Tag Archives: Rule of 55

2025 Solo 401(k) Update

Before we explore new developments for 2025, 2024 was so chock full of Solo 401(k) developments that it deserves its own rundown. Then we will move onto 2025 Solo 401(k) changes.

Vanguard Out!

Vanguard transferred all of their Solo 401(k) accounts to Ascensus in 2024. Vanguard is now entirely out of the Solo 401(k) business.

The good news for those fond of Vanguard is that the Ascensus Solo 401(k) offers Vanguard mutual funds.

The transition was not entirely smooth. Notably, beneficiary designation forms did not transfer from Vanguard to Ascensus. The Ascensus Solo 401(k) contribution portal is quite different from Vanguard’s and is not intuitive, in my opinion. I did a YouTube video about making contributions to a Solo 401(k) at Ascensus.

I’m not in the business of making generic recommendations about which Solo 401(k) plan provider to use. In my book, I advocate strongly for considering a pre-approved plan (sometimes referred to as a prototype plan). Schwab, Fidelity, and Ascensus are now among the larger providers of pre-approved plans. While I will not provide any plan provider recommendation, I believe Ascensus, Fidelity, and Schwab are all reasonable options to consider.

Solo 401(k)s at Retirement

During 2024 I did a deep-dive on some Solo 401(k) history. The results of that research is a 27 page self-published article concluding that for Schedule C solopreneurs, a Solo 401(k) should survive the solopreneur’s retirement.

One of the implications of that finding is that Solo 401(k)s should qualify for the Rule of 55. However, one must always consult with their own individual plan, as the plan itself must have rules facilitating Rule of 55 distributions.

Doubts About SECURE 2.0

SECURE 2.0 made dozens of changes to retirement account rules. It made what I believe to be rather inconsequential changes to Solo 401(k) planning. Nevertheless, it did change some Solo 401(k) rules.

Based on a court case in federal district court in Texas, the legal foundation of SECURE 2.0 is now shaky. I discussed the situation on YouTube. It will be very interesting to see what the new Administration does with SECURE 2.0 considering that a federal district court judge made a very convincing argument that the passage of the Omnibus bill (which included SECURE 2.0) in December 2022 was not valid.

New Solo 401(k) Employee Contributions Limit for 2025

The IRS announced that for 2025, the employee deferral limit for all 401(k)s, including Solo 401(k)s, will be $23,500.

Solo 401(k) Catch-Up Contributions Limit for 2025

The IRS also announced that for 2025, the normal employee deferrals catch-up contribution limit remains $7,500. As a result, those aged 50 or older can contribute, in employee contributions, a maximum of the lesser of $31,000 ($23,500 plus $7,500) or earned income.

New Solo 401(k) All Additions Limit for 2025

The new all-additions limit for Solo 401(k)s is $70,000 (or earned income, whichever is less). For those aged 50 or older during 2025, the $70,000 number is $77,500 ($70,000 plus $7,500).

New Additional Catch-Up Contributions for Those Aged 60 Through 63

SECURE 2.0 increased the catch-up contribution for those aged 60 through 63 (see page 2087 of this file). In 2025, the catch-up contribution for these people is $11,250, not $7,500. As this is a SECURE 2.0 rule, I believe that Solo 401(k) users should (1) proceed with caution and (2) stay tuned.

Traditional Solo 401(k) Contributions More Attractive Than Ever

I believe traditional Solo 401(k) contributions are now more attractive than ever. Why? The change in tax policy coming with the 2024 Election results.

There’s been plenty of debate: traditional versus Roth. The way to resolve that is to compare today’s marginal tax rate with the tax rate on the income in retirement. Today’s rate is pretty knowable, but tomorrow’s rate isn’t.

That said, we do know that America has a history of standard deductions and graduated progressive tax rates. That, combined with Congress’s political incentives (retirees tend to vote), suggests that retirees will be relatively low taxed in retirement.

Social Security has been a fly in the ointment to that view. Up to 85 percent of Social Security income fills up the standard deduction and lower tax brackets with income. Doesn’t that mean that traditional retirement account withdrawals will be taxed against higher tax brackets?

