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Is Your 401(k) About to Lose Solo Status? Here’s How to Prepare

Eric Droblyen

February 14, 2023

Table Of Contents

401(k) plans that only cover business owners - and their spouses - are commonly called one-participant (or "solo”) plans. Solo plans are subject to fewer requirements than other 401(k) plans because there are no non-owners - or common-law employees - to protect. 401(k) plans automatically lose their solo status once a common-law employee becomes plan-eligible. Small businesses should prepare their 401(k) plan for this status change before it happens to avoid nondiscrimination testing issues down the road.

Preparing a 401(k) plan to lose its solo status is not complicated. Here's what you need to know to smoothly transition your plan. If you need additional assistance, an experienced 401(k) provider can help.

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Eligibility Requirements for a Solo 401(k) Plan

Solo 401(k) plans can only cover business owners and their spouses. In other words, employers are ineligible for a solo if they employ a common-law employee that meets the plan's age and service eligibility requirements - even if that employee does not participate.

Related employers - which include controlled and affiliated service groups - are considered a single employer for purposes of meeting the solo requirements. That means a business owner can't exclude the employees of related employers from their plan to meet solo standards.

401(k) Rules that Don't Apply to Solo Plans

Solo 401(k) plans are not considered an "employee benefit plan" under the Employee Retirement Income Security Act of 1974 (ERISA) because they do not cover any common law employees. As such, solo plans are not subject to ERISA Title I requirements. They are, however, subject to all applicable requirements of the Internal Revenue Code.

Below is a summary of the 401(k) administration requirements that do not apply to solo plans:

  • Nondiscrimination testing - 401(k) plans must pass certain nondiscrimination tests annually to ensure Highly-Compensated Employees (HCEs) do not disproportionately benefit.
  • Top heavy testing - A 401(k) plan is considered top heavy when the account balances of “key employees” exceed 60% of total plan assets. For years in which a 401(k) plan is top heavy, a top heavy minimum contribution must be allocated to non-key employees.
    • Solo plans are 100% top heavy, but they don't cover any non-key employees - so a top heavy minimum contribution is not required.
  • Participant disclosures - Solo plans have no obligation to distribute Title I disclosures to participants.
  • Form 5500 - Solo plans have no Form 5500 filing requirement if plan assets as of the end of the plan year are $250,000 or less. If plan assets are greater than $250,000, a Form 5500-EZ must be filed.
  • Fidelity bond - “Plan officials” who are responsible for the day-to-day administration of an ERISA-covered 401(k) plan must be covered by a fidelity bond. The purpose of the bond is to protect plan participants against losses caused by acts of fraud or dishonesty. As a non-ERISA plan, solos have no fidelity bond requirement.

Preparing a 401(k) Plan for Non-Solo Status

Preparing a 401(k) plan for non-solo status is a straightforward process. Here are the steps I recommend you take before a common law employee meets your plan's age and service eligibility requirements:

  1. Notify your 401(k) provider! - Let your 401(k) provider know as soon as possible that a common law employee will be joining your plan. Your plan will need additional services once it no longer meets solo requirements to be administered properly.
  2. Amend your plan - To avoid nondiscrimination testing issues down the road, consider the following plan amendments:
    1. Add a safe harbor contribution - By adding a safe harbor contribution, your plan can automatically pass the ADP/ACP and top heavy tests. The deadline for adding a safe harbor contribution will depend upon the type of contribution:
      1. Safe harbor match - deadline is the last day of year preceding the plan year in which the plan will be safe harbor.
        1. However, plan participants must receive a safe harbor notice sooner - 30-90 days before the start of the plan year.
      2. Safe harbor nonelective - The SECURE Act made the deadline much more flexible for nonelective-based safe harbor plans. The deadline will depend upon the amount of the nonelective contribution:
        1. Less than 4% - up to 30 days before the close of the plan year in which the plan will be safe harbor.
        2. 4% or greater - The last day of the plan year following the plan year in which the plan will be safe harbor (i.e., the deadline for distributing ADP/ACP corrective refunds).
    2. Remove voluntary contributions - Solo plans often include voluntary contributions to make a “mega back door Roth” tax strategy possible. However, voluntary contributions are rarely a viable option for non-solo plans due to their effect on the ACP nondiscrimination test. If your solo plan includes voluntary contributions, you probably want to amend them out.
      1. If voluntary contributions were made during a year in which a common law employee is plan-eligible, they will be subject to ACP testing even if your plan is safe harbor for that year.
    3. Add a new comparability profit sharing contribution - If a goal for your 401(k) plan is maximizing the annual contributions of business owners, consider a new comparability profit sharing formula. A new comparability formula will allow you to allocate a higher rate of profit sharing to business owners than common law employees assuming the 401(a)(4) general nondiscrimination test can pass.
  3. Purchase a fidelity bond - ERISA fidelity bonds can only be purchased from a surety or reinsurer that's named on the Department of the Treasury's Listing of Approved Sureties.

The most important step in this process is notifying your 401(k) provider as soon as possible. That way, they can guide you through the remaining steps.

The Price of Delay Can Be Steep!

In my experience, it's common for business owners to wait too long to notify their 401(k) provider that a common law employee has met their solo plan's age and service eligibility requirements. Often, they had no idea that a 401(k) plan automatically loses its solo status as soon as a common law employee becomes plan-eligible - even if that employee chooses not to participate.

This delay can lead to steep consequences - including contribution refunds for the business owner(s) and/or avoidable common law employee contributions. With the guidance of a qualified 401(k) provider, these consequences can be easy to avoid.

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