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Solo 401k Eligibility

SECURE Act: New part-time eligibility rules for 401(k) plans

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In 2020 and prior years, Solo 401k plans could exclude part time W-2 employees who worked less than 1,000 hours from participating in a 401k plan. This all changes for both full-time employer 401k plans and owner-only Solo 401k plans starting on January 1, 2021.

The SECURE Act
Stemming from the Setting Every Community Up for Retirement Enhancement Act (SECURE Act), Solo 401k plans will be impacted by the three years, part-time (500 but less than 999 hours) employee rule that will allow part-time employees to choose to make employee elective contributions to the company-sponsored 401k plan.

2020 and Prior
Before the passage of the SECURE Act, non-owner W-2 employees (common law employees) who worked less than 1,000 hours during the plan year could be excluded from having the option to participate in a 401k plan and thus did not impact the owner-only businesses from setting up a Solo 401k plan. Only those years after 2021 are counted.

2021 and Future Years
The three year provision is effective for the 2021 plan year, but years before 2021 do not count for purposes of counting the three-year eligibility.

Long-Term, Part-Time Employee
A W-2 employee will be deemed a long-term, part-time employee once he or she completes 500 hours of service/work in three consecutive 12-month periods.

Does the SECURE Act nullify the 1,000 hours of service per year rule?
No. 401k plans must now have dual eligibility requirements. An employee can become eligible for the plan by fulfilling either: (a) the one year of service requirement (1,000 hours of service in one year), or (b) the three years of service requirement (at least 500 hours of service for three consecutive years).

Controlled group

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I expect to own a separate business with full time employees. Will this affect my existing Solo 401k for a business I own where I'm the sole owner and the only employee?

Answer:

One must first determine whether you are part of the CONTROLLED GROUP RULES set up by the IRS and Department of Labor. The Controlled Group Rules were created essentially to protect employees from a business owner or executive establishing a separate 401(k) plan for another business and thereby not offering those employees the benefits inherent in participating in a 401(k) qualified retirement plan.

The IRS and Department of Labor were concerned that business owners wanting to establish a qualified retirement plan, but not wanting the burden of having to provide benefits to all eligible employees, would create a new separate business which would have no employees other than the owner or executive and then adopt a Solo 401(k) plan for that company. Since the new company would be wholly owned by the business owner and would not have any full-time employees, the business owner could establish his or her own Solo 401(k) plan and, thus, enjoy all the benefits of having a qualified retirement plan without having to provide any benefit to the employees from the other company.

WHAT IS A CONTROLLED GROUP OF CORPORATIONS?

As per Internal Revenue Code Section 414, a controlled group is any two or more corporations connected through stock ownership in any of the following ways:

Parent-subsidiary group

  • 80% of stock of each (subsidiary) corporation is owned by another member of the group
  • Parent corporation must own 80% of the stock of at least one of the other members of the group
  • The rules are subject to the stock attribution rules under Internal Revenue Code Section 318

Brother-sister group

  • The same five or fewer individuals own at least 80% of the stock of the corporations
  • “Individual” includes ownership by an estate or trust
  • “Ownership” includes having a controlling interest and effective control of the corporations
  • The rules are subject to the stock attribution rules under Internal Revenue Code Section 318

Combined group

  • Combination of a Parent-subsidiary and a Brother-sister group

In certain situations it might be difficult to determine the controlled group status. Therefore, we recommend that you consult experienced CPA and/or a qualified ERISA attorney.

The resource below will be helpful:

https://www.law.cornell.edu/cfr/text/26/1.1563-1

What if I want to hire employee(s) in the future?

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I know the Solo 401k is only for self-employment businesses without employees (other than the owner). What if I want to hire employee(s) in the future?

Answer:

The Solo 401k plan is an Owner-Only plan. You cannot set up a Solo 401k/ Owner-Only plan if you have full-time employees or long-term part-time employees (Long-term part-time employees are defined as those who work over 500 hours within a 12-month period for 2/3 consecutive years). The only exception is a spouse who also works for the business.

If you would like to hire employee(s) in the future, please remember that the employee must work under 500 hours in a 12-month period. Otherwise, you may become ineligible for the Solo 401k plan.