Starting in 2025, that issue may go away. Eliminating income tax on Social Security was a major promise of the Trump campaign. Considering the GOP majorities in both houses of Congress, the tax on Social Security should be repealed. Stay tuned!

Removing Social Security from taxable income means significant amounts of traditional retirement account withdrawals should be tax free (offset by the standard deduction) or subject to the lower 10 percent and 12 income tax brackets. The possibility of even lighter taxation on traditional retirement account withdrawals makes traditional Solo 401(k) contributions more attractive than ever.

2025 Update to Solo 401(k): The Solopreneur’s Retirement Account

Solo 401(k): The Solopreneur’s Retirement Account explores the nooks and crannies of Solo 401(k)s. On page 16 of the paperback edition, I provide an example of the Solo 401(k) limits for 2022 if a solopreneur makes $100,000 of Schedule C income. Here is a revised version (in italics) of the example (with the footnote omitted) applying the new 2025 employee contribution limit:

Lionel, age 35, is self-employed. His self-employment income (as reported on the Schedule C he files with his tax return) is $100,000. Lionel works with a financial institution to establish his own Solo 401(k) plan and choose investments for the plan. Lionel can contribute $23,500 to his Solo 401(k) as an employee deferral (2025 limit) and can choose to contribute, as an employer contribution, anywhere from 0-20% of his self-employment income.

Lionel’s maximum potential tax-advantaged Solo 401(k) contribution for 2025 is $42,087! That is a $23,500 employee contribution and a $18,587 employer contribution. Note there’s no change in the computation of the employer contribution for 2025 in this example.

On page 18 I provide an example of the Solo 401(k) contribution limits factoring in catch-up contributions. Here’s the example revised for 2025:

If Lionel turned 50 during the year, his limits are as follows:

Employee contribution: lesser of self-employment income ($92,935) or $31,000: $31,000
Employer contribution: 20% of net self-employment income (20% X $92,935): $18,587
Overall contribution limit: lesser of net self-employment income ($92,935) or $77,500: $77,500

Amazon Reviews

If you have read Solo 401(k): The Solopreneur’s Retirement Account, you can help more solopreneurs find the book! How? By writing an honest, objective review of the book on Amazon.com. Reviews help other readers find the book!

FI Tax Guy can be your financial planner! Find out more by visiting mullaneyfinancial.com

Follow me on X at @SeanMoneyandTax

This post is for entertainment and educational purposes only. It does not constitute accounting, financial, legal, investment, or tax advice. Please consult with your advisor(s) regarding your personal accounting, financial, legal, investment, and tax matters. Please also refer to the Disclaimer & Warning section found here.

SECURE 2.0 and Section 72(t) Comment Letter

Recently, the IRS and Treasury issued Notice 2024-55. This notice provided initial rules for SECURE 2.0 emergency personal expense distributions (“EPEDs”), domestic abuse victim distributions, and repayments into retirement accounts. The Notice also asked for comments on the above and on Section 72(t) in general.

I wrote a comment letter (which you can read here) to the IRS and Treasury obliging that request. The letter addresses EPEDs, repayments into retirement accounts, and the impact of Texas v. Garland on SECURE 2.0. Further, the comment letter requests clarification that Solo 401(k)s of retired solopreneurs qualify for the Rule of 55 exception to the Section 72(t) ten percent early withdrawal penalty.

Follow me on X: @SeanMoneyandTax

This post (and the linked-to comment letter) is for entertainment and educational purposes only. They do not constitute accounting, financial, investment, legal, or tax advice for you or any other individual. Please consult with your advisor(s) regarding your personal accounting, financial, investment, legal, and tax matters. Please also refer to the Disclaimer & Warning section found here.

Roth 401(k)s and the Rule of 55

We live in a world where two things are true. First, more investors are using the Roth 401(k) to save and invest for retirement. Second, as demonstrated by the strength of the financial independence movement, many are interested in retiring early by conventional standards.

Some potential “early” retirees are thinking about the so-called “Rule of 55” and many of them have Roth 401(k)s.

