The role of the plan trustee: Solo 401k | Individual 401k | Self Directed 401k

A Solo 401k or Individual 401k must have a named trustee, and all plan assets must be held in a trust. The trustee holds the Solo 401k or Self Directed 401k plan non cash assets (e.g., real estate purchase documents, private investment certificates and forms, promissory notes or trust deed documents, to name a few), and ensures the cash assets are deposited in the Solo 401k’s checking account through the bank.  Additional responsibilities assigned to the trustee include managing the plan’s investments, although this function can be delegated by trustee to another individual such as an investment manager, or financial professional. Please refer to the following regulation for more information on this: [ERISA 403(a), 29 U.S. C. 1103 (1974)]
What’s more, the Individual 401k or Solo 401k plan trustee is usually responsible for processing contributions and investment transactions, disbursing funds or paying fees and expenses of the Solo 401k trust, and filing Form 1099-R (only required if distributions from the Solo 401k are processed or if assets are rolled over to an IRA), and Form 5500 once the Solo 401k reaches $250,000 in value (this value applies to cash and noncash assets combined).

Basic Trust Document Requirements and Advantages: Self Employed 401k | Solo 401k | Self Directed 401k

Self Employed 401k plans, like other types of qualified plans, must meet the basic qualification requirements for retirement plans as outlined in Code Section 401(a).

Advantages afforded to a Solo 401k plan that is qualified

The many advantages of having a qualified Self Directed 401k plan or Solo 401k include the following:

1. The employer can take a tax deduction for making contributions to the self employed 401k plan.

2. Investment earnings of the Solo 401k plan's assets are not subject to current taxation.

3. As a Participant or Trustee of the plan, you can avoid current taxation of amounts allocated to the self directed 401k.

4. As a Participant/Trustee of the plan, you may roll over plan benefits from or to other employer-sponsored plans or IRAs  tax-free.

The Solo 401k plan must be in writing

Some states recognize the existence of an oral trust; however, a Solo 401k or self employed 401k plan will not be considered qualified unless it is established and operated in accordance with a definite written program. This is outlined in the following regulation- [Treas. Reg. 1.401-19(a) (2)]. The Solo 401k written document must include all provisions essential for qualification as outlined in [Rev. Rul. 74-466, 1974-2 C.B. 131]. The Solo 401k Plan document serves to define the rights and obligations of the plan sponsor, Participant/Trustee, and beneficiaries. It also must be reviewed by the IRS, which it then issues a determination letter confirming that the plan is tax-qualified.

Employer may establish a 401k plan that covers only one participant: Self Directed 401k | Solo 401k

Nothing in the law prohibits an employer from establishing a 401k plan that covers only one participant. In fact, because elective deferrals (the maximum elective deferral is also referred to as employee contribution and for 2011 the cap is $16,500) do not count toward the Code Section 404 deduction limit (25 percent of compensation also known as employer contributions), and because that limit is based on compensation before reduction for elective deferrals, a greater amount can be contributed to a one-person 401k also know as a Solo 401k or Self Directed 401k plan that can be contributed to a profit sharing plan.

Example 1. In 2011, The XYZ Corporation has only one employee, Jack, who has annual pay of $110,000. If XYZ Corporation adopts a profit sharing plan, the maximum amount that can be contributed and deducted for Jack is $27,500. On the other hand, XYZ Corporation would be better off establishing a Solo 401k plan to which it can contribute the same $25,000, but to which Jack can also contribute $16,500 of elective deferrals for a total contribution of $44,000.

Example 2. The facts are the same as those in Example 1 except that Jack’s compensation in 2011 is $50,000. If XYZ Corporation makes a contribution for Bill to a profit sharing plan, the contribution would be limited to $12,500 (25% X 50,000). However XYZ Corporation has the option to contribute the same amount to a Solo 401k plan, which would allow Jack to contribute an additional $16,500.

Sole Proprietor Plan Types: Owner only 401k or Solo 401k vs. SEP and SIMPLE

A sole proprietorship is the simplest business type—and unincorporated business entity owned by one person. While sole proprietorships can have employees, the majority of entities are owner-only business. The simplicity of a sole proprietorship’s business structure calls for a retirement plan that is specific to sole proprietor or has its best interest. Sole proprietors generally require a retirement plan that is cost-effective for a small business, easy to administer, and beneficial from an income tax perspective.

