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Retirement

Solo 401k Withdrawal Rules & Penalties Explained

Overview

  • To withdraw from your traditional solo 401k account with no penalties, you must wait until you turn 59½ year of age.
  • To withdraw from your Roth solo 401k account with no penalties, you must wait until you turn 59½ year of age AND your account must be at least 5 years old.
  • Early withdrawals will be hit with a 10% fee plus income tax on the amount you take out.
  • Some 401k plans offer a hardship withdrawal, which allow you to withdraw early without paying the 10% fee.
  • After you turn 59½ and your account is at least 5 years old, withdrawals made from your Roth solo 401k account will be tax-free. Withdrawals made from your traditional solo 401k account will be taxed according to whatever the tax rate is that year, and your tax bracket.
  • Once you reach the age of 72, the required minimum distributions (RMD) rule forces you to withdraw a certain amount each year. Failure to withdraw by the deadline could result in penalties up to 50%.

The solo 401k has strict rules around withdrawals and the penalties could be steep if you break them. 

The good news is that the withdrawal guidelines are fairly straightforward and easy to stay in compliance with. And in emergency situations, there are certain exceptions where you could withdraw early with no penalties. 

Some solo 401k plans also offer a loan option, allowing you to borrow money from your account instead of making an early withdrawal. 

How do solo 401k withdrawals work?

As with any other retirement account, you’re required to reach the age of 59½ before you can make any withdrawals from your solo 401k.

As long as you reach the eligible age, you're allowed to take money out of your account.

The Roth solo 401k has a 5-year rule

Because the Roth solo 401k is a Roth account, it has one additional rule: The account must also be at least 5 years old in order for you to withdraw without penalties. The 5-year rule starts when you make your first contribution.

For example, if you open a solo 401k at the age of 57 and make your first contributions to both the traditional solo 401k and Roth solo 401k accounts that year:

  • You can take withdrawals from your traditional solo 401k as soon as you reach the age of 59½.
  • You can take withdrawals from your Roth solo 401k when you're 62 years of age, since that is when 5 years have passed since making your first contributions.

Do I have to pay taxes when I withdraw?

When making qualified distributions after the age of 59½ you'll only have to pay taxes on withdrawals for the non-Roth portion of your solo 401k account.

A solo 401k is comprised of two parts: traditional (pre-tax) and Roth (after-tax). 

  • The traditional solo 401k is funded with pre-tax dollars. You don’t pay taxes when you contribute to your account, but you pay taxes when you withdraw in retirement.
  • The Roth solo 401k is funded with after-tax dollars. You contribute with after-tax dollars, but you don’t pay any taxes when you withdraw.

In retirement, you could choose which one to withdraw from. 

  • Withdrawals made from your Roth solo 401k will be tax-free. The whole thing is yours!
  • Withdrawals made from your traditional solo 401k will be taxed according to the tax rate at the time, and whatever tax bracket you fall under.

Is there a penalty for withdrawing early?

Yes. Any withdrawals made from your solo 401k before you’re 59½ years old will be hit with a 10% early-distribution penalty plus income tax on the amount you withdraw.

For example, let’s say that you’re 35 years old and, due to some hardship, made zero taxable income this year.

The job hunt isn’t going well, and you decide to tap into your solo 401k nest egg and make an early withdrawal of $10,000.

The good(ish) news is, because you made zero taxable income for the year, you’re in the lowest tax bracket and would only pay 10% in income tax.

The bad news is, the early withdrawal penalty adds an additional 10%.

Combined, you would need to hand over 20% out of the $10,000 withdrawal to the IRS, leaving you with just $8,000.

Indirect losses

The fees and taxes are just one part of why an early solo 401k withdrawal is so damaging. You’re also depleting your retirement account of funds that would otherwise be invested and earning you interest.

So you’re not just losing 20% on the $10,000 withdrawal. You also need to take into account the fact that you’re also losing the potential interest earned from it being invested in your solo 401k account.

Are there any exceptions to the 10% tax?

Yes, some 401k plans allow for a 401k hardship withdrawal in extreme situations such as:

  • You become disabled
  • You pass away and your solo 401k is transferred to your beneficiary
  • You need the funds to prevent being evicted or having your home foreclosed
  • Funeral expenses
  • Higher education costs
  • Uninsured medical expenses
  • Purchase of a primary residence
  • Repairing your primary residence

Not all cases are eligible and your plan provider will need to assess each application case-by-case.

Withdraw up to $50,000 with a solo 401k loan

With a solo 401k, you're allowed to take out a loan from your account. This wouldn't be counted as an early distribution and the money wouldn't get penalized.

You're allowed to borrow up to 50% of your account's value up to a maximum of $50,000. While there's no early withdrawal penalty for taking a loan, you'll still have to pay interest.

The interest rate is Prime Rate + one or two percent. The one or two percent is decided by your plan provider, and the Prime Rate goes to the IRS.

You'll have 5 years to pay back the loan, but if you use it to buy a primary residence, you're given up to 15 years to pay it back.

What if I inherit a solo 401k?

If you inherited a solo 401k as a beneficiary, you're exempt from the 10% early-distribution penalty. You don't have to wait until you turn 59½ and can withdraw with no penalties at any age.

However, the income tax rules will still apply. Any withdrawals from the Roth solo 401k account will be able to be made tax-free. But any withdrawals from a traditional solo 401k account will be subject to income taxes based on the tax rate at the time, and your tax bracket.

Required Minimum Distributions

Yes. Unfortunately, you can't keep the money in your account growing tax-free forever. The Solo 401k has a required minimum distribution (RMD) rule, which basically forces you to take a certain amount of money out each year once you reach the age of 72.

How much am I required to withdraw?

The solo 401k RMD is not the same for everybody. The amount you're required to withdraw depends on your account balance and your age.

There are other factors, but put simply, the IRS uses your account balance as of December 31 and then divides it by your age.

When do I need to withdraw the money by?

With the solo 401k, you need to make your first RMD by April 1, the year AFTER you turn 72 years old. For every year after that, the RMD must be taken by December 31.

What if I don't take it out by then?

Penalties for not taking the RMD for any given year are extremely steep. You'll be charged 50% of the amount you were required to take out, but didn't.

For example, if your RMD for the year was $10,000 and you missed the deadline, you'll have to pay 50% of that ($5,000) to the IRS.

Put simply, don't miss your RMD dates! You can learn more about the solo 401k RMD in this guide.

What age can I start withdrawing from my solo 401k?

You're allowed to start taking qualified distributions from your traditional solo 401k account once you reach the age of 59½. Any withdrawals before you reach 59½ years old will be considered an early distribution and will be subject to a 10% fee plus income taxes on the amount drawn.

The taxes you'll have to pay depend on your tax bracket and tax rates the year you make the withdrawal.

To make withdrawals from your Roth solo 401k account, you must be at least 59½ years of age AND your account must be at least 5 years old.

Wrapping Up

With a solo 401k, you can't withdraw from your account until you reach the age of 59½. Early withdrawals incur a penalty of 10% plus income tax on the amount you take out.

Once you turn 59½, you can take out as much as you want with no penalties. You'll pay income tax on withdrawals from your traditional solo 401k account, but none on the Roth account.

The Ocho Solo 401k Plan is a fully managed solo 401k that keeps you in compliance each year. Learn more about it here.

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