Roth Solo 401(k) Vs Roth IRA: Which Is Best For You?

Roth Solo 401(k) Vs Roth IRA: Which Is Best For You?

Solopreneurs have a variety of options when it comes to investing and retirement savings, so you’re justified in wondering which is the right choice for you.

A Roth IRA is a common (and popular) way for investors to save for retirement, however, if you are a solopreneur a Roth Solo 401(k) may be a better option (more on that later).

To the novice investor, these plans sound/seem similar - they are retirement plans that allow you to make Roth (post-tax) contributions with the key benefit being that the earnings on the investments from the contributions are not taxed when withdrawn from the account later. But a closer look at the details, contribution limits, and fine print shows they are quite different. 

Which one is right for you? We’ll explore that question and more in this article. Read on to learn more about the differences between a Roth IRA and a Roth Solo 401(k) to answer that question.

What is a Solo 401(k)?

Like an employer-provided 401(k), a Solo 401(k) plan allows you to save for your retirement, invest, and reduce your taxable income. 

A Solo 401(k) is a retirement plan geared specifically toward the unique needs of self-employed individuals and micro-business owners. One of its most appealing features is that it permits an enrollee to wear two contributor’s hats: one as an employee and another as an employer. Under the right circumstances, even the spouse of a participant can contribute to a Solo 401(k) since the spouse of the owner is also considered an owner.  

As of 2023, a Solo 401(k) plan allows you to contribute up to $66,000 and $73,500 if you're aged 50+. Assuming, of course, your income will support the contribution. 

As an employee of your business:

• You can contribute up to $22,500 ($30,000 if you are 50+ years old)

• Your contributions can be pre-tax, post-tax (Roth), or a mix of both.

The employee contributions are also called “effective deferral” or “employee deferral”. These function similarly to how you would contribute to a 401(k) plan with your full-time job. 

The limit however is based on all deferrals you make to all plans you participate in combined. 

As an employer (of yourself):

• You can contribute up to 25% of your compensation if your business is incorporated (20% if not)

• These contributions can be made on a pre-tax or post-tax (Roth) basis.

That is the beauty of a Solo 401(k) - because you contribute to both the employee and employer side, you can contribute more than you would to a 401(k) plan of an employer you work for. 

Roth Solo 401(k) vs traditional Solo 401(k)

There’s one more clarification we have to make. Not only can you make pre-tax contributions to lower your taxable income, but you also have the option to make your contribution as a Roth (post-tax) contribution.

The biggest difference between the two plans is how and when you get taxed. Let’s make it simple and think of it as pre-tax (traditional) vs post-tax (Roth).

With the traditional Solo 401k, you don’t pay taxes now, but you pay taxes when you make withdrawals in retirement. This allows you to contribute pre-tax dollars and therefore reduce your taxable income when you contribute.

With a Roth plan, you pay taxes now, but you don’t pay any taxes when you withdraw in retirement. This means you can contribute post-tax dollars (so it will not reduce your taxable income) however you do not pay tax when you withdraw. You only get this tax-free benefit though if you had the Roth for 5 years or more and are either 59 ½, became disabled, or passed away. Because of this, by making a Roth contribution as early as possible you can “start the clock” and receive your tax-free earnings once you are eligible to withdraw.

One key advantage of the SEPira(k) Solo 401(k) platform is that we support Roth contributions whereas many competitors do not.

What is a Roth IRA?

Roth IRAs are similar to an ordinary IRA except for one key difference: Roth contributions are post-tax (so they cannot reduce your taxable income) however you are not taxed on the contribution and earnings when you withdraw your funds. The 2023 contribution limit for a Roth IRA is $6,500, so much less than a Solo 401(k) (though largely because this is an account for individuals as opposed to businesses).

One wrinkle with Roth IRAs is that if your income exceeds a certain amount then your contribution limit will change.

For instance, for married couples filing jointly (as of 2023)

• If you make less than $218,000, you can contribute up to the allowed limit.

• If you make $218,000 but less than $228,000, your allowed contribution will be reduced.

• If you make $228,000 or more, you may not contribute to a Roth IRA.

And for those filing as single or heads of households:

• If you make less than $138,000, you can contribute up to the allowed limit.

• If you make $138,000 but less than $153,000, your allowed contribution will be reduced.

• If you make $153,000 or more, you may not contribute to a Roth IRA.

This is the key downside to a Roth IRA, especially for solopreneurs as your income grows.

What are the differences between a Solo 401(k) and a Roth IRA?

There are key differences to be aware of when comparing a Roth Solo 401(k) and a Roth IRA side by side for 2023:

  Contribution limits Catch-up contribution? Can you take a loan? The date you need to set up Requirements to operate the plan Roth IRA $6,500 Yes, $1000 No  On or before your tax return due date plus extensions depending on the business type. Requires reporting and record-keeping Roth Solo 401(k) $66,000 Yes, $7,500 Yes On or before your tax return due date plus extensions depending on the business type. Requires reporting and record-keeping

Advantages of a Roth Solo 401(k)

Solo 401(k) plans offer a host of advantages compared to a Roth IRA. 

Much higher contributions

For one, you can contribute as an employee of the business as well as the employer which opens the door for more savings (and tax reduction). The contribution limits for a Solo 401(k) are much higher than those of a Roth IRA, which makes a Solo 401(k) plan a very sound option for retirement savings. 

No income limits like a Roth IRA

Unlike a Roth IRA, you can make Roth contributions to a Solo 401(k) regardless of your income. This is a key advantage of a Solo 401(k) compared to a Roth IRA, as you can quickly become ineligible for a Roth IRA as your income grows.

You can take out loans

Solo 401(k) plans also support loans that give you quick access to capital whether it’s for business or personal use whereas a Roth IRA does not.

Advantages of a Roth IRA

Compared to other IRAs the key benefit of a Roth IRA is that because the dollars invested are post-taxed, you are not taxed when withdrawing your funds in the future. That said, this benefit is moot with Roth contributions to a Solo 401(k) as you reap the same benefits.

Can you have both a Roth IRA and a Roth Solo 401(k)?

Yes, you can contribute to both a Roth IRA and a Solo 401(k) plan in the same year. Roth IRAs have a slight catch in that if your income makes you ineligible to contribute, then you can only contribute to a Solo 401(k) plan. 

You could explore other IRAs such as a SEP IRA if you are unable to contribute to a Roth IRA (check out our guide comparing a Solo 401(k) to a SEP IRA to learn more about the differences between the two).

Which should you choose?

Ultimately it comes down to personal preferences - though due to the much higher contribution limits of a Solo 401(k), loan options, no income eligibility requirements to worry about, and the fact that you can still make Roth contributions, we think a Solo 401(k) is a superior option when saving for retirement. 

How to open a Solo 401(k) plan

Opening a Solo 401(k) is easy!

You can create an account in minutes on the SEPira(k) platform to unlock serious retirement savings while letting our platform do the heavy lifting to ensure you are compliant. 

Create your account and start saving today.