If you’re earning $300,000 a year then you want to contribute to a pre-tax solo 401k rather than an after-tax or Roth solo 401k. The main reason is that you want to use that 401k to lower your taxes.
The solo or individual 401k option is only available to independent contractors and business owners, not employees. And a common reason for a physician to work as a per diem is to enjoy more free time – which means less income.
With less income it might start to make sense to contribute to a Roth solo 401k rather than it’s pre-tax sister.
Roth Solo 401k
There is the traditional IRA and Roth IRA. There is also the 401k and Roth 401k. Then there is the solo 401k and the Roth solo 401k. We’re gonna talk about this last one.
I have an individual 401k account (same thing as a solo 401k) with Vanguard but I never funded it.
This year my income is right around $100,000 and it’s all 1099-MISC income as an independent contractor.
Not only will I qualify to contribute $5,500 to a Roth IRA but I can max out my Roth solo 401k to the tune of $18,500.
Roth solo 401k taxation
This section is easy, there is no taxation once I contribute to my Roth solo 401k.
Withdrawal=distribution. Any time you withdraw money from your 401k or IRA it’s referred to as a distribution.
I can pull the money out after age 60 without ever owing income taxes on the distribution and ….. AND … I won’t even get taxed on any income or capital gains from the investments in that account.
I want to repeat this because it’s something I wasn’t aware of myself: your Roth 401k contributions could grow by 300% – as in, your $100k invested could grow to $300,000 and you would owe no taxes on that money, ever.
There will be a 10% penalty if you try to withdraw your Roth solo 401k contribution early.
Not only is there a 10% penalty but any capital gains (income investments) will also be taxed at your current federal and state income tax rates.
Most of us won’t be starting a Roth account of any sort if we see the need for early access to it. It’s always best to drain your taxable brokerage account first and leave the qualified accounts for last since they continue to grow tax-free.
Roth IRA rollover
You can roll your Roth solo 401k into your Roth IRA which can have a few fun benefits.
Your Roth solo 401k will have RMD’s which can be a pain in the ass for the productive medical professional.
But your Roth IRA doesn’t have any RMD’s. Roll it over and you no longer have to worry about the RMD matter.
The Roth IRA ladder method can also be used to slowly convert from a traditional IRA to a Roth IRA.
Multiple investment options
You don’t have to buy index funds or individual stocks with your Roth solo 401k. You can invest in real estate and even private businesses.
To do so you must find a custodian who will allow for this but the option is there.
So if you’re not going to get a tax deduction for your Roth solo 401k contributions then why not just put that money in a private brokerage? You’re just going to buy some index fund like VTI anyways, shouldn’t you just enjoy the accessibility of a private brokerage?
Over the years I have definitely leaned towards a private brokerage just so that I could maintain access to my money. The liquidity is huge for me. It’s why I don’t care to invest in hedge funds or syndicated real estate deals.
The main advantage, however, of a Roth solo 401k is that whatever I invest in will grow tax-free for however many years I have the money invested. It grows tax-free and it comes out tax-free. Double winner.