Using a Roth 401(k) Individual Plan as a Tax Shelter for Self-Employed Business Owners

The Roth 401(k) individual plan is a great way for small business owners to save money on taxes.

What is a Roth 401(k) individual plan?

The Roth 401(k) individual plan is exactly the same as the Roth 401(k) plan established by companies, except that the person running the business has no employees.

Who should use this type of plan?

This plan is ideally suited for self-employed men and women who own small businesses without employees, or do a lot of freelance work, earn income from consulting, or engage in activities that will generate earned income. Compared to its closest competitor, the SEP-IRA plan, the “401(k) for the self-employed” allows for a larger amount of money to be contributed each year due to the way limits and matches are calculated.

Example of how a Roth 401(k) works

To illustrate the power of this tool for super savers and aggressive investors: a successful married couple in 2021 can put up to $39,000 between them into these tax shelters. To clarify, imagine a wealthy husband and wife, both 30 years old, belonging to the highest income distribution. They establish and fund their own retirement system, earning an average of 7% annually for 35 years, without missing any contributions to the Roth 401(k) individual plan. By age 65, they could have over $5.8 million in tax-free wealth.

Disadvantages for self-employed individuals wishing to set up a Roth 401(k) individual plan

Although it is often the best choice if you qualify, there are some things that make the Roth 401(k) individual plan a little less than perfect:

• Setting up a Roth 401(k) individual plan can involve a lot of initial paperwork.
• The Roth 401(k) individual plan, unlike a Roth IRA, requires mandatory distributions once you reach age 72. However, you may be able to roll over Roth 401(k) individual plan assets into your Roth IRA once you are no longer working, allowing you to bypass this rule.
• Not all brokers offer Roth 401(k) individual plan products.
• You cannot change your mind about Roth 401(k) contributions and switch them to a traditional 401(k) and meet the tax deduction later. Once done, it is done. It is a better deal in the long run, anyway.

Anyone who can benefit from these tax shelters should do so. At the very least, it is worth having a meeting with a qualified tax advisor to seriously discuss the subject. The implications in terms of real-world dollars and cents are profound.

Source: https://www.thebalancemoney.com/401k-self-employed-tax-shelter-357118