan is generally limited to one-person businesses, though business partners and spouses are also eligible to participate.

The Roth solo 401(k) offers a number of great benefits for those who can take advantage of it.

What is a Roth solo 401(k)?

A Roth solo 401(k) is a special kind of solo 401(k) account that allows participants to make after-tax contributions. The biggest benefit is that the contributions can grow on a tax-free basis and then be withdrawn tax-free at retirement, if the account holder meets certain criteria such as reaching age 59 ½ and having the account open for at least five years. So if you use a Roth solo 401(k), you’ll never have to pay taxes again on your contributions and earnings.

A solo Roth 401(k) works just like a Roth 401(k) option in a regular employer-sponsored 401(k). Plus, workers can mix and match between Roth and traditional contributions up to those limits.

A Roth solo 401(k) offers the same contribution limits as a Roth 401(k) with a normal employer. For 2022, this limit is $20,500, and those 50 and over can make a $6,500 catch-up contribution. The employer can make profit-sharing contributions to the plan for participants, bringing the total maximum annual contribution to $61,000, plus the additional catch-up for older savers.

Employer contributions, however, must be made to a traditional solo 401(k) account, not the after-tax Roth portion of the account.

One key difference between the Roth solo 401(k) plan and other self-employed retirement plans is that employees can contribute all of their salary up to the annual maximum, and they’re not limited to the 25 percent cap with other plans. For example, if you have a side gig and earn just $16,000 doing it, you could hide it all away in a Roth solo 401(k) each year. With other plans you might be able to contribute as little as $4,000, so that’s a big bonus with the solo 401(k).

It’s important to note that employee contributions across all your 401(k) accounts cannot exceed the annual cap, $20,500 (in 2022) for those under age 50 or $27,000 for older workers. But even if you’ve hit that limit, you could still make an employer contribution to your Roth solo 401(k), if you have profits from your side gig, up to the combined annual limit there ($61,000 for those under age 50 in 2022), which also includes any matching funds from a main employer.

Whether or not you can access a Roth solo 401(k) depends on whether the custodian through whom the plan was opened allows the Roth option.

Who should consider opening a Roth solo 401(k)?

A Roth solo 401(k) can be an excellent option for a self-employed individual or an eligible spouse who wants to contribute more to a Roth account than would be allowed with a Roth IRA. Additionally, unlike a Roth IRA, the Roth solo 401(k) has no income limitations that reduce or prohibit participants from contributing.

Once a person ceases employment with the business associated with the solo 401(k) account, they can roll the Roth solo 401(k) over to a Roth IRA to avoid the required minimum distributions that must otherwise begin at age 72.

Whether or not contributing to the Roth option makes sense will depend on the individual’s overall situation including their tax status and the balance they have between Roth and traditional retirement accounts.

Other small business retirement plans to consider

Other small business retirement plans offer a variety of features that may fit the needs of small businesses.

SEP IRA

A SEP IRA is a type of IRA plan for small businesses that allows contributions for employees as well as for the business owner. The contributions are made solely by the employer up to a limit of $61,000, or 25 percent of the employee’s compensation, whichever is less. As a practical matter, SEP IRAs can be expensive if there are numerous employees, as business owners are required to make the same percentage contribution for the employees as they do for themselves.

Unfortunately, a SEP IRA does not offer a Roth option.

SIMPLE IRA

A SIMPLE IRA is a small business retirement plan limited to companies with 100 or fewer employees. The main appeal with this option is that there’s minimal paperwork for the business owner. Employee contribution limits for a SIMPLE IRA are $14,000 for 2022, with a limit of $17,000 for those age 50 and older. There is also a mandatory employer contribution as well, and employers are required to fully match employees’ contributions up to three percent of salary or make non-elective contributions of up to two percent of all employees’ salary.

A SIMPLE IRA can also be used by someone who is self-employed. There are restrictions on rolling a SIMPLE IRA over within the first two years that the plan was opened.

A SIMPLE IRA does not offer a Roth option.

IRAs

An option to be considered by itself or in conjunction with a small business retirement plan is an IRA. Whether or not you can contribute to a Roth IRA will depend upon your income. But as long as you have earned income, you can take advantage of an IRA, even if it is non-deductible.

Bottom line

For those who are self-employed in a one-person business, a solo 401(k) can be an excellent option. A Roth solo 401(k) offers higher contribution limits than a Roth IRA without the income limitations that accompany a Roth IRA. For those who are self-employed and want to contribute to a Roth account, a Roth solo 401(k) can be a solid option to consider.

Written by
Roger Wohlner
Contributing writer
Roger Wohlner is a contributing writer for Bankrate.
Edited by
Senior wealth editor