Solo 401(k)s have become a popular retirement plan option for self-employed persons. Unfortunately, many of the plans are not properly maintained and are at the risk of significant penalty and/or plan termination. If you have a Solo 401(k), you need to ensure that the 401(k) is being properly maintained. Here’s a quick checklist to make sure your plan is on track.
- Is the Plan Up-to-Date? The IRS requires all 401(k) plans, including solo 401(k)s, to be amended at least once every 6 years. If you’ve had your plan over 6 years and you’ve never restated the plan or adopted amendments, it is not compliant and upon audit you will be subject to fines and possible plan termination (IRS Rev Proc 2016-17). If your plan is out of date, your best option is to restate your plan to make sure it is compliant with current law. On average, most plan documents we see update every 2-3 years as the laws effecting the plan documents change.
- Are You Properly Tracking Your Plan Funds? Your solo 401(k) plan funds need to be properly tracked and they must identify the different sources for each participant. For example, if two spouses are contributing Roth 401(k) employee contributions and the company is matching traditional 401(k) dollars, then you need to be tracking these four different sources of funds, and you must have a written accounting record documenting these different fund types.
- Plan Funds Must Be Separated by Source and Participant. You must maintain separate bank accounts for the different participants’ funds (e.g. spouses or partners in a solo K), and you must also separate traditional funds from Roth funds. In addition, you must properly track and document investments from these different fund sources so that returns to the solo 401(k) are properly credited to the proper investing account.
- Does Your Solo 401(k) Need to File a Form 5500? There are two primary situations where you may be required to file a Form 5500 for your solo 401(k). First, if your solo 401(k) has more than $250,000 in assets. And second, if the solo 401(k) plan is terminated (regardless of total asset amount). If either of these instances occur, then the solo 401(k) must file a Form 5500 to the IRS annually. Form 5500 is due by July 31 of each year for the prior year’s plan activity. Solo 401(k)s can file what is known as a 5500-EZ. The 5500-EZ is a shortened version of the standard Form 5500. Unfortunately, the Form 5500-EZ cannot be filed electronically and must be filed by mail. Solo 401(k) owners have the option of filing a Form 5500-SF on-line through the DOL. The on-line filing is a preferred method as it can immediately be filed and tracked by the plan owner. In fact, if you qualify to file a 5500-EZ, the IRS/DOL allow you file the Form 5500-SF on-line but you can skip certain questions so that you only end up answering what is on the shorter Form 5500-EZ.
- Are You Properly Reporting Contributions and Rollovers? If you’ve rolled over funds from an IRA or other 401(k) to your solo 401(k), you should’ve indicated that the rollover or transfer was to another retirement account. So long as you did this, the company rolling over the funds will issue a 1099-R to you, but will include a code on the 1099-R (code G in box 7) indicating that the funds were transferred to another retirement account, and that the amount on the 1099-R is not subject to tax. If you’re making new contributions to the solo 401(k), those contributions should be properly tracked on your personal and business tax returns. If you are an s-corp, your employee contributions should show up on your W-2, and your employer contributions will show up on line 17 of your 1120S s-corp tax return. If you are a sole prop, your contributions will typically show up on your personal 1040 on line 28.
Make sure you are complying with these rules on an annual basis. If your solo 401(k) retirement plan is out of compliance, get with your attorney or CPA immediately to make sure it is up-to-date. Failure to properly file Form 5500 runs at a rate of $25 a day up to a maximum penalty of $15,000 per return not properly filed. You don’t want to get stung by that penalty for failing to file a relatively simple form. The good news is there are correction programs offered for some plan failures, but don’t get sloppy, or you’ll run the risk losing your hard-earned retirement dollars.