Solo 401k Parachute

Are you looking to Retire Early, but don’t want to pay a penalty to access the money you saved before you turn age 59.5?

 

Got a ton of retirement money stashed in the TSP, an IRA, former employer’s 401k, or other Qualified Retirement Plan?

 

Are you also looking to implement a withdrawal strategy that does not force you in to a 5-year waiting period like the ‘Roth Conversion Ladder’ does?

 

There’s a perfectly legal method to get to your Retirement Plan money at age 55 without paying a penalty, and it’s called the Solo 401k.

The Solo 401k strategy is exactly the same as taking penalty-free withdrawals from a regular employer’s 401k after you leave your employer in (or after) the calendar year of your 55th birthday-  Only you’re the ’employer’ now.

 

Before we go any further…
  1. Consult your Tax Professional for specific advice on the Solo 401k Parachute strategy. 
  2. There are no ‘Primary’ Tax resources referenced here – Just ‘Secondary’ resources.
  3. For Feds, I’m also not addressing the impact on your FERS Benefit/Annuity of leaving Federal Employment before your Minimum Retirement Age.
Note: I’m using the term ‘Solo 401k’ interchangeably with other aliases for what the IRS refers to as  One-Participant 401(k) plans:
  • Solo-K
  • Solo 401(k)
  • Self-Employed 401(k) (Fidelity’s preferred terminology)
  • Uni-K

 

Ok, Here’s how the Solo 401k Parachute strategy works.
First, you have to put money IN to a Solo 401k.
So how do you get money in to a Solo 401k?  It’s easy – Start a second job (doing anything) and earn some income.  Just make sure you don’t run afoul of the IRS’ 401k participation and contribution limits in each calendar year.
Typically, Solo 401ks can take rollovers from IRA’s, former employers’ 401ks and SEP IRAs.  Here’s an example from Fidelity.   Double check that your Solo 401k provider will accommodate each type of rollover.
Second, You have to follow the rules to get the money OUT of the Solo 401k you created.
The IRS clearly allows you to take money out of a 401k at age 55.
There’s even a handy IRS table showing you the age 59.5 exceptions (look at the bottom, under ‘Separation from Service’).
In the case of any 401k, ‘Separation from Service at age 55’ means two things:
     1) You left the employer (for ANY reason) that provided you with the 401k benefit
     2) You left that same employer in the calendar year of your 55th birthday (or later)
So, unlike the case where you quit or retire from a big company at age 55 and commence 401k Plan withdrawals at your leisure the next morning, there’s no Private Letter Ruling on how long you can stretch withdrawals from a Solo 401k after you ‘retire’ from the self-employed business that provides the Solo 401k income.

 

You can choose between two Solo 401k Withdrawal Parachutes – The ‘All In’ strategy with a single Solo 401k in the backpack, or you can hedge your tax bets by packing multiple jobs and multiple Solo 401k Parachutes in your backpack.

 

Option 1 – ‘All In’ on a Single Solo 401k Parachute at age 55.
Here’s how The ‘Single Solo 401k Parachute’ strategy works:
Start a self-employment or independent contractor gig some time before age 55.  Use that self-employed money to start a Solo 401k some time in or before the year you turn 55, and roll as much of your existing IRA or former large employer’s 401k monies in to your Solo 401k.  Quit your self-employment in the calendar year of your 55th birthday (but not before!) and start taking penalty-free withdrawals from your Solo 401k.
Note that if you open a Solo 401k with Invesco, their Solo 401k withdrawal form explicitly indicates you can check the ‘Retirement at age 55’ box, then withdraw from the Solo 401k as long as you want.  Invesco treats everything after age 55 the same as age 59.5, and does not list age 59.5 as a requirement on its Solo 401k withdrawal form. 
      I could not find any other Solo 401k withdrawal forms from any of the other major brokerage houses (Schwab, Fidelity, Vanguard, ETrade, TDAmeritrade) that were as straightforward with age 55 Solo 401k withdrawals as Invesco’s.  Invesco either has a different opinion from their team of lawyers and accountants, or may be using this as a marketing tool to differentiate themselves.  Again, none of the other brokerage houses explicitly forbids age 55 Solo 401k withdrawals, but in each and every one of their Solo 401k withdrawal forms you must fish through 10+ pages of legal font to make this determination for yourself.   
     If I was implementing the Solo 401k strategy as an early retirement vehicle, I might be willing to swallow Invesco’s higher fees (vs. Vanguard, Schwab, or Fidelity) in exchange for the simplicity of their Solo 401k withdrawal form.   

