401(k) plans that only cover business owners - and their spouses – are commonly called “solo” 401(k) plans. Because they don’t cover non-owners, solo 401(k) plans aren’t subject to many of the most complex 401(k) plan qualification requirements – including annual nondiscrimination testing. That makes these 401(k) plans easy to administer while allowing plan participants to receive large annual contributions - up to the 415 limit ($66,000 + $7,500 catch-up for 2023) – without restriction. These benefits have made solo 401(k) plans a popular retirement plan choice for business owners that want to save more than personal IRAs allow.
However, if you’re considering a solo 401(k) plan for your small business, there are some things you should know. First, you want to be 100% sure your business is eligible to sponsor a solo 401(k) plan at all – because the consequences for improperly excluding non-owners from a 401(k) plan can be severe. Second, you want to understand your solo 401(k) plan design options – because not all 401(k) providers will give you the chance to take full advantage of them.
Fortunately, these pitfalls are easy to avoid with some basic education – allowing you to enjoy the benefits of a solo 401(k) plan worry-free. We’ve outlined the key points to consider below. If you need additional assistance, an experienced 401(k) provider should be able to help.
Solo 401(k) plan eligibility requirements
To be eligible for a solo 401(k) plan, your business can’t employ non-owners that meet the plan’s age and service eligibility requirements. Meeting this solo requirement is very important because improperly excluding eligible non-owners from a 401(k) plan can trigger severe consequences – including expensive corrective contributions or even plan disqualification.
To stay out of trouble, you must understand (and correctly apply) your solo 401(k) plan’s eligibility requirements to both owners and non-owners. Like all 401(k) plans, a solo plan must define its eligibility requirements in a written plan document. If a non-owner ever meets these requirements, you must let them enter your 401(k) plan on the “entry date” specified in your plan document. This will take your 401(k) plan out of solo status, but you have no choice to avoid the consequences for improperly excluding a non-owner. You’ll also want to notify your 401(k) provider before a non-owner becomes plan-eligible – to ensure they make any changes necessary to properly administer your plan as a non-solo.
Be sure to consider the controlled group rules applicable to 401(k) plans when applying your solo plan’s eligibility requirements. Under these rules, two or more employers with common ownership are considered a single employer for 401(k) plan purposes. That means you can’t exclude controlled group employees meet your solo plan’s eligibility requirements.
Solo 401(k) plan design options
Because solo 401(k) plans cover few employees and don’t require much administration, 401(k) providers typically charge low fees to administer them. That’s the good news. The bad news is that solo 401(k) providers often fail to make popular 401(k) plan design options like participant loans or in-service distributions available to business owners to maximize their profit from these plans.
They rarely make voluntary after-tax contributions available either. These contributions are uncommon today because they make annual nondiscrimination testing difficult to impossible to pass. However, this shortcoming is moot with solo 401(k) plans because they don’t require annual testing.
So why should you want voluntary after-tax contributions in your solo 401(k) plan? They make “mega back door” Roth IRA contributions possible. Under this tax strategy, you make voluntary after-tax contributions to your 401(k) account – up to the 415 limit - and then immediately roll them to a Roth IRA where their investment earnings can grow tax-free. For the strategy to work, your solo 401(k) plan must also allow the in-service distribution of voluntary contributions at any time.
It pays to know your solo 401(k) plan options!
Solo 401(k) plans are popular with business owners because they offer unrestricted contributions – including “mega back door” Roth IRA contributions – up to the 415 limit. The kicker? They’re typically much less expensive than other 401(k) plans because they’re small and not subject to many plan qualification requirements.
However, you want to avoid 401(k) providers that limit your solo 401(k) plan design options. Their limitations can keep you from maximizing your plan benefits.