Solo 401k conversion to a Roth 401k
I have a client age 56 1/2 who has a vacation rental property that is in his solo 401K. It generates a six figure income annually. The business owner wants to amend his plan to allow for Roth conversion of the income portion within the plan. He is conservative and wants to use an annuity for the converted funds.
Can it be done? If so, how should it be structured? should the plan be the owner of the annuity and the participant the annuitant? Or can the participant (business owner) be the owner and annuitant?
His earned income is considerably greater than the solo 401k earnings of the property. Is there a contribution limit on the income generated by the property owned by the plan, or is it all allowable because it is generated by an asset in the plan?
If he was age 59 1/2 we could do an In Service Transfer to an IRA/Annuity, and either convert it before or after it was rolled. The big question is how can we do it now (before age 59 1/2) while taxes are on sale?
Thanks
Rick F.
Permalink Submitted by William Tuttle on Tue, 2021-06-08 16:47
A one-participant 401k plan could be amended to support an in-plan Roth Rollover (IRR).
Any such rollover would be taxable at the participant’s marginal tax rates and payable by the participant’s non-plan assets for the tax year of the rollover.
The earnings (income) from this rental invested in marketable securities could be rather easily rolled over. They would have an easily determined FMV.
Any rollover of any percentage of the rental property would require a FMV valuation (professional appraisal) on the date of rollover.
Only the income on the percentage of any rental property rolled over would be allocated to the designated Roth account.
The income on the percentage of any rental property not rolled over would continue to be allocated the pre-tax account.
The tax code and IRS regulations prohibit the in-service withdrawal/rollover of employee deferrals and associated earnings prior to age 59 1/2
The tax code and IRS regulations allow but do not require employer contributions and earnings to be withdrawn/rolled over prior to age 59 1/2. Most one-participant 401k plans place some restrictions on such rollovers.
Previous rollover contributions and earnings typically do not have any such restrictions.
Even if permitted, any withdrawals/rollovers prior to 59 1/2 will be subject to ordinary income taxes and early withdrawal penalties.
This will be a rather complicated process and should not be undertaken without the engagement of a professional third party administrator. I am not referring alternative investment custodians and/or glorified one-participant 401k document resellers. I am specifically referring to knowledgeable, skilled and experienced TPAs.
You and your client do not know what you do not know about 401k plan compliance.
Not to mention, I would never place tax-free Roth assets in an annuity.