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Solo 401(k) Nondeductible Contribution
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 nondeductible 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 Nondeductible Contributions
When you reach age 50, you can make employee deferrals in a pre-tax or Roth fund as high as $19,000. If you’re over 50, contributions are as high as $25,000. You can make a profit-sharing contribution in pre-tax funds in the amount of or equal to 25% your compensation, or 20% in of a self-employment or a single member LLC
The after-tax contribution, however, is neither Roth, nor pre-tax. The after-tax deferral allows you to go dollar-for-dollar and includes other plan contributions (employee and profit-sharing). Therefore, as a self-employed individual, you can make a maximum employee deferral contribution in pre-tax or Roth and make an additional after-tax contribution (dollar-for-dollar).
If you choose to make an after-tax contribution over a profit-sharing contribution, you can make dollar-for-dollar contributions rather than a small percentage of your compensation. This allows you to defer more money for retirement, if you have the extra income to do so.
Convert to Roth
To gain the advantages of a Roth Solo 401(k), you can convert contributions to Roth. An after-tax contribution compared 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 Nondeductible 401(k) Contribution New?
A nondeductible 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 Nondeductible Contributions?
Not all Solo 401(k) plans allow nondeductible contributions. You must check the 401(k) plan documents to confirm that the plan allows for nondeductible contributions.
The Solo 401(k) retirement plan at IRA Financial Group allows nondeductible contributions along with pre-tax and Roth contributions. If you have any questions, you can contact IRA Financial Group directly at 800-472-0646 so 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.