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Solo 401(k) is a "Qualified" Retirement Plan

Don't Wait for Assets to Exceed $250,000 Before Filing Form 5500 - December 8, 2009

By Barry R. Milberg

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ARTICLE SUMMARY

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Pick your favorite name: Solo 401(k), Individual(k), Mini(k) Plan, Owner-only plan or One-participant plan (the legal name); whatever label you choose, they're all "Qualified" Retirement Plans.  Therefore, in the real world of pension compliance services, they're all Profit Sharing Plans with 401(k) features.

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This portends that owner-only businesses and self-employed individuals who sponsor these plans must follow the same rules, and more that Microsoft must follow regarding its own 401(k) plan.  FYI, the "more" refers to the "top heavy" plan qualification requirements.  And for the uninformed reading this, top heavy does not mean failing the 401(k) nondiscrimination test.

 

Barry Milberg quoted on Forbes.com  Learn more

LEGAL DEFINITION

A "ONE PARTICIPANT" Plan is a "Qualified Retirement Plan" that:

a) provides benefits to the 100% business owner only (or the 100% owner and his/her spouse); or

b) provides benefits to one or more partners in a business partnership only (or partner(s) and spouse(s) only in a partnership). 

This applies to all business entities including: C or S Corporations, Sole Proprietorships, Partnerships, LLCs, or LLPs.

Yes, the rules say these plans do not have to file Form 5500EZ until total assets exceed $250,000; however... 

If you believe that's in the best interest of the business owner or self-employed individual responsible for maintaining a compliant plan, I have a bridge in Brooklyn to sell you.  Hyperlink to bookmark in article below: Form 5500EZ

Before reading about the technical compliance facts about these plans discussed below, I suggest you read Ashlea Ebeling's consumer-friendly article on Forbes.com: "Deadline For Self-Employed Savers" in which yours truly is quoted on the benefits of these plans.  Then ask yourself why many institutional providers no longer offer these plans; and why those that do rarely offer the ability to obtain loans or to make after-tax Roth contributions? 

I suspect (but can't confirm) they no longer offer these plans since most plan accounts are too small to be profitable.  Consider that perhaps they are too small because this plan type is no longer the appropriate plan (or perhaps never was)?  As to loans and Roth features, I suspect the providers realize that even the "Simplest" plans are not really all that simple to understand and operate in accordance with the rules; so why complicate things if there's no profit in it?

Selecting the wrong plan can burden the owner-only business or self-employed individual with unanticipated compliance requirements, limit plan contributions (and the resulting benefits at retirement), or lose estate planning opportunities (like those afforded by a Roth 401(k)). 

Access Case Studies that compare the benefits of SIMPLEs, SEPs and Solo 401(k)s

Article: "Odds Against Choosing the Optimum Plan"

Article: "Roth 401(k): An Extraordinary Retirement and Estate Plan Opportunity"

Bottom line:  Before you choose (or recommend) a particular plan, consider all available options and weigh all costs...  like the cost to engage a pension third party administrator, and the cost of losing future benefits at retirement.

Solo 401(k) is a "Qualified" Retirement Plan

A Qualified Retirement Plan is an employer sponsored retirement plan that satisfies the requirements of Internal Revenue Code Section 401(a) in both its form and operation

Adoption and maintenance of a compliant plan document typically satisfies the form requirement; operating the plan in accordance with the provisions of the plan document, applicable law and regulations typically satisfies the operation requirement.

If the plan is "qualified," the owner-only business or self-employed individual is entitled to a myriad of benefits and features including but not limited to:

  • Tax deductions for contributions made to the plan

  • The tax-free growth on plan investments

  • The ability to transfer the accumulated benefits at retirement to an individual retirement account (IRA) or other qualified retirement plan

Failure to comply with the aforementioned standards may "disqualify" the plan resulting in a potential loss of the plan’s favorable tax related benefits. 

Commentary  Regarding the operation of your plan in accordance with the provisions of the plan document, applicable law and regulations...  Want to know when you (as the employer) are obliged by regulations to contribute your own (as a W-2 employee) 401(k) deferrals?  Here's what one of the world's largest mutual fund providers says on there website:

"Contribution Deadline  The deadline to deposit salary deferrals... is generally as soon as possible, but no later than the 15th business day following the month in which salary deferrals are withheld."

