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401k
Add a Roth Contribution to Your Solo 401(k)
By William Brennan & Michael Byman
Bill-Principal, Michael-Director, Capital Management Group, LLC
A good thing – the Solo 401(k) – just got a whole lot better.
A Solo 401(k) plan is already a great tax-advantaged retirement savings vehicle for a business (including corporations) where the owners and their spouses are the only employees. In 2006, tax- deductible retirement contributions can be as high as $49,000 per person (assuming you are over age 50 and have sufficient adjusted gross income to qualify for the maximum contribution). Amounts contributed to the plan grow tax-deferred until withdrawn, at which time regular income tax rates will apply.
Starting in 2006, 401(k) plans can be amended to include a Roth contribution option. This permits you to make all or part of the “employee deferral” portion of the plan contribution – up to $20,000 for people over 50 – on an after-tax basis. Even if you are self-employed, technically your 401(k) is funded by a combination of employer contributions and employee salary deferrals; only the employee deferrals can go into the Roth account. The subsequent distributions after you retire are not just tax- deferred; they are tax-free, putting more money in your pocket.
Because it’s part of a 401(k) plan, the Roth 401(k) has some notable features that distinguish it from the Roth IRA:
High earners can contribute to a Roth 401(k) – unlike the Roth IRA where contributions phase out for incomes higher than $95,000 single / $150,000 joint (in 2006).
You can contribute more to a Roth 401(k) – up to $20,000 vs. a maximum of $5,000 per year to the Roth IRA.
If you need quick cash, you can borrow from your 401(k), but not your IRA.
Roth 401(k)s have Required Minimum Distributions at age 70 ½. You can avoid these by rolling your Roth 401(k) over to a Roth IRA prior to age 70 ½ . Just remember to setup the Roth IRA at least five years before you need to make a withdrawal, to avoid taxes and penalties.
Contributing to a Roth 401(k) does not prevent you from also contributing to a Roth IRA – raising the annual potential Roth contribution to $25,000, depending upon your income level.
These features make the new Roth 401(k) especially good for:
Young people with low net income
Their current low tax bracket means they would get a relatively small benefit from the traditional 401(k)’s tax break now.
Their long time horizon until retirement increases their tax-free growth potential.
Individuals with high income
They now have a way to make immediate Roth contributions (income limits on Roth IRA conversions are still in place until 2010).
If you have self-employed income and don’t already have a 401(k) plan, consider setting one up. If you already have a 401(k), consider adding the “Designated Roth Account (DRAC)” option. The sooner you get started, the greater the benefit you will reap from tax-free growth of your retirement savings.
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