Sole proprietors typically open one of the following types of retirement plans. Each plan type offers a different approach to retirement plans saving.

Simplified Employer Pension (SEP IRA)

SEP IRA plans allow sole proprietors to shield a substantial portion of employer income from taxes each year (25% of compensation). The contributions are also discretionary, which means you don’t have to make a contribution every year. One of the main differences between a SEP plan and a profit sharing plans is that SEP contributions are made to the sole proprietor’s Traditional IRA rather than to a plan account.  

Saving Incentive Match Plan for Employers (SIMPLE IRA)

SIMPLE IRA plans are also effective and simple to administer retirement options for sole proprietors. SIMPLE IRA plans allow the sole proprietor reduce his or her taxable business income by allowing for the deferral of income on top of a required match contribution.

Solo 401k or Individual 401k or Individual K or Solo K
A sole proprietor with no employees (other than his spouse) also has the option of establishing an owner only 401k plan also known as a Solo 401k or Self-Directed 401k. While owner-only 401k or Solo 401k plans have been available since the inception of the 401k plan, there had been no persuasive tax reason for an owner-only business to establish such a plan. Reason being, other plan types offered the same or larger tax benefit or savings limits, without the added complications. This all changed, however, with passage of the Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA), which changed the way deferrals are included in determining the employer’s deductible contribution. This change resulted in higher contribution amounts in a cost-effective, less complex plan. Also known as Solo k or self-employed 401k or Single K, Solo 401k plans have gained popularity since EGTRRA provisions became effective in 2002.

Process for Terminating or Closing a: Solo 401k | Solo K | Individual 401k | Individual K

Does a Solo 401khave to be maintained indefinitely? Although all qualified retirement plans, including Solo 401k plan or Individual K, are required to be established with the intention of being continued indefinitely, the IRS has outlined procedures for terminating a Solo 401k or Solo K.

What's the IRS required process for terminating a Solo 401k? After the assets have been distributed (e.g., taxes are paid on distribution or assets have been transferred to another 401k or IRA), a Final Form 5500-EZ, Annual Return of On-Participant (owners and Their Spouses) Retirement Plan, must be filed with the IRS. See IRC Sec. 6058a.

IMPORTANT:In the year in which final distribution occurs, even if the assets are under $250,000, Form 5500-EZ is always required, even if the employer has never filed one before.

What's the deadline for distributing all assets from a terminating Solo 401k? All Solo 401k plan assets generally must be distributed within one year of the Solo 401k termination date.

What's the due date of the final Form 5500-EZ? The final Form 5500-EZ is due at the end of the seventh month following the month in which all Solo 401k plan assets are distributed.

Who Must File Final Form 500-EZ?

The plan administrator or employer/Trustee is responsible for filing the annual 5500 series return.

Is a Final Form 1099-R, Distributions From Pensions, Annuities, Retirement or Profit-Sharing Plans, IRAs, Insurance Contracts, etc., required when closing out Solo 401k?

Yes a final Form 1099-R must be filed with the IRS when terminating a Solo 401k or Solo K.

Investing in Life Insurance with: Solo 401k| Individual 401k| Solo k| Individual K

Though restricted, you may use your Solo 401k to invest in Life Insurance. This makes sense in the following cases:

·         You may not otherwise qualify for life insurance because of health reasons;

·         don’t have other disposable funds; or

·         want more protection for your beneficiaries.

General Guidelines for investing in Life Insurance with Solo 401k: In general no more than 50% of Solo 401k or Individual 401k plan contributions may be used to purchase “whole” life insurance (i.e., policies with both nondecreasing death benefits and nonincreasing premiums), and no more than 25% may be used to purchase term or “universal” life insurance.