To learn more about the actual deadline: Participant Contributions are "Plan Assets" After 7 Business Days

Bottom line: You get what you pay for.

Form 5500EZ Filing Exemption if Assets less than $250,000

Consider the following...

  • Filing the Form 5500EZ starts the statute of limitations regarding plan qualification (3-year vs. no statute regarding taxes and penalties due if the plan is disqualified).

  • The Form 5500EZ filing requirement, or lack thereof, should not be confused with the law's qualification requirement to maintain the "form" of the plan.  For example, an owner-only business or self-employed individual establishes a Solo 401(k) plan through institution A in 2006, then institution B in 2007, then institution C in 2008, the the business owner or self-employed individual is now responsible for maintaining the "form" of all three plan documents in writing (unless the plans are merged, or are an amendment and restatement of the prior plan).  This means that every time plan amendments are required (historically ever year or two), the plan sponsor (the owner-only business or self-employed individual) must amend all 3 plans.

  • If the plan assets are held at multiple institutions, who monitors when the assets achieve the $250,000 threshold?

  • Whether the plan has in excess of $250,000 or as little as $5,000, the owner-only business or self-employed individual plan sponsor is required to file a Form 5500EZ for the year in which a plan is terminated.

  • If the trust assets are not reconciled annually, how would the eventual preparer of the Form 5500EZ timely determine if the owner-only business or self-employed individual "operated" the plan in accordance with the applicable rules under the law and permitted by the particular plan relative to the use of plans funds?  For example, were contributions made timely?  Were there any distributions during the plan year?  If yes, for what?  A loan...  does the plan permit loans, if yes, was it properly documented; repaid timely?  Etc., etc., etc.

Commentary The retirement plans available for owner-only businesses and self-employed individuals are numerous and far more complex than even the most well informed consumer might suspect.  Selection of the right plan type, benefits and features portends the plan's ultimate success or failure. Therefore, unless they are familiar with all of the available plan types and features, odds are that they will not choose the optimum plan for their individual situation. See article: Odds Against Choosing the Optimum Plan

Plans for Owner-only Businesses and Self-employed Individuals

SEP, SIMPLE, or SOLO 401(k)?  SEPs and SIMPLE plans are typically "IRS model plans" (Form 5305-SEP and Form 5305-SIMPLE).  By definition, an IRS model plan's benefits and features are predetermined by the IRS; therefore, they do not require formal plan documents or compliance services.  However...

The owner-only business or self-employed individual is solely responsible for monitoring compliance with the rules that govern each respective plan type which include but are not limited to determination of the:

  • Eligibility for Plan Participation (age and service requirements)

  • Eligible Compensation (is it considered "earned income" for retirement plan purposes?  Is the source of the income from a "related" or "affiliated" party?)

  • Compensation Limit (e.g., the compensation limit for a SIMPLE IRA that elects to use an employer match is not the same as the compensation limit for a SIMPLE IRA or SEP that elects to use an employer contribution.

  • Contribution Limit (regarding W-2, K-1 or self-employment income from multiple sources, do you really believe your software program can calculate this important limit?)

Commentary  Selecting the wrong plan can burden a self-employed individual with unanticipated compliance requirements, or it can limit him/her from making higher deductible contributions (or nondeductible Roth 401(k) contributions) that translate into the loss of hundreds of thousands of dollars at retirement, or the estate planning opportunities afforded by the Roth 401(k). 

Access Studies that compare the benefits of SIMPLEs, SEPs and Solo 401(k)s

Article: Odds Against Choosing the Optimum Plan

Article: Roth 401(k): An Extraordinary Retirement and Estate Plan Opportunity

Bottom line:  Before you choose a particular plan, consider all available options and weigh all costs...  like the cost to engage a pension third party administrator, and the cost of losing future benefits at retirement.

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© 2009 Milberg Consulting LLC  All Rights Reserved

The information provided is intended as a general resource, not as investment or retirement planning, or legal plan compliance advice or counsel.  If you consider any actions discussed in this update, we suggest that you consult a qualified planning, tax or ERISA professionalERISA Expertise LLC and Barry R. Milberg do not warrant and are not responsible for any errors and omissions from this update.  Any tax advice included in this written or electronic communication is not intended or written to be used, and it cannot be used, by the taxpayer for the purpose of avoiding any penalties that may be imposed on the taxpayer by any governmental taxing authority or agency.

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