If you have a Nabers Group Solo 401k, it comes with a Roth Solo 401k option. It’s another type of retirement funding opportunity. This often overlooked and advanced tax strategy is the In-plan Roth Conversion.
Here’s a list of reasons to fund an existing Roth 401k or convert other retirement funds into a Roth Solo 401k:
- Qualified distributions are tax-free (completely different from the way a pre-tax 401k pays taxes at distribution).
- Both contributions and earnings grow tax-free and are distributed tax-free.
- Enables you to pay taxes at a lower bracket rate today if you anticipate a higher tax bracket during retirement.
- Protects against the possibility that Federal, State, and Local income tax rates will rise overall.
- Can be a vehicle for providing a tax-free inheritance to loved ones.
- Increases “tax diversification” (gives you access to assets taxed at different rates that provides both taxable income and tax rate flexibility).
If a Roth Solo 401k interests you, your goal is getting as much money into the Roth as soon as possible so that it grows tax-free for as long as possible.
In-plan Roth Conversion Strategy
The In-Plan Roth Conversion is also known as an In-plan Roth Rollover. This is when you convert retirement funds that have not been taxed into an after-tax retirement fund that will be distributed tax-free. The motivation to do an in-plan conversion is the same as opening a Roth Solo 401k or continuing to fund an existing Roth account.
The in-plan conversion is attractive to both young and older workers. For older workers, it could because you realize you are going to have a wealthy retirement that could put you in a higher tax bracket. Or you have more than you’ll need for retirement and want to pass on a tax-free inheritance. For younger workers, it’s an opportunity to pay the taxes while still in a lower tax bracket. For both, it is another tax strategy with possibilities for softening the impact of rising taxes and providing tax diversification options.
Those in their early retirement planning years and those closer to retirement can both use our Roth Conversion Calculator to consider the advantages and disadvantages of an In-Plan Roth conversion.
What to Know About the In-Plan Roth Conversion
- The Nabers Group Roth Plan allows for In-Plan Conversions.
- All participants are eligible to convert pre-tax or traditional after-tax money to a Roth Solo 401k within the plan.
- Tax-free withdrawals could be a significant benefit, especially if you expect to be in the same or a higher income tax bracket at the time of withdrawal than you are at the time of the conversion to Roth.
- You can convert your entire balance or just a portion of it.
- Taxes will be due on pre-tax funds for the year of the conversion.
- After the conversion and the taxes are paid, you cannot convert back to a pre-tax 401k.
- Tax-free distributions of earnings have a five-year waiting period after each conversion. The five-year time frame is based on tax years. (A tax year is Jan. 1 to Dec. 31). Conversions done on December 31, 2021, start the time clock the same as if you completed the conversion on January 1, 2021.
- You must reach age 59.5 to have penalty-free access to the funds. (Or you have a qualifying circumstance)
- Contributions to a Roth can be withdrawn at any time regardless of age without tax or penalty. (These are after-tax contributions).
- Roth 401k accounts require Required Minimum Distributions at the age of 72.
- The conversion amount is taxable income. You should consider federal, state, and local income taxes that will apply. The conversion could push you into a higher federal income tax bracket for the conversion year.
Before executing an In-plan Roth Conversion, you should talk with your tax and/or legal advisor.
What You Need to Know About a Conversion to Roth Solo 401k in 2021
There is a hard deadline of December 31, 2021, to complete the Roth conversion. Don’t confuse the 401k contribution deadline with the IRA deadline. The IRA deadline for completing contributions is more generous, going up to the tax-filing deadline of the current year (including extensions). For 2021 tax filings involving an IRA, this means April 15 or October 15 of 2022. For a Roth Solo 401k in-plan conversion the deadline is December 31, 2021. However, there are a few exceptions for a later contribution:
- Plans adopted in year 2022 for 2021 cannot make pre-tax or Roth deferrals, but can still make after-tax and employer contributions.
- Partnership LLC and S Corps have until March 15, 2022, to set up and contribute to a 401k (employer portion of contributions).
- If a business requests and receives an extension, it may have until September or October 15, 2022, or until it files taxes.
This means that for Roth 401k contributions to count for 2021, the funds and/or assets must be moved from the Solo 401k pretax bank/brokerage account to the Roth Solo 401k bank/brokerage account by 12/31/2021.
Paying Taxes on a Roth Solo 401k Conversion
An in-plan conversion of pretax Solo 401k funds to the Roth Solo 401k account is considered a taxable event but is not subject to the 10% early distribution penalty.
There can be one-time tax consequences for the conversion year that go beyond the tax on the converted funds. The income increase could potentially cause the loss of some exemptions, credits, tax deductions, taxation of Social Security, and increase Medicare Part B and Part D premiums. As long as your income returns to its previous level the next year, this will only happen for the year of the conversion. What you receive in return is all future qualified distributions from your Roth Solo 401k will be completely tax-free.
Converting earlier in the year generally gives you more time to pay taxes. Taxes aren’t due until the tax deadline of the following year, so you may have more than 15 months to pay the taxes on your converted balances. (Note: If you pay estimated taxes, you may need to make some payments sooner.)
There are also reasons why you might want to do the conversion later in the year. You might want to start the five-year clock in 2021 instead of waiting until next year. A conversion completed in December has the same five-year period as a conversion completed the previous January.
There is another strategy you may want to consider for maximizing your tax-free distributions:
If you’ve maxed out your Solo 401k and Roth IRA but you still want to contribute to your retirement – Consider a Mega Backdoor Roth.
The Mega Back door Roth Strategy allows you to put more money into a Roth Solo 401k or Roth IRA than would otherwise be possible. The result is that you can eventually take the funds out of the Roth 401k/IRA without tax penalty.
The Solo 401k by Nabers Group allows you to convert a portion or all your Solo 401k funds to Roth. Our expert team will share best practices, articles, and guides with you so that you have the tools to work with your CPA or tax preparer to calculate and pay the taxes on your conversion. The converted funds may remain in your same Solo 401k with Nabers Group with no paperwork, and Nabers Group will never charge you any fees on in-plan conversions.
It’s advisable to consult with a financial advisor before making any decisions.