Am I understanding correctly? Solo 401k -> Roth IRA

[LooneyNick]

I have a solo 401k at Ascensus that has Roth contributions (employee) and Pre tax contributions (employer profit sharing). I am looking to pay the tax now on the pre tax part of the plan and let it grow tax free.

I contacted Schwab and they seemed to suggest I could do this with them. Does this sound right to others? The steps:

1) Open a solo 401K, traditional IRA, and Roth IRA at Schwab
2) Roll the solo 401k from Ascensus into the new solo 401k at Schwab
3) Roll the newly funded solo 401k at Schwab into the traditional and Roth IRAs (with pre taxed funds going to traditional and Roth going to Roth)
4) Do a ROTH CONVERSION on the traditional IRA, paying the tax on all those funds and putting them into the Roth IRA

Other institutions and advisors have either suggested I may not be able to do this without closing out the solo 401k entirely (thereby prohibiting me from future solo 401k contributions), or that Roth conversions are ineligible on funds transferred from profit sharing plans.

I'm still waiting for an answer from my CPA but wanted to see what others here thought. Thank you in advance.

[aristotelian]

The process sounds correct. However, why do you want to pay tax now? You will have tax free growth but you will have less money growing. Generally it is advantageous to defer tax until retirement, which is presumably why you contributed to the Solo 401k in the first place.

If you liquidate the Solo 401k, remember that you need to fill out a 5500-EZ.

[toddthebod]

I have a solo 401k at Ascensus that has Roth contributions (employee) and Pre tax contributions (employer profit sharing). I am looking to pay the tax now on the pre tax part of the plan and let it grow tax free.

I contacted Schwab and they seemed to suggest I could do this with them. Does this sound right to others? The steps:

1) Open a solo 401K, traditional IRA, and Roth IRA at Schwab
2) Roll the solo 401k from Ascensus into the new solo 401k at Schwab
3) Roll the newly funded solo 401k at Schwab into the traditional and Roth IRAs (with pre taxed funds going to traditional and Roth going to Roth)
4) Do a ROTH CONVERSION on the traditional IRA, paying the tax on all those funds and putting them into the Roth IRA

Other institutions and advisors have either suggested I may not be able to do this without closing out the solo 401k entirely (thereby prohibiting me from future solo 401k contributions), or that Roth conversions are ineligible on funds transferred from profit sharing plans.

I'm still waiting for an answer from my CPA but wanted to see what others here thought. Thank you in advance.

You would terminate the solo 401k in order to do the rollovers, which would prevent you from sponsoring a new 401k for a year. Given the way solo 401k contributions work, this is an irrelevant issue unless you terminate the plan on December 31st or January 1st.

[KlangFool]

OP,

You are missing some information.

A) Are you 59 1/2 years old or older? Or, you are not.

B) Does the Schwab Solo 401K plan allowed you to do an in-service rollover to IRA without closing the Solo 401K?

C) Does Schwab Solo 401K only allowed you to do the Rollover if and only if you are 59 1/2 years old or older?

KlangFool

[LooneyNick]

Hi KF, thank you for the reply. I am younger than 59.5. The people I spoke to at Schwab knew my age and did not bring up that that might be an issue, but I will double check.

Schwab seemed confident it would work but it seemed too good to be true, especially after other institutions had told me it was impossible.

[toddthebod]

Hi KF, thank you for the reply. I am younger than 59.5. The people I spoke to at Schwab knew my age and did not bring up that that might be an issue, but I will double check.

Schwab seemed confident it would work but it seemed too good to be true, especially after other institutions had told me it was impossible.

It's fine. You terminate the solo 401(k), rollover to an IRA, and one calendar year later sponsor a new 401(k).

[LooneyNick]

The process sounds correct. However, why do you want to pay tax now? You will have tax free growth but you will have less money growing. Generally it is advantageous to defer tax until retirement, which is presumably why you contributed to the Solo 401k in the first place.

If you liquidate the Solo 401k, remember that you need to fill out a 5500-EZ.

Thanks Aristotle for the reply. My reasoning is that I'm already maxing out my Solo 401k contributions (~23k Roth on employee side, and then 25% of profit on the pre-tax employer side), so I don't think converting that pre-tax portion to Roth will mean that there is less money in the account to start growing. I suppose the amount that I pay in taxes up front could just instead go into my brokerage account and that would mean I would have more money growing. I suppose I should graph out which would be better long-term, higher principal w/ a tax-hit or lower principal w/o taxes. I am anticipating working until pretty close to death rather than having a long retirement, and I am also anticipating that tax rates will go up; these two points suggest to me that my marginal tax rate might not be much higher now vs late in life.

