What You Need to Know
- Solo 401(k)s for side jobs or businesses can possibly be rolled into mega backdoor Roth IRAs.
- Only after-tax contributions are allowed to be used in this strategy.
- A client's successful side business must not be related to regular job to take advantage of this rollover.
Solo 401(k)s — in addition to company 401(k)s — can help clients save additional retirement money on an after-tax basis, even with the possibility of converting them to mega backdoor Roth IRAs, but there are rules, according to Ian Berger, an IRA analyst with Ed Slott & Co.
Why Solo 401(k)s?
A solo 401(k) is a retirement account for a sole proprietor and their spouse. The account is particularly advantageous if it’s tied to a side company unrelated to the client’s main company or business.
Let’s say your client normally works as a corporate manager at a food company but at night he has a side business as an artist for comic books. This side job is profitable, and is not considered a “related entity” to his main job by the Internal Revenue Service.
This would be an opportunity to set up a solo 401(k) that would allow him to put in up to $58,000 in after-tax contributions — assuming the side business was profitable.
Berger notes that a client couldn’t contribute more than what they earn in the side job to that solo 401(k). “So this isn’t going to be for everyone,” he says.
A second part of this is being able to convert those after-tax contributions to a mega backdoor Roth IRA, an option that is “virtually tax-free,” he notes in his blog.
Solo 401(k)s, like company 401(k)s, have required minimum distributions beginning at age 72, while Roth IRAs do not.
The Mega Backdoor Roth IRA Conversion
To do this, a solo 401(k) must allow after-tax contributions and in-service (while the person is still working) distributions of after-tax contributions, and the client would need to be able to afford to contribute the after-tax contributions, Berger notes.