The Solo 401k Law

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The Solo 401k Law

ERISA

The body of law that governs retirement plans including Solo 401k is the Employee Retirement Income Security Act of 1974, as amended (ERISA) which was comprehensive legislation that culminated after a decade of Congressional and Administrative discussion and consideration. ERISA is made up of four sections or Titles. Jurisdiction over retirement plans is split under ERISA between two Administrative Departments: the Department of Labor (DOL) and the Department of the Treasury [and its administrative agency, the Internal Revenue Service (IRS).

ERISA includes four sections or Titles. They are:

Title I of ERISA

In addition to including minimum standards for eligibility, vesting and funding, Title I of ERISA also allocates reporting and disclosure rules and fiduciary standards.

Title II of ERISA: Contains the tax-related provisions of ERISA that amended the IRC sections relating to qualified plans.

Title III of ERISA: Includes the administrative provisions of ERISA that divide enforcement responsibilities between the IRS and the DOL

Title IV of ERISA: While this section does not apply to Solo 401k, it established the Pension Benefit Guaranty Corporation (PBGC), which provides and insurance program for defined benefit plans.

Solo 401k Basic Plan Qualifications Requirements

The technical definition of a qualified plan is one that satisfies the requirements of IRC 401(a). IRC 401(a) lists the countless requirements with which a qualified plan including Solo 401k and its sponsor must comply to obtain the available tax advantages of having the Solo 401k plan.

Qualified plans may take several forms, including defined benefit plans, profits sharing plans, money purchase plans, 401(k) plans and stock bonus plans.

Solo 401k Form and Operational Requirements

The IRC 401(a) requirements must be satisfied in form and in operation. Compliance in form means the plan document includes the relevant provisions of IRC 401(a). Treas. Reg. 1.401-1(a)(2) requires the plan to be a definite written plan. Failure to