Different treatment for Solo 401k contributions used to purchase life insurance: when a self-employed business owner invests her Solo 401k in Life Insurance, she does not receive a tax deduction for Solo 401k contributions attributable to the purchase of a life insurance benefit, therefore, she does not pay taxes on P.S. 58 costs (that is, life insurance premiums) for the year of contribution. By denying the self-employed individual the Solo 401k contribution deduction, she is effectively including the PS-58 costs in income like the common-law employee.  

Issuing life insurance policy: A group or individual life insurance policy purchased by the Solo 401k Plan may be issued on the life of an Owner-Employee, an Owner-Employee’s spouse, an Owner-Employee’s child or children, a family member of the Owner-Employee, or any other individual with insurable interest.

Ownership of Life Insurance Policies: The Trustee of the Solo 401k is the owner of any life insurance policies purchased under the Solo 401k plan. Further, any life insurance policy purchased under the Solo 401k Plan must designate the trustee as owner and beneficiary under the policy. The insurance premiums are paid with funds from the Solo 401k’s checking account.

Reasons not to invest Solo 401k plan assets in life insurance: Although IRC §501(a) provides tax-exempt status to a qualified plan, including a Solo 401k, resulting in tax-deferred investment accumulation on the Solo 401k plan assets, a life insurance vehicle is tax-deferred on its accumulation outside of the plan as well. As such, the assets in the Solo 401k plan that are used to purchase life insurance are not getting any special income tax benefit on the accumulation in the contract by being held in the Solo 401k or Individual K plan.
Less Solo 41k funds to invest: The purchase of life insurance will reduce the amount available for investing in other assets such as real estate. Although life insurance may have an investment element (i.e., cash value accumulations), you may be foregoing higher returns by not investing all your Solo 401k plan in other investments.

Solo 401k | Individual 401k | Solo K: Contribution Deadlines That Fall on Weekend or Holiday

If the due date of the employer’s tax return for making the Solo 401k annual, tax-deductible contribution falls on a holiday or weekend, then the contribution due date is the next business day. For example, the due date for a sole proprietor’s tax return for a taxable year ending December 31, 2011, normally would be April 15, 2012; however, because that date is a Sunday, the due date will be April 16, 2012. Since a Solo 401k plan contribution made on April 16, 2012, falls on the deduction deadline for the year ending December 31, 2011, it is deductible in that prior year.

Rule Also Applies to Extensions: The weekend/holiday rule also applies to extensions of the tax return due date. For instance, if a corporation obtained the 6 month extension on its tax return for a taxable year ending December 31, 2011, the extended due date normally would be September 15, 2012, but because that date is a Saturday, the extended due date will be September 17, 2012. As such, a Solo 401k plan contribution made on September 17, 2012, would be within the allowable deduction period for the taxable year ending December 31, 2011.
MPORTANT: The Solo 401k | Individual 401k | Solo 401k| must be in existence by the end of taxable year for which deduction is first allowed. Simply put, a deduction is not allowed for a prior taxable year if the Solo 401k plan is not established by the end of that taxable year.

EXAMPLE: Establishment of Solo 401k Plan. Corporation Y is a calendar year corporation. It establishes a Solo 401k plan on February 1, 2011. The plan cannot be made effective for the taxable year ending December 31, 2010, to obtain a deduction  for 2010, because the plan is established after the close of the taxable year (i.e., after December 31, 2010).

Note: Although the Solo 401k plan must be established by the end of the taxable year, it is not required to be funded by that date.  

Solo 401k | Solo K | Individual 401k: Annual Contribution Deadline Depends on Type of Employer

When the employer is a corporation, the Solo 401k contribution deadline is based on the due date of the tax return (Form 1120) that is filed by the corporation for the taxable year. See chart below.

When the employer is a partnership, the applicable due date is for the tax return (Form 1065) filed by the partnership for the taxable year, not the individual tax returns of the individual partners.

When the employer is a sole proprietorship, the applicable Solo 401k contribution deadline depends on the tax return (Form 1040) due date, filed by the sole proprietor. Note that a sole proprietor's trade or business income is reported on Schedule C of Form 1040.

A limitedliability company (LLC) will file Form 1120 or Form 1065 (or Form 1040, if there is one owner), depending if it has elected to be treated as a corporation or an unincorporated entity for federal tax purposes.

