Withdrawing money from a retirement plan and having to pay taxes is not the best financial decision. While we hope you can avoid it, sometimes it's necessary to take money out of the Solo 401k.
Because the 401k enjoys growing at a tax-deferred rate, there are taxes due anytime you take money out of the 401k plan. If you take funds out before age 59.5, early withdrawal penalties will also apply.
Anytime you are going to take money out of the 401k plan via a taxable distribution, you'll want to work with your CPA to ensure the proper paperwork is filed and taxes paid.
Some best practices on what's required when you take an early withdrawal from your Solo 401k plan are below.
Have your CPA complete form 1099-R. Document the amount of the distribution in Box 2a. This amount adds to your taxable income for the year.
2. Report your early 401(k) plan withdrawal on Line 16b of Form 1040.
3. Complete IRS form 5329 to document the additional penalty for the early withdrawal. In form 5329, report the total amount of your early 401(k) plan withdrawal on Line 1. If this is an early withdrawal subject to penalty, report that amount on Line 2.
There are a couple exceptions where the early withdrawal penalty doesn't apply, including suffering a permanent disability or taking the distribution because of a qualified domestic relations order. If you qualify for one of these exceptions to the early withdrawal penalty, enter that code next to Line 2. Input the amount of your early Solo 401k plan withdrawal subject to the penalty on Line 3. Enter the amount of the penalty on Line 4. You'll also enter the amount of the penalty on Line 58 of your general tax return (Form 1040). The penalty is equal to 10 percent of the amount of the distribution (that is not exempt from the early withdrawal penalty).
The taxes owed plus the early withdrawal penalty should be paid with your income taxes when they are filed.
An Alternative to the Early Withdrawal: Solo 401k Participant Loan
If you need access to cash, there is a way to get money out of your Solo 401k plan without having to pay taxes on the withdrawal and by (compliantly) avoiding the early withdrawal penalty.
Each Solo 401k by Nabers Group includes a participant loan feature unique to our Solo 401k. The participant loan allows you to take a tax-free loan of 50% of your account value of up to $50,000.
You have 5-years to pay back the participant loan and any interest earned on the loan is paid directly into your Solo 401k bank account (no middleman, no custodian, no fees on the loan origination).
If your participant loan is used to pay for your primary residence, you have up to 15 years to pay back the loan.
A Solo 401k participant loan is an excellent way to tap into capital when you need it, without suffering the penalties of an early withdrawal from your Solo 401k plan.
The Solo 401k by Nabers Group includes a participant loan option at no extra cost and we'll help you prepare your loan documents in under 30 seconds (literally!). Your loan documents include the promissory note, loan amortization schedule and loan repayment schedule.