 

Option 2 – Pack more than one Solo 401k Parachute in your backpack
Since there has not yet been a Private Letter Ruling on Solo 401k withdrawals at age 55, the ultra-conservative approach to the age 55 Solo 401k strategy is to do a series of Solo 401k plans (and jobs), terminating each Solo 401k (and job) each year starting at age 55.
This is much more of a ‘Brute Force’ withdrawal strategy- Bordering on tax paranoia. But in the absence of a Private Letter Ruling or IRS Notice, it is less likely to bring an unsolicited visitor from the IRS to your doorstep. 
Note: For the ‘multiple Solo 401k Parachute’ strategy, withdrawal/termination of the Solo 401k cannot be done earlier than the calendar year you turn age 55 , else you pay the 10% tax penalty on all withdrawals.

 

Here’s how to implement the Multiple Solo 401k Parachutes:
Year Zero (Age 54)
Start a blog in year zero (age 54), make $100 bucks in net revenue from ads etc on the blog, establish the Solo 401K, roll in some IRA or other former employer 401k $$

Year 1 (age 55)

Withdraw the lump sum from the blogging Solo 401k and terminate the plan (and the income-earning blogging) in Year 1 the next year (age 55).

Drive for Uber or Lyft for a few weeks in year 1, make a few net revenue bucks, establish a solo 401k for your ride-sharing business.  Roll some IRA money in during year 1.

Year 2 (age 56) 
Terminate the Uber-Lyft 401k plan in year 2 and withdraw the Uber-Lyft solo 401k balance.   Terminate the business of driving and earning for Uber-Lyft in Year 1 or Year2.
Start a new side hustle business making surf racks on Etsy.  Collect a few $$ in net revenue from the business and establish a Solo 401k for Etsy in Year 2.
Year 3 (age 57)
Withdraw the money from your Etsy Solo 401k and Terminate the Etsy Solo 401k plan.  Stop earning money for Etsy in Year 3 or Year 2.
Start a business doing other people’s laundry at $35 per load.   Open a Solo 401k for your laundry business and roll-in money.
Year 4 (age 58)
Withdraw the money from your laundry business 401k in a lump sum and terminate the plan.  Cease doing other peoples’ laundry for money in year 3 or year 4.
Year 5 (age 59)
If you turn age 59 1/2 during Year 5, you’re home free.  You can now withdraw money from any retirement plan (IRA, SEP, 401k, 403b etc) penalty-free after turning age 59 1/2.  If you don’t turn 59 1/2 in this calendar year you know what to do by now.

 

Other notes on the Solo 401k Early Retirement Parachute Strategy:
Q: What is the Roth Conversion Ladder, and where does the 5-year holding period come from?
A1: Mr. Money Mustache is widely credited with coining the phrase and strategy ‘Roth Conversion Ladder‘.  It is a strategy you can use at any age to convert a Traditional IRA to Roth Basis money – You pay taxes on the conversion amount NOW and must wait 5 years to use the converted cash.
A2:  The 5-year holding period is from IRS reg 1.408a-6.
Q: Why would you want to do penalty-free withdrawals from a taxable retirement plan instead of a Roth?
For the uninitiated, here’s a good summary by a CPA about withdrawing from a regular employers’ 401k at age 55.

 

Notes on the Solo 401k forms from the major brokerage houses:
As mentioned above, Invesco had the only Solo 401k withdrawal form that endorsed age 55 withdrawals without penalty.
Fidelity’s form is vague and indicates age 59.5, although the mouse-font on page 9 indicates it is kosher.  Page 1 lists ‘Severance From Employment’ as an option and warns that there ‘may’ be a penalty before 59.5:
Schwab’s reads the same way, with age 55 exception in the mouse font on page 7:
Vanguard’s reads the same.  See page 12:
ETrade has mouse font on page 9 of 15 but does list Termination as a check box at the front:
TD Ameritrade has a check box for ‘Early Distribution’ at age 55 on page 1:

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