How does the Roth 401(k) work with the Rule of 55? Is there a better option than the Rule of 55 for those looking to retire using in part or in whole a Roth 401(k) prior to turning age 59 ½?

We will explore both the Roth 401(k) and the Rule of 55, then we will discuss planning involving the potential combination of the Roth 401(k) and the Rule of 55. We will also discuss a planning alternative to combining the Roth 401(k) with the Rule of 55.

Roth 401(k)

The Roth 401(k) is a 401(k) that is taxed as a Roth. Employers offering a 401(k) are not required to offer a Roth 401(k) option, but many do.

Roth 401(k) Contributions

There are now three main potential sources of “Roth contributions” to a Roth 401(k).

Employee Deferrals: In 2024, these are limited to the lesser of earned income or $23,000 ($30,000 if age 50 or older). These are done through W-2 withholding into the Roth 401(k).
Mega Backdoor Roth: These are after-tax contributions by the employee (also through W-2 withholding) to the traditional 401(k) followed by a soon-in-time Roth conversion of the after-tax 401(k) amount to the Roth 401(k).
Employer Contributions: Employers contribute to 401(k)s. SECURE 2.0 allows for employers to contribute to Roth 401(k)s. Traditionally, employer contributions had always been to the traditional 401(k), but SECURE 2.0 established the possibility of Roth 401(k) employer contributions. Note that a February 2024 federal court decision has called SECURE 2.0 into question.

There’s a limit on the combination of 1 plus 2 plus 3. I refer to this limit as the “all additions limit” and some refer to it as the “415(c)” limit, as that’s where the limit lives in the Internal Revenue Code. For 2024, the all additions limit is $69,000. For those aged 50 or older, it is $76,500.

Note that Roth IRAs cannot be rolled over to a Roth 401(k).

There’s a fourth potential source of Roth 401(k) funds: Taxable conversions from traditional 401(k)s. Taxable Roth conversions (traditional 401(k) to Roth 401(k)) have no limit. These are usually not done during one’s working years.

Roth 401(k) Withdrawals

If “done right” a Roth 401(k) withdrawal in retirement is fully tax and penalty free.

However, if a distribution from a Roth 401(k) occurs before either (or both) the account owner is 59 ½ years old or the owner has owned that particular Roth 401(k) for five years, the “earnings” portion of the distribution is subject to ordinary income tax and the potential 10 percent early withdrawal penalty.

Here’s a quick example illustrating that rule:

Ken is age 53. He’s early retired. At a time when his Roth 401(k) is worth $200,000 and he’s previously contributed $100,000 to it, Ken takes a $50,000 distribution from the Roth 401(k) to help fund his retirement. Fifty percent of the distribution ($25,000) is a return of Ken’s previous contributions and fully tax and penalty free. The other fifty percent of the distribution ($25,000) is earnings and since Ken is under age 59 ½ will be taxable to Ken and subject to the 10 percent early withdrawal penalty.

Rule of 55

The Rule of 55 is an exception to the 10 percent early withdrawal penalty. It applies to a specific employer’s qualified plan, such as a 401(k). It applies distributions from an employer’s qualified plan if

The qualified plan account owner separated from service from the employer no earlier than the beginning of his or her age 55 birthday year, and
The distribution occurs after the separation from service.

Here is an example:

Rob was born on June 7, 1969. On January 16, 2024, Rob retired from Acme Industries. 2024 is Rob’s 55th birthday year. Any distribution occurring after January 16, 2024 from the Acme Industries 401(k) to Rob qualifies for the Rule of 55 exception to the 10 percent early withdrawal penalty.

Note that a transfer from the former employer’s qualified plan to an IRA blows qualification for the Rule of 55. Distributions from an IRA are not distributions from the employer’s qualified plan. Further, the Rule of 55 applies only to the particular employer’s plan. If Rob had separated from Consolidated Industries at age 52 and still had a 401(k) there, distributions from that 401(k) would not qualify for the Rule of 55.