[LooneyNick]

Hi KF, thank you for the reply. I am younger than 59.5. The people I spoke to at Schwab knew my age and did not bring up that that might be an issue, but I will double check.

Schwab seemed confident it would work but it seemed too good to be true, especially after other institutions had told me it was impossible.

It's fine. You terminate the solo 401(k), rollover to an IRA, and one calendar year later sponsor a new 401(k).

Hi Todd, thank you for the reply. I was actually hoping to keep the solo 401k plan open for future contributions without having to wait a year to reopen one. I'm finding ambiguous information on the internet -- do you know whether it's typically possible to rollover just a portion of a solo 401k plan, e.g. just the pre-tax employer subaccount, without rolling over all funds within the entire plan? Thereby presumably not having to close out the plan.

[LooneyNick]

The process sounds correct. However, why do you want to pay tax now? You will have tax free growth but you will have less money growing. Generally it is advantageous to defer tax until retirement, which is presumably why you contributed to the Solo 401k in the first place.

If you liquidate the Solo 401k, remember that you need to fill out a 5500-EZ.

Thanks Aristotle for the reply. My reasoning is that I'm already maxing out my Solo 401k contributions (~23k Roth on employee side, and then 25% of profit on the pre-tax employer side), so I don't think converting that pre-tax portion to Roth will mean that there is less money in the account to start growing. I suppose the amount that I pay in taxes up front could just instead go into my brokerage account and that would mean I would have more money growing. I suppose I should graph out which would be better long-term, higher principal w/ a tax-hit or lower principal w/o taxes. I am anticipating working until pretty close to death rather than having a long retirement, and I am also anticipating that tax rates will go up; these two points suggest to me that my marginal tax rate might not be much higher now vs late in life.

Ya know what, Aristotle, I just did the math and you were completely correct. I would earn roughly 17% more by not paying taxes now according to the investment-return parameters I just tried out. Does this mean that I should stop making my employee contributions as Roth as well?

[toddthebod]

It's fine. You terminate the solo 401(k), rollover to an IRA, and one calendar year later sponsor a new 401(k).

Hi Todd, thank you for the reply. I was actually hoping to keep the solo 401k plan open for future contributions without having to wait a year to reopen one. I'm finding ambiguous information on the internet -- do you know whether it's typically possible to rollover just a portion of a solo 401k plan, e.g. just the pre-tax employer subaccount, without rolling over all funds within the entire plan? Thereby presumably not having to close out the plan.

Given that you can open a new one the following calendar year, what's the difference? You can make all your contributions at the end of the year after you've opened the new one. In fact, I was incorrect earlier about the December 31st comment, when you are opening a new plan, you can do so and make contributions until April of the following year, so this limitation does not in fact limit you in any way. It's just a paperwork issue.

[HomeStretch]

Verify i401k plan advice from plan provider reps as there seems to be a few forum threads where the advice given is inaccurate.

As you are <age 59-1/2, you cannot take a plan distribution, such as a rollover out to an IRA, unless it is for “hardship”, as defined in your plan, or in connection with a plan termination.

If a plan allows an in-plan Roth rollover (IRR) (i.e. traditional i401k to Roth 401k), you could do that. I am not sure Schwab’s plan allows that so you need to check. E*TRADE’s plan does allow an IRR so that is an option for you.

[aristotelian]

Thanks Aristotle for the reply. My reasoning is that I'm already maxing out my Solo 401k contributions (~23k Roth on employee side, and then 25% of profit on the pre-tax employer side), so I don't think converting that pre-tax portion to Roth will mean that there is less money in the account to start growing. I suppose the amount that I pay in taxes up front could just instead go into my brokerage account and that would mean I would have more money growing. I suppose I should graph out which would be better long-term, higher principal w/ a tax-hit or lower principal w/o taxes. I am anticipating working until pretty close to death rather than having a long retirement, and I am also anticipating that tax rates will go up; these two points suggest to me that my marginal tax rate might not be much higher now vs late in life.

Ya know what, Aristotle, I just did the math and you were completely correct. I would earn roughly 17% more by not paying taxes now according to the investment-return parameters I just tried out. Does this mean that I should stop making my employee contributions as Roth as well?

Yes, usual recommended approach is to max traditional 401k with Roth on the IRA side.

[LotsaGray]

The process sounds correct. However, why do you want to pay tax now? You will have tax free growth but you will have less money growing. Generally it is advantageous to defer tax until retirement, which is presumably why you contributed to the Solo 401k in the first place.

