Navigating a One-Participant Retirement Plan

What Is a Solo 401(k) Plan?

Simple; a solo 401(k) plan is just a 401(k) plan that happens to have just one participant.  This occurs when an employer, either a self-employed individual, a corporation or a limited liability company adopts a retirement plan and either has no employees, or no employees are yet eligible to participate in the plan.

How Is a Solo 401(k) Plan Different Than a Traditional 401(k) Plan?

Realize there is no reference to “solo” 401(k) in the code and regulations.  The reference to “solo” 401(k) is really used more as a marketing term, or a frame of reference.  Clearly there are many differences between a one-participant plan and a plan that covers employees, with the most relevant as follows:

Features	Solo 401(k) Plan	Traditional 401(k) Plan
Subject to the Qualification Requirements of IRC 401(a)	Yes	Yes
An “Employee Benefit Plan” for Department of Labor Regulations on Reporting and Disclosure	No	Yes
Form 5500/Form 8955 Filing Requirements	Exempt until the earlier of: 1) assets reaching $250,000 2) termination of the plan	Always required
Plan Document	Always required, but some investment institutions will provide for minimal cost	Always required
401(k) Elective Deferral Limit	$18,000 + $6,000 catch-up for those age 50 or older	Same
Roth Elective Deferrals	Permitted	Permitted
Employer Deductible Contribution Limit	25% of eligible compensation	Same
Investment Options	Anything permitted in the plan document	Same, though options for employees must be non-discriminatory
Participant Loans Permitted	Yes	Yes
Form 1099-R Reporting Required to Report Distributions from Plan	Yes	Yes
Non-discrimination Testing	N/A	Applies
Participant Level Fee Disclosures	N/A	Required if plan includes ANY participant direction of investments (unless PD limited to participant loans)
Bonding Requirement	N/A	Yes, with coverage of not less than the greater of 10% of the total assets, or 100% of the non-qualified assets.

 

 

Who Can Adopt a Solo 401(k) Plan?

Any “employer” generating earned income that is then reflected:

• On the individual’s Schedule C to their Form 1040 (i.e. a sole proprietor), or
• On Schedule K-1 to the Form 1065, line 14A – self employment income (i.e. a partner in an entity taxed as a partnership), or
• Via W-2 wages issued by the corporation (employer) to the owner-employee of an entity taxed as a corporation.
  • Note that a partner in an entity taxed as a partnership is deemed to be an employee of the entity and, therefore, cannot adopt a retirement plan as an employer. Rather, the LLC would need to adopt the plan, and the plan would need to consider for coverage under the plan all other employees of the LLC.  That may consist of the other partners, and/or non-partner employees of the LLC.

What Are the Most Common Errors We See With Solo 401(k) Plans?

• Lack of executed plan document:
  • The plan document serves as the very foundation of a qualified retirement plan, and without a fully executed, dated, up-to-date document, the plan’s trust will fail to meet the minimum “qualification” requirements for tax favored status.
  • The plan document sets forth several operational rules of the plan, including when an employee becomes eligible to participate in the plan, how contributions are allocated among the participants, how the participant vests in those contributions over time, etc., etc.
  • The most commonly used IRS pre-approved documents available from certain financial institutions, attorney’s and third-party administrators must be “amended and restated” once every 6-years to incorporate various changes that may have occurred in the law.
• Failure to file Form 5500s when required:
  • Failure to file Form 5500 when the plan’s assets reach $250,000. Unfortunately there’s nothing that really prompts this to occur, so it is easily missed.
  • Failure to file Form 5500 when the plan is terminated. The plan is NEVER exempt from filing permanently, even if the assets have never reached $250,000.  Again, there’s nothing that really prompts this to occur, so again it is easily missed.
  • As a best practice, here at Pinnacle Plan Design we’ve taken advantage of the opportunity to file the one-participant plan via Form 5500-SF rather than Form 5500-EZ, because it allows us to file the return electronically. In doing so, we have an assurance that the return has indeed been filed and received by the IRS.  With the election made on the Form 5500-SF to indicate it is a one-participant plan, only limited questions are required to be answered and the document is not posted on EFAST2 for public viewing.
• Failure to “convert” operations as an “employee benefit plan” when an employee becomes eligible to participate in the plan:
  • Although a 401(k) plan may be adopted prior to there being any eligible employees, that could certainly change at some point. Unless the plan is formerly “frozen”, or amended to freeze contributions, the eligible employee must, at a minimum, be provided with the opportunity to contribute to the plan.
• Failure to limit contributions to maximum limitations:
  • Generally when your tax accountant is involved in calculating the contributions, this will go well. However, in our experience, the accountant generally relies on verbal communications with the self-employed individual.  Obviously that works well when the information is properly communicated.  Recently a one-participant plan came to us for restatement of the plan document and on-going administration, and it was discovered that the plan was being treated as a 401(k) plan, yet was simply a profit sharing plan with no 401(k) provisions.
• Failure to provide minimum required contributions to eligible employees.
• Failure to issue required minimum distributions (RMDs) upon attainment of age 70 ½.
• Failure to properly track the plan’s assets by “money type”:
  • Although it is perfectly acceptable and a common practice to hold 401(k) elective deferrals and employer matching or profit sharing contributions in one brokerage account, realize that each “type” of money contains different characteristics affecting the permissible timing of withdrawals as well as vesting provisions.  Therefore, it is important to track the contributions and gains or losses related to each from year-to-year.