Read more about the legislative history of the Rule of 55 on page 18 of my article Solo 401(k)s and the Rule of 55: Does the Answer Lie in 1962?

Planning

Perhaps you’re sitting at home saying “Roth 401(k)s are great. The Rule of 55 is great. Why not combine them?”

I have four reasons not to combine them.

Taxing Roth 401(k) Earnings

Paying tax on a Roth distribution is the planning equivalent of breaking into jail. Combining the Roth 401(k) with the Rule of 55 means taxing Roth earnings as ordinary income. That isn’t a great outcome, particularly when there was no tax deduction on the way into the Roth 401(k).

Here is an example:

Ted leaves Maple Industries at age 56. He withdraws $60,000 from his Maple Industries Roth 401(k) at a time it was worth $300,000 and had $120,000 of previous contributions. Forty percent of the withdrawal ($24,000) is a tax and penalty free return of contributions. Sixty percent of the withdrawal ($36,000) is penalty free under the Rule of 55 but is subject to income taxation.

Perhaps a significant portion of the taxable withdrawal is protected by the standard deduction (what I refer to as the Hidden Roth IRA in the context of traditional retirement account withdrawals). But even at a 10 or 12 percent marginal federal income tax rate, from a planning perspective having any sort of taxable distribution from a Roth account is a bad outcome.

Further, taking money out of a Roth in our 50s means foregoing additional years or decades of tax free growth on that money.

A Great, Easily Accessible Alternative Exists

Before age 59 ½, a Roth 401(k) represents a challenge and an opportunity for an early retiree.

First, the challenge. The challenge is the “cream-in-the-coffee” rule I previously discussed in this post. Distributions before age 59 ½ attract both old contributions and earnings. Earnings are subject to both ordinary income tax and the 10 percent early withdrawal penalty.

Here’s an example:

Moe is age 53. He has a $500,000 Roth 401(k). $200,000 is old contributions and $300,000 is growth on those contributions (earnings). If Moe takes a distribution of $10,000 from the Roth 401(k), $4,000 (40%) will be a tax and penalty free return of contributions and $6,000 (60%) will be a distribution of earnings, subject to both income taxation and a 10 percent early withdrawal penalty (add 2.5% if Moe lives in California).

Here’s the opportunity: Someone like Moe can “isolate” his $200,000 of Roth 401(k) basis and avoid taxation on his Roth withdrawals.

It’s pretty easy. Moe can simply transfer his entire Roth 401(k) to a Roth IRA. That will immediately give Moe $200,000 of “basis” in his Roth IRA (old annual contributions which can be removed at any time for any reason tax and penalty free). Once the Roth 401(k) is in a Roth IRA, Moe has $200,000 (plus any other Roth basis he has separately built up) he can withdraw entirely tax and penalty free for early retirement.

A Good, Not Too Difficult Alternative Exists

There’s another path to basis isolation and avoiding taxation on a Roth 401(k) distribution, but it will be more complicated. This path involves Moe keeping most of the money inside the Roth 401(k).

Returning to the facts of Moe’s example: Say Moe is 53 years old and early retired. If the Roth 401(k) plan allows partial pre-age 59 ½ withdrawals, and Moe wants $10,000 tax and penalty free, he could withdraw $25,000 from the Roth 401(k) and (i) keep $10,000 (40%) and (ii) transfer $15,000 (60%) to a Roth IRA. The transaction will be entirely tax and penalty free as Moe is deemed to get the basis ($10,000) distributed to him and to have transferred the earnings ($15,000) to his Roth IRA. See Exception 3: Roth 401(k) Withdrawal then Rollover in this post for more details.

Why Not Use Taxable Accounts, if Possible?

I’ve said it before and I’ll say it again: I prefer using taxable accounts, if possible, to fund retirement prior to using retirement accounts. While that will not be possible for everyone, why not save before retirement in a manner that facilitates (1) living off taxable accounts prior to age 59 ½ (and pay very low capital gains taxes) while (2) doing very low tax rate Roth conversions in retirement.

