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Maximize Solo 401(k) Contributions
Solo 401(k) Tax Strategy
Many investors are aware that they can make contributions in pre-tax, after-tax or Roth. Fewer people know that a Solo 401(k) plan allows them to make non-deductible plan contributions based off their income on a dollar for dollar basis. This tax strategy can be very advantageous for investors.
Solo 401(k) Plan Contributions
A pre-tax 401(k) contribution is tax-deductible, but subject to tax when you take a distribution.
A Roth Solo 401(k) contribution is after-tax that is included in gross income. When you take a distribution, it is generally tax-free.
When you make an after-tax plan contribution with your employee compensation, then you must include it as income on your tax return (excluding Roth contributions).
Solo 401(k) Tax Strategy for Non-deductible Contributions
If you are over 50, you can make employee deferrals in pre-tax or Roth 401(k) of up to $19,000 or $25,000 for 2019. You can make a profit-sharing contribution in pre-tax funds in the amount of or equal to 25% of compensation (20% in case of self-employment or a single member LLC), and both contributions cannot exceed $56,000 or $62,000 in the aggregate for 2019. An after-tax deferral, (neither Roth or pre-tax), is also an option that can go up to $53,000 or $59,000 on a dollar for dollar basis and include other plan contributions such as employee deferrals and profit sharing.
For example, if you earn $100,000 in 2019, you can make a maximum employee deferral contribution of $19,000 in pre-tax funds or Roth. You can make an after-tax contribution dollar-for dollar equal to $37,000.
This is the difference between $56,000 (the maximum annual 401(k) contribution for 2019) and $19,000, the maximum employee deferral contributions limit. You can then convert your employee deferral or employer profit sharing contributions to a Roth.
The advantage of after-tax contributions versus a profit sharing contribution is that you can make a dollar for dollar contribution. Profit-sharing contributions are based off a percentage of your compensation (20% or 25%). If you make a profit sharing contribution over an after-tax contribution, you will be limited to a $20,000 contribution (20% of the $100,000 salary).
Using the after-tax contribution strategy allows you to defer an additional $17,000 versus only making employee deferrals and employer profit sharing contributions. The advantage of after-tax contributions is that the salary deferral limits that apply to other participant contributions do not necessarily apply to after-tax contribution. However, you must have disposable income available to make the after-tax contributions. If you do, this strategy can help you boost your retirement savings.
Convert to Roth
To gain the advantages of a Roth Solo 401(k), you can convert contributions to Roth. An after-tax contribution in comparison to a profit-sharing contribution is that you can make a dollar for dollar contribution rather than a profit-sharing contribution. As you may know, profit-sharing contributions are based off a percentage of your compensation (20% or 25%). If you make a profit-sharing contribution instead of an after-tax contribution, you can only make a $20,000 contribution. This will give you an annual contribution of just $39,000 versus $56,000 if employee deferrals were combined with after-tax contributions.
Is the Non-deductible Solo 401(k) Contribution New?
A non-deductible 401(k) plan contribution is not new. However, there are new IRS regulations that make after-tax contributions more appealing. The rules allow you to effectively segregate the after-tax assets from the pre-tax funds. The pre-tax funds can be rolled into a Traditional IRA, whereas the after-tax dollars can be converted into a Roth IRA.
Do all Solo 401(k) Plans Allow Non-deductible Contributions?
Not all Solo 401(k) plans allow non-deductible contributions. You must check the 401(k) plan documents to confirm that the plan allows for non-deductible contributions.
At IRA Financial Group, our Solo 401(k) plan allows for nondeductible contributions along with pre-tax and Roth contributions. If you have any questions, contact IRA Financial Group directly at 800-472-0646 and a 401(k) specialist can assist you.
We wrote the book on the Solo 401(k)
A simple, yet informative handbook, Going Solo: America’s Best-Kept Retirement Secret for the Self-Employed was written to help small business owners and self-employed individuals discover the many advantages of establishing a Solo 401(k) Plan.
In an effort to eliminate the complexity of how one can establish an individual 401(k) plan, Adam Bergman wrote Solo 401(k) in a Nutshell. The book “…simplifies the process (of establishing a Solo 401(k) while…providing everything one needs to maximize their retirement assets” and gain financial freedom.
Get in Touch
To summarize, you cannot invest your 401(k) in real estate. You can, however, establish a self-directed 401(k) to invest in real estate. Do you want to learn more about investing your Solo 401(k) in real estate? Contact IRA Financial Group at 800-472-0646. You can also fill out the form to speak with a 401(k) specialist.