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Retirement

Roth IRA vs Roth Solo 401k

Similaries

  • Both the Roth IRA and the Roth solo 401k are funded with after-tax dollars. Your money compounds tax-free and you don't pay any taxes when you withdraw in retirement.

Differences

  • The Roth IRA is more accessible. Anyone with any kind of earned income can open an account. To open a Roth solo 401k account, you need self-employment activity with no employees.
  • The Roth solo 401k has a contribution limit of $20,500 ($27,000 if 50 or older). The Roth IRA has a contribution limit of $6,000 ($7,000 if you're 50 or older).
  • The Roth IRA has an income restriction. If you make over $144,000 you are not eligible. The Roth solo 401k has no income restrictions.
  • The Roth IRA has no minimum age requirement. It is easy for minors to open an account and start compounding their money early. With a Roth solo 401k, it depends on your plan provider.
  • For both accounts, you must be at least 59½ years old to withdraw from your account with no penalties. However, with a Roth IRA, you're allowed to withdraw only your contributions (not the gains) if you've held the account for at least 5 years.

Both the Roth Solo 401k and the Roth IRA are funded with after-tax dollars. You pay taxes now, but you don’t pay any taxes when you withdraw from either of the two accounts in retirement.

In other words, your money compounds tax free, and then you get to keep everything when you decide to take the money out.

They're both great retirement accounts, but there are some key differences between the two.

The Ocho Solo 401k Plan is a fully managed solo 401k plan with a Roth option, done-for-you tax filings, and compliance monitoring. Learn more.

It's easier to open a Roth IRA than a Roth Solo 401k

The Roth IRA is much more popular than the Roth solo 401k. Not because it’s better, but because not everyone qualifies for the superior Roth solo 401k.

A Roth solo 401k is just one part of a solo 401k account. You need to qualify for a solo 401k first, in order to consider contributing to the Roth portion of the plan.

What does that mean? How do you qualify?

A solo 401k has two basic eligibility requirements:

  1. You must have self-employment activity.
  2. You must not have any employees that work over 1000 hours per year in your business (besides your spouse).

If you meet those conditions, you can open a solo 401k account and consider contributing to the Roth option.

The Roth IRA, on the other hand, doesn’t have any self-employment requirements. Anyone with earned income can open an account and make contributions. Whether you make that income working as a full-time employee at a company, or through self-employment, both are eligible.

Contribution Limits

While the Roth IRA is more accessible than a Roth solo 401k, it comes with a much lower contribution limit.

In fact, a Roth solo 401k has a limit three times larger than a Roth IRA.

  • In 2022, the contribution limit for a Roth solo 401k is $20,500 ($27,000 if you’re 50 years of age or older).
  • In comparison, the contribution limit for a Roth IRA is just $6,000 ($7,000 if you’re 50 years of age or older).

If you're trying to save for retirement, it's worth looking into opening a solo 401k account for the higher contribution limits alone.

Due to the small contribution limit of a Roth IRA, most people don't consider it as their only retirement account. Usually, they'll have a Roth IRA in addition to a company 401k or a SEP IRA.

On the other hand, with a solo 401k, the Roth option is only one part of your account. You also contribute on the employer side, bringing your total contribution limit to $61,000 ($67,500 if you're 50 years of age or older).

Tip: Using the Mega Backdoor Roth strategy with a solo 401k, you could technically contribute up to $61,000 into a Roth IRA or Roth solo 401k.

Fun fact: You can rollover funds from any retirement account into a solo 401k, with the only exception being a Roth IRA.

Income Restrictions

In addition to a lower contribution limit, the Roth IRA also comes with income restrictions.

If your income is too high, your contribution limit can get reduced even further, or you may not be able to contribute anything at all. 

In 2022, the Roth IRA income restriction is $144,000 for individuals and $214,000 for married couples filing jointly.

  • If your income falls between $129,000 and $144,000, your contribution limit will get reduced.
  • If it’s over $144,000, you're disqualified and can't contribute at all.

In other words, if you make a lot of money, the Roth IRA isn't for you.

On the other hand, the Roth solo 401k has no income restrictions. It doesn’t matter if you made $25,000 or $250,000 - both cases are eligible to contribute up to the maximum allowed amount.

Age Requirements

One area where the Roth IRA is better than the Roth solo 401k is the lack of any minimum age requirement.

There is no minimum age to set up a Roth IRA. Even if you’re an elementary school student with a paper route, you can set one up. 

Even though the contribution limit for a Roth IRA is much smaller than a Roth solo 401k, minors can start compounding their money at an earlier age. And unless you’re making bank as a superstar YouTuber in 8th grade, you likely don’t have to worry about the income restriction.

Given that the Roth IRA is simpler to open and set up, it’s a better option if you want to start contributing small amounts each year before you reach adulthood.

Note: A Roth IRA set up by minors will be treated as a custodial account. The minors’ guardian must serve as the custodian of the account until they turn 18 years old.

Are minors not allowed to set up a Roth solo 401k account?

Yes and no. It depends on the plan provider. Most 401k plans typically have any custodial options for minors.

Withdrawal rules

For both the Roth IRA and the Roth solo 401k, the eligible age to withdraw from your account with no penalties is 59½. Any early withdrawals will get hit with a 10% fee plus income tax on the amount drawn.

The Roth IRA also has a 5-year rule, which states that you cannot withdraw any earnings until you've held your account for at least 5 years, even if you're over the age of 59½.

However, the Roth IRA does allow you to withdraw only your contributions from your account with no penalty at any time.

So if you contributed $50,000 over a 5 year period, you're allowed to withdraw $50,000. But let's say your investments grew over that time, and your assets are now worth $1 million. Then you're still only allowed to take out $50,000 without a penalty.

If you wanted to withdraw more than $50,000, you would have to pay a 10% fee PLUS income tax on the amount drawn, unless you're over the age of 59½ and your account is at least 5 years old.

The Roth solo 401k doesn't have an option for early contribution withdrawals. Any early withdrawals made are subject to the same fee of 10% plus income tax on whatever amount you withdraw.

Wrapping Up

Due to the much higher contribution limit, a Roth solo 401k is the superior investment vehicle if your goal is to save as much as you can for retirement. However, not everyone qualifies since you need to have self-employment activity with no employees.

The Roth solo 401k also has no income requirements, while high income earners are ineligible for a Roth IRA.

However, the Roth IRA is a good account for smaller contributions, making it a good choice for minors to start saving and compounding their money from an early age.

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