To ensure compliance, it is important that you, as the employer, do two things:

  • Notify Sense Financial Services immediately if you have hired an employee (other than your spouse). Having an employee will require your plan documents to contain eligibility criteria. Unless you have notified us, your plan documents do not contain this eligibility criteria. It is important to notify us as soon as possible so your plan documents can be updated to reflect this change.
  • Keep track of the number of hours that the employee works in a 12-month period. Once the employee hits 500 hours within a 12-month period and does so for 2/3 consecutive years, he/she automatically becomes eligible for the Solo 401k plan. This causes you to become ineligible for the Solo 401k plan.

If you do hire full-time employees who meet the eligibility criteria, you must offer them the same benefits (e.g. a 401k plan). The Solo 401k is not set up to have any other employees besides the owner and his/her spouse. With full-time employees, you will have to terminate the Solo 401k plan and switch to a 401k plan which can include employees.

If you decide to terminate your Solo 401k plan, you will have to file a final 5500-EZ form with the IRS and transfer the funds out to another qualified plan. If you have assets in your Solo 401k plan such as real estate, you will need a self-directed type of plan or account to transfer your funds into. Most retirement plans will not accept assets such as real estate.

Self-directed 401k plans which include employees are expensive to maintain. Though it is possible, you may not want to go that route. Your two best options would then be:

  • Terminate the Solo 401k plan.  Set up a self-directed IRA and transfer all of your assets including real property into it.
  • Freeze your Solo 401k plan when you have eligible employees. Freezing a plan allows you to maintain your investments and continue to manage it as the trustee. However, you can no longer contribute to the plan. Freezing the plan is meant to be a temporary measure.

What happens when my spouse stops working for my business?

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Answer:

If you and your spouse work in your business together and your spouse stops working in the business, (s)he can still participate in the plan in terms of directing their existing assets in the plan. Your spouse has all the rights of the participant except the ability to make contributions into the plan.

Your spouse does not need to transfer their funds out of the plan and stop being a participant. However, (s)he can not make contributions.

Solo 401k Plan and full time employee other than the plan owner and their spouse

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For my Solo 401K plan, if I have more than one employee besides me and my wife, do I have offer them a plan as well?

Answer:

You and your wife are considered owner-employees of the plan.  If you have any other full-time employees (working over 1,000 hours per year), they cannot participate in this plan. You cannot have a Solo 401k if you have full-time employees working for you. You can have independent contractors working for you. Please consult your tax advisor, CPA or  legal counsel to determine how you would need to structure the roles you need to fill where you’re hiring people to be independent contractors.

Can you open a Solo 401K when you’re 70 years old?

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My parents are selling their business and retiring. They're going to make some money on the sale and are worried about taxes. They have earned income for this year to date from the business, so I am wondering if they can contribute the max to a newly opened Solo 401K and at least get the tax deferred until later. Or does it not make sense because they'll need to make mandatory withdrawals since they're 70. Is this something they should try to pursue?

Answer: Unlike a Traditional IRA which the regulations do not permit contributions once the owner reaches age 70 1/2, the solo 401k is not subject to this restriction. Therefore, the solo 401k participant can open a solo 401k and make contributions past age 70 1/2; however, he or she must commence taking required minimum distributions (RMDs) at age 70 1/2. Be aware of confusion surrounding the RMDs rule that allows participants in full-time employer plans who do not own 5% or more of the employer to delay taking RMDs past age 70 1/2 as long as they are still working. This exception to the RMD rules does not apply to solo 401k plans because the solo 401k owner is a 5% or more owner.

What happens if sponsoring company shuts down

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What are the options for my Solo 401K plan if the company that sponsors the plan shuts down (I am no longer self-employed)?

Answer:

A 401k plan is an employer-sponsored plan, therefore in order to maintain your Qualified Retirement Plan, you must maintain a small business or some sort of self-employment activity in some legitimate form. If you shut down your current entity, but continue another type of self-employment activity and make earnings then we can amend the plan to reflect the change.

If, let's say, you quit all of your self-employment activity and get a full-time job, and that is the only income you have (W2 wages working for someone), then the Qualified Plan must be terminated. You will then have the option of rolling over your account into an IRA.

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