The below table lists the filing deadlines for calendar year entities, and is a good source for determining applicable Solo 401k or Individual 401k contribution deadlines:

Employer Type*	Tax Return	Filing Deadline	Extended Deadline
Corporation	Form 1120	March 15	September 15
LLC Taxed as Corp.	Form 1120	March 15	September 15
Partnership	Form 1065	April 15	October 15
LLC Taxed as Part.	Form 1065	April 15	October 15
Sole Proprietorship	Form 1040	April 15	October 15
*Calendar year tax filer

EXAMPLE: Individual Partner Extends Her Return

Partnership X is owned by Ed and Jane. The tax return (Form1065) for 2010 tax year is filed on time. However, Jane extends her personal tax return until August 15, 2011. The partnership must make the contribution for Jane to the Partnership X Solo 401k plan by the due date of the Form 1065, regardless of the due date of Jane's personal return, in order to deduct the Solo 401k contribution for the 2010 tax year.

Process for Moving Assets Between Solo 401k or Individual 401k or Individual K Plans

The distributing Solo 401k or Self-Directed 401k may process the direct rollover/transfer to another Solo 401k or Individual K plan in any one or combination of the following methods in accordance with Treas. Reg. 1.401(a)(31)-1, A-3.

1. Issue check directly to the Solo 401k or Individual 401k plan that is receiving the rollover.

EXAMPLE: Jane Do Solo 401k Trust, f/b/o Jane Do, Trustee

2. A wire transfer of the funds to the eligible Solo 401k or Self-Directed 401k that is receiving the rollover.

EXAMPLE: Wiring instructions are submitted to releasing Solo 401k/Individual 401k custodian by new bank or brokerage firm holding new Solo 401k/Individual 401k and funds as subsequently wired.

3. Issue a check to the participant/trustee that is made payable to the eligible Solo 401k or Individual 401k plan that is receiving the rollover.

EXAMPLE: John Do Solo 401k Trust, f/b/o Jane Do, Trustee

The only difference here is that the check is mailed directly to the Solo 401k or Individual 401k trustee.

4. Transfer/Direct Rollover of Noncash Assets: To the extent the direct rollover is in the form of noncash assets, title to the property would be directly transferred to the eligible Solo 401k or Individual 401k plan that is receiving the rollover, and the noncash assets would be mailed to the Trustee of the Solo 401k or Individual 401k.

Negative Consequences of investing Solo 401k or Individual 401k Assets in Collectibles

IRC 408(m) provides that the investment by a retirement account, including a Solo 401k or Self-Directed 401k, in personal property items known as "collectibles" subjects the plan's participant/trustee to immediate taxation on the purchase amount.

Collectibles Defined: A collectible is a work of art, rug, antique, metal, gem, stamp, coin, alcoholic beverage, musical instrument, or historical object pursuant to IRC 408(m)(2) and Prop. Treas. Reg. 1.408-10(b). The Treasury may expand this list to include any other tangible personal property.

Treated as Distribution: When the Solo 401k or Self-Directed 401k participant/trustee invests the plans assets in collectibles, the cost of the collectibles is treated as a distribution to the participant/trustee for tax purposes in accordance with IRC 408(m). This deemed distribution for tax purposes applies even though an actual distribution is not available to the participant/trustee of the Solo 401k or Solo k at the time the investment in collectibles is made.

Definition of Cost: The "cost" of the collectible is the fair market value at the time of the acquisition. This is outlined in Prop. Treas. Reg. 1.408-10(e).

Definition of Acquisition: A purchase of the collectible occurs if Solo 401k or Individual 401k acquires the collectible by purchase, exchange, contribution, or any method by which the account directly or indirectly acquires a collectible. This is detailed in Prop. Treas. Reg. 1.408-10(d).

10% premature (under age 59 1/2) distribution penalty applies: Since the acquisition is treated as a distribution for tax purposes, the premature distribution penalty under 72(t) is applicable.

Reported on Form 1099-R. The distribution is reported on a Form 1099-R and treated as if the Solo 401k or Individual K participant/trustee has actually received a distribution.