• Failure to properly value non-traditional assets:
  • This impacts the $250,000 filing waiver and Form 1099-R reporting on distribution values.
• Failure to properly document and repay participant loan:
  • This often results in a failure to properly issue Form 1099-R upon default of the participant loan.
• Failure to properly register non-traditional assets in the name and tax ID assigned to the plan.
• Failure to redirect income/distributions from non-traditional investments to other plan accounts, or to pay expenses related to non-traditional investments (capital calls, real estate taxes, etc.) from plan accounts.
• Lack of RMDs due to a lack of liquid investments.

What Are the Alternatives to Solo 401(k) Plans?

• SEP (Simplified Employee Pension)
  • This is not considered a qualified plan under 401(a), but rather an Individual Retirement Account evidenced by a more brief and inexpensive “plan document” requirement.  Many financial institutions will provide the required documentation, or the IRS’ Form 5305-SEP may be utilized.  The deduction limitations are the same as under a qualified retirement plan (i.e. 25% of eligible compensation).  No elective deferral contributions are permissible in this type of IRA.
• SIMPLE IRA (Savings Incentive Match Plan for Employees)
  • This is also not considered a qualified plan under 401(a), but rather Individual Retirement Accounts evidenced by a plan document.  This type of plan is used more frequently by small employers with employees.  The deduction limitations are irrelevant here, as the plan provides for required employer contributions of set amounts, with no employer discretion to provide anything more or less.  Eligible employees may also contribute via elective deferral contributions, yet at lower limits than offered in a 401(k) plan.

When Does One of the Alternative Plans Make More Sense than Adopting a Solo 401(k) Plan?

Depending on the amount of earned income or W-2 wage, one plan may make more sense than another.  Based on the 2016 compensation and contribution limitations:

W-2 Wage *	SEP	SIMPLE IRA	401(k)/Profit Sharing Plan
$100,000, age 50 or older	$25,000 employer contribution	$12,500 elective deferral plus $3,000 catch-up plus $3,000 “employer” contribution	$18,000 elective deferral plus $6,000 catch-up contribution plus $25,000 “employer” contribution
$130,000, age 50 or older	$32,500 employer contribution	$12,500 elective deferral plus $3,000 catch-up plus $3,900 “employer” contribution	$18,000 elective deferral plus $6,000 catch-up contribution plus $32,500
$212,000, age 50 or older	$53,000 employer contribution	$12,500 elective deferral plus $3,000 catch-up plus $6,360 “employer” contribution	Same as SEP, unless “catch-up” eligible to make additional $6,000 elective deferral
When income is less than $212,000, the 401(k) plan will always have higher contribution opportunities than a SEP. When income is equal to or great than $212,000, the 401(k) plan contribution opportunities will be greater only if individual is catch-up eligible. *Note that “earned income” other than W-2 wages are subject to a circular formula to determine the compensation on which the contribution is calculated.

 

What Are the Most Recent Agency Initiatives Related to Solo 401(k) Plans?

• The IRS had issued letters to potential one-participant plans inquiring as to their Form 5500 filings. In connection with this initiative, they offered to waive penalties associated with the failure to file their Form 5500 as long as filings were brought up to date by June 2, 2015.  Shortly thereafter, the IRS also extended to these plans a program similar to the DOL’s Delinquent Filer Voluntary Correction Program (DFVCP).  Under the IRS’ program, multiple year historical filings may be made at a cost that is greatly reduced from the otherwise applicable penalties for failure to file.  Note that the program is available for use only when the employer has not already been notified of a failure to file.
• Failure to remit 945 tax, or the federal withholding from eligible rollover distributions not rolled to an IRA or another qualified retirement plan. The IRS also did outreach based on tax IDs assigned to qualified retirement plans.
• New compliance questions on Forms 5500 were initially reflected on the 2015 Forms 5500, but the questions were initially indicated to be “optional”. However, preparers were later notified that the questions were to be disregarded entirely for 2015.  It is anticipated that the new compliance questions will be required commencing with the 2016 Form.  Included are questions related to the dates of adoption of amendments to the plan document, the plan document’s IRS approval letter, whether an RMD was required, whether any in-service distributions were issued, etc.  Therefore, now is the best time to bring any unresolved issues up-to-date.

What Services Does Pinnacle Perform for a Solo 401(k) Plan?

• Plan Document Preparation
  • While a plan document offered by a financial institution may be cheap, the reasons why it might not be as advantageous as a robust plan document from Pinnacle are as follows:
    • The financial institution may require that ALL plan assets be held at the financial institution from which the document is obtained. Often times we see one-participant plans invested in other non-traditional investments that may not be permissible in the financial institution’s plan.
    • The plan’s assets may move from time to time as they follow a move of a financial advisor. This is where we most often find that a plan document has not been properly amended for changes that have occurred in the law, as notification of the required changes may not be received.
    • The document may be so “generic” as to allow more immediate eligibility to participate in the plan by any newly hired employees.

• Annual Administration Services
  • Calculation of maximum contribution limitations
  • Tracking assets by money type
  • Prompting RMD requirements
  • If applicable, preparation of Form 5500-SF
  • If not applicable, notification of eligibility to waive Form 5500 filing requirement
  • Tracking of any participant loan

T.J. Orr is a partner at Pinnacle Plan Design. 

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Pinnacle Plan Design is a third-party administrator (TPA) for employer-sponsored qualified retirement plans. We specialize in retirement plan design, administration and actuarial consulting for 401(k)/profit-sharing plans, defined benefit plans, cash balance plans, and 403(b) plans. Pinnacle Plan Design proudly serves businesses nationwide.