Obviously, there’s only so much tax planning anyone can do if they are in their mid-to-late 50s and a couple of months away from retirement. But for those in their 30s, 40s, and even early 50s, now is the time to plan to set up a retirement that is as tax advantageous as possible.

For anyone with a decent amount of time between now and retirement, I would not recommend planning into relying on using the Rule of 55 for a Roth 401(k).

ACA Premium Tax Credit Considerations

I’m concerned that some people take the Roth too far. If you get to retirement prior to age 65 and need to go on an ACA medical insurance plan, having every last penny in Roth accounts is not a good place to be. It can mean that you’re not able to generate taxable income in retirement, meaning you can’t qualify for a significant Premium Tax Credit against hefty ACA insurance premiums.

In theory, the Rule of 55 could be a workaround to that problem. Imagine Jane retires at age 56, and other than a paid off house and $50,000 in a savings account she has a $2,000,000 Roth 401(k) and a $500,000 Roth IRA. How is she going to create any taxable income to qualify for the Premium Tax Credit?

The answer, for a few years, can be the Rule of 55. Jane could take from her Roth 401(k) (assuming it allows partial pre-age 59 ½ distributions), create taxable income on the “earnings” portion of the distribution as discussed above, and avoid the 10 percent early withdrawal penalty under the Rule of 55.

This is still not something that should be planned into. Why not? At age 59 ½, assuming Jane has had the Roth 401(k) for 5 or more years, she will qualify for a “qualified distribution” from the Roth 401(k), meaning that all distributions from it will be entirely tax free.

That’s bad news from a Premium Tax Credit perspective: at that point Jane will have hardly any taxable income (just some interest income from the small savings account) and thus will not generate sufficient income to qualify for the Premium Tax Credit!

Conclusion

It is good that the Roth 401(k) and the Rule of 55 are available options for retirement. Absent unique and extreme circumstances, they generally should not be combined when it comes to retirement planning.

FI Tax Guy can be your financial planner! Find out more by visiting mullaneyfinancial.com

Follow me on Twitter: @SeanMoneyandTax

This post is for entertainment and educational purposes only. It does not constitute accounting, financial, investment, legal, or tax advice. Please consult with your advisor(s) regarding your personal accounting, financial, investment, legal, and tax matters. Please also refer to the Disclaimer & Warning section found here.

Revisiting Solo 401(k)s and the Rule of 55

On a recent episode of ChooseFI, I stated my then-held view that it is unlikely a distribution from a Solo 401(k) qualifies for the Rule of 55. My concern was this: once the Schedule C solopreneur retires, there does not appear to be an “employer” remaining in the picture to sponsor the Solo 401(k).

If that is the case, the Solo 401(k) should be rolled over to an IRA and there’s no ability to use the Rule of 55.

Until now, I’m not aware that anyone has done a deep dive to validate or disprove that concern. So I decided to do it myself. My research took me as close to the year 1962 as one can get without a flux capacitor, a DeLorean, and 1.21 gigawatts of electricity.

I’ve now changed my view on the Solo 401(k) Rule of 55 issue. The analysis is too complicated to write adequately in a blog post. Thus, I’m self-publishing an article, Solo 401(k)s and the Rule of 55: Does the Answer Lie in 1962? (accessible here), on the topic.

Of course, the article is not legal or tax advice for you, any other individual, and any plan.

For those of you who read my book, Solo 401(k): The Solopreneur’s Retirement Account (thank you!), please know the article is written differently. The book is a “101” and “201” level discussion of tax planning for the self-employed with some beginning and intermediate tax rule analysis. The article is much more akin to a “501” level discussion of a complex and somewhat uncertain tax issue emerging from ambiguities in the Internal Revenue Code

Enjoy the article and let me know what you think in the comments below.

FI Tax Guy can be your financial planner! Find out more by visiting mullaneyfinancial.com

Follow me on Twitter: @SeanMoneyandTax

This post and the linked-to article are for entertainment and educational purposes only. They do not constitute accounting, financial, investment, legal, or tax advice. Please consult with your advisor(s) regarding your personal accounting, financial, investment, legal, and tax matters. Please also refer to the Disclaimer & Warning section found here.