Exception for investments in certain coins and bullion: IRC 408(m)(3) exempts Solo 401k or Individual K from the collectibles rule any investments in gold, silver and platinum coins, and other coins issued under the laws of any State, and to gold, silver, platinum, or palladium bullion. This has been in effect since January 1, 1998 and is detailed in section 304 of the Taxpayer Relief Act of 1997.

Solo 401k or Individual 401k and Filing Form 1099-R with the IRS

Solo 401k or Self Directed 401k participants/trustees use IRS Form 1096, Annual Summary and Transmittal of U.S. Information Returns, to submit paper Forms 1099-R, Distributions From Pensions, Annuities, Retirement or Profit-Sharing Plans, IRAs, Insurance Contracts, etc., to the IRS.

Filing for Extension for Reporting Solo 401k or Individual 401k Distribution

Form 8809, Request for Extension of Time to File Information Returns, is used to request an extension of time to file Form 1099-R. This request must be submitted by the due date of the 1099-R return. This form may be used to request an extension of time to file information returns submitted on paper to the IRS.

Automatic 30-Day Extension

The automatic extension requirements are outlined in Treas. Reg. 1.6081-8. The regulations allow for an automatic 30-day extension to filers of Form 1099-R, that submit Form 8809 to the IRS by the deadline for filing the 1099-R form. The Solo 401k or Self-Directed 401k trustee/participant that fills out the remaining Form 8809 information properly and files Form 8809 on or before the date prescribed for filing the Form 1099-R to report distributions from their Solo 401k or Individual 401k return will automatically qualify for a the 30-day extension.

Additional 30 Day Extension

One additional 30 day extension may be allowed provided the Solo 401k or Individual K filer submits a request before the expiration of the automatic 30-day extension. To process the request the following applies:

· is submitted on Form 8809,

· provide detailed explanation as to why the additional time is needed, and

· include the filer's (Solo 401k trustee's) signature.

Federal Income Tax Withholding Applicable to Solo 401k or Individual 401k

Since Solo 401k or Solo k distributions are for the most part includible in the taxable income of the participant/trustee, the withholding for federal income taxes applicable to distributions is the responsibility of the Solo 401k or Individual 401k trustee. Consider the following two primary items when determining the proper amount to be withheld from the Solo 401k distribution: 1) the type of distribution the participant/trustee is receiving and 2) whether any part of the distribution includes after-tax contribution amounts or Roth Solo 401k contributions.

Who is Responsible for the Tax Withholding on Solo 401k or Individual 401k Distributions?

Treasury regulations provide that the plan administrator (usually the employer or trustee) is responsible for the withholding on Solo 401k or Individual 40k distributions. This is outlined in Treas. Reg. 35.3405-1T, A-13. The following information is helpful for preparing Form 1099-R:

1. Name, address, and social security number of the payee (Solo 401k Trustee or participant) and the payee's spouse or other beneficiary, if applicable;

2. The existence and amount of any premiums paid for the current cost of life insurance that were previously includible in income;

6. A statement of the reason (e.g., death, disability, retirement) for the payment or distribution;

7. The date on which payments commence and the amount and frequency of payments;

8. The age of the payee and of the payee's spouse or designated beneficiary, if applicable; and

9. Any other information required by IRS Form 1099-R, Distributions From Pensions, Annuities, Retirement or Profit-Sharing Plans, IRAs, Insurance Contracts, etc.

Reporting Distributions from Solo 401k or Individual 401k

When a Solo 401k plan or Self-Directed 401k trustee/participant or beneficiary takes a distribution, IRS reporting applies. This is done through Form 1099-R, Distributions From Pensions, Annuities, Retirement or Profit-Sharing Plans, IRAs, Insurance Contracts, etc. This form is sent to the IRS and the individual receiving the distribution.

Form 1099-R is used to report distributions that a Solo 401k participant intends to roll over. 

A 1099-R is issued for rollover distributions because the Solo 401k participant has the option to spend some of these funds before depositing them to another retirement plan such as a Solo 401k or Self-Directed 401k. Form 1099-R must be submitted to the IRS by February 28, or March 31 if filing electronically.