If you liquidate the Solo 401k, remember that you need to fill out a 5500-EZ.

The delay taxes to retirement logic only works if your tax rates are lower in retirement. With RMDs, potential death of one of a couple, and lifetime of savings in 401K this may not be true.

The more growing tax deferred doesn’t matter if tax rates remain the same; multiplication is commutative. Consider:
$100k, pay 15% taxes, let grow 10 yrs and it doubles to $170k

Or

$109k, let grow 10 yrs and doubles to $200k, now pay 15% taxes, you have $170k

[LotsaGray]

The process sounds correct. However, why do you want to pay tax now? You will have tax free growth but you will have less money growing. Generally it is advantageous to defer tax until retirement, which is presumably why you contributed to the Solo 401k in the first place.

If you liquidate the Solo 401k, remember that you need to fill out a 5500-EZ.

Thanks Aristotle for the reply. My reasoning is that I'm already maxing out my Solo 401k contributions (~23k Roth on employee side, and then 25% of profit on the pre-tax employer side), so I don't think converting that pre-tax portion to Roth will mean that there is less money in the account to start growing. I suppose the amount that I pay in taxes up front could just instead go into my brokerage account and that would mean I would have more money growing. I suppose I should graph out which would be better long-term, higher principal w/ a tax-hit or lower principal w/o taxes. I am anticipating working until pretty close to death rather than having a long retirement, and I am also anticipating that tax rates will go up; these two points suggest to me that my marginal tax rate might not be much higher now vs late in life.

If the tax rate now and later are the same, if the earnings rates are the same (should be), then the when you pay taxes doesn’t matter

[toddthebod]

Thanks Aristotle for the reply. My reasoning is that I'm already maxing out my Solo 401k contributions (~23k Roth on employee side, and then 25% of profit on the pre-tax employer side), so I don't think converting that pre-tax portion to Roth will mean that there is less money in the account to start growing. I suppose the amount that I pay in taxes up front could just instead go into my brokerage account and that would mean I would have more money growing. I suppose I should graph out which would be better long-term, higher principal w/ a tax-hit or lower principal w/o taxes. I am anticipating working until pretty close to death rather than having a long retirement, and I am also anticipating that tax rates will go up; these two points suggest to me that my marginal tax rate might not be much higher now vs late in life.

If the tax rate now and later are the same, if the earnings rates are the same (should be), then the when you pay taxes doesn’t matter

If those things are equal, then Roth is preferable because there are no RMDs, and because they effectively have a higher contribution limit.

[LotsaGray]

If the tax rate now and later are the same, if the earnings rates are the same (should be), then the when you pay taxes doesn’t matter

If those things are equal, then Roth is preferable because there are no RMDs, and because they effectively have a higher contribution limit.

Not talking about contributions. Talking about converting. Even for contributions, that does assume the person fills the Roth by saving more. I.e. they have the funds to pay the taxes that would be avoided. You have tilted the equation by increasing the principal. There is also the uncertainty o rates in the future plus good chance at least some pretax can come out at lower rate if one has medical costs they can deduct or if they are gifting to charities.

Dso I feel most need balance of traditional and Roth and maybe do Roth conversions when retired before taking SS. But accumulators need to watch the tax free balance. Personally my pretax got and is “too big”. Now I have to increase income via conversions to avoid even bigger income when RMDs hit much less when I or DW have to file single. But for nearly all of my career Roth 401K we’re not available to me

A

[toddthebod]

If those things are equal, then Roth is preferable because there are no RMDs, and because they effectively have a higher contribution limit.

Not talking about contributions. Talking about converting.

Even when converting, if you pay the taxes from a non-tax-advantaged account, Roth wins at fixed tax rates, because you can stuff more dollars into tax-advantaged accounts. If you have to pay the taxes out of your pre-tax account, Roth wins because there are no RMDs.

The rest of your points are valid, of course.

[terran]

I would be skeptical that you can transfer assets out of the solo 401(k) without closing it. I've done Roth conversions in my E*Trade solo 401(k).

[AnEngineer]

Even when converting, if you pay the taxes from a non-tax-advantaged account, Roth wins at fixed tax rates, because you can stuff more dollars into tax-advantaged accounts. If you have to pay the taxes out of your pre-tax account, Roth wins because there are no RMDs.

This is true on the margin, but if you end up with all Roth and no other income sources you gave up some advantage because tax rates are progressive. You want enough income to fill up those lower tax brackets (when deciding trad vs. Roth).