Solo 401k Laws

Solo 401k Laws | Solo 401k Rules | Individual 401k Law

 

Solo 401k Laws

ERISA

The Employee Retirement Income Security Act of 1974, as amended (ERISA) is the law that applies to retirement plans including Solo 401k. Consisting of four parts or Titles, the enforcement of ERISA is the responsibility of the Department of Labor (DOL) and the Department of the Treasury (the IRS).

Qualified Plan

A qualified plan such as Solo 401k is one that meets the requirements of IRC 401(a). So before you proceed to Open Solo 401k study IRC 401(a) as it contains all the requirements with which a qualified plan and its sponsor must comply to obtain all the available tax advantages of having a qualified plan including Solo 401k.

The following are types of qualified plans: defined benefit plans, profits sharing plans, money purchase plans, 401(k) plans (including Solo 401k or Individual 401k) and stock bonus plans.

Form and Operational Rules

The IRC 401(a) rules must be met in form and in operation. Compliance in form means the Solo 401k plan document encompasses the relevant provisions of IRC 401(a). Treas. Reg. 1.401-1(a)(2) mandates the Solo 401k Plan to be a definite written plan. Not satisfying the form requirement causes the Solo 401k to be disqualified regardless if the Solo 401k plan is operated properly.

IRC 401(a)(1) (Plan Has to be for Employees and The Plan Assets Must Be Held in Trust)

To be qualified, the Solo 401k plan is required to be for the employees of the employer (in the case of the Solo 401k, the business owners or business partner). Therefore, the term employee encompasses a self-employed individual of a sole proprietorship or partnership.

In order to comply with the rules, the Solo 401k plan must be sponsored by an employer. Note that under IRC and ERISA, the word employer has different meanings in both sections.

Employer Defined for Tax Qualification Purposes

Pursuant to IRC 401(a), the employer is any employer (under common law principals) of the employees covered by the plan. The IRS details that a plan including a Solo 401k plan ceases to be a qualified plan when the sponsoring employer goes out of business, unless a successor employer takes over sponsorship of the plan. Such plan is commonly referred to as an orphan plan.

A self-employed individual is an employee of the trade or business with respect to which he or she is a self-employed individual within the meaning of IRC 401(c)(1). Therefore, the self-employed business is the employer that must maintain the qualified plan that covers the self-employed individual. For instance, if the trade or business is a sole proprietorship, then the employer is the sole proprietor (i.e., the sole proprietor is both the employer and an employee of the employer). On the other hand, if the trade or business is a partnership, the individual partners are treated as self-employed individuals, however it is the partnership that is the employer, as such it is the partnership that must establish the plan (i.e., the individual partners are treated as employees but the partnership is the employer).

Employer Defined for ERISA Purposes

In accordance with ERISA 3(5), the employer is “any person acting directly as an employer, or indirectly in the interest of an employer, in relation to an employee benefit plan.” The term also includes a group or association of employers acting for an employer in such capacity. A sole proprietorship or partnership is an employer for ERISA purposes only with respect to its common law employees. Note that for ERISA purposes, neither a sole proprietor nor a partner is treated as an employee.

Assets Required Held in Trust

IRC 401(a)(1) also mandates that Solo 401k plan assets be held in trust. A trust is a separate legal entity that holds title to assets set aside on behalf of beneficiaries. The written trust document outlines who is entitled to benefit from trust assets. Furthermore, the trust is administered by a trustee—in the case of Solo 401k, the business owner—who is responsible for safeguarding and investing the funds for the beneficiaries—again, I the case of Solo 401k the business owner.

IRC 401(a)(2) (Exclusive Benefit Rule)

A Solo 401k plan must be maintained for the exclusive benefit of the participant (business owner) and their beneficiaries. Known as the exclusive benefit rule, it prohibits the employer from diverting the assets for its own benefit. Not that even though the employer receives tax benefits from the maintenance of the Solo 401k plan (for instance, an income tax deduction for the contributions) does not violate the exclusive benefit rule. As you will learn, almost every rule has exceptions, and the exclusive benefit rule is no different. The payment of expenses from the Solo 401k plan, although not providing benefits to the plan participants, is permissible under the exclusive benefit rule, as long as the expenses are reasonable and relate to the administrative or fiduciary operations of the plan.

Paying Solo 401k Plan Expenses with Plan Assets

A Solo 401k plan may pay expenses relating to reasonable expenses of administering the plan, including investment management fees, recordkeeping fees, and reporting and disclosure expenses incurred by the Solo 401k plan. The DOL has issued only piecemeal guidelines in this area.

IRC 401(a)(9) (Required Minimum Distribution Rules)   

Just like all  qualified plans, a Solo 401k Plan must commence the payment of benefits no later than the required beginning date prescribed by IRC 401(a)(9), which is wholly or partly determined by when the employee attains age 70 ½.

IRC 401(a)(13) (Antiassignment Rule)

A participant’s accrued benefit is protected from assignment or alienation. This is called the antiassigment rule. The protection extends to garnishment, levy, execution or other legal or equitable process by the Solo 401k participant’s creditors. The trust assets are protected from the employer’s creditors because the trust assets are held for the exclusive benefit of the participants and their beneficiaries and are not part of the employer’s general assets.  

IRC 401(a)(16) (Annual Addition Limits)

A qualified plan including Solo 401k is not allowed to exceed the limitations on contributions and benefits that are imposed by IRC 415.

IRC 401(a)(17) (Annual Addition Limits)

A qualified plan may not determine contributions or benefits by taking into account more than a prescribed dollar amount of compensation, which is maximum of $250,000 for tax year 2012 and it usually increases by $5,000 increments each year, but may decrease in some years.

Domestic Trust

IRC 401(a) requires that the Solo 401k trust be created or organized in the United States (i.e., a domestic trust).

Treas. Reg. 1.401-1(a)(3)(I) mandates that a trust including a Solo 401k trust forming part of a qualified plan be created or organized in the United States, and be maintained at all times as a domestic trust. Failure to qualify as a domestic trust would cause the trust to lose its tax exemption under IRC 501(a).

The Solo 401k Trustee

The trustee is the person named in the Solo 401k trust or who is appointed as trustee by a named fiduciary, usually the employer in the case of a sole proprietorship. The trustee has exclusive authority and discretion to manage and control the assets of the plan, unless the trustee is subject to the investment directions of a named fiduciary or investment manager.

Solo 401k Summary Plan Description

The summary plan description (SPD) is the primary disclosure document required by Title I of ERISA. Through the SPD, the participants and beneficiaries receive information about the material provisions of the Solo 401k plan, how to make claim for benefits and rights under ERISA. The Solo 401k Provider must provide the SPD to  each employer that adopts the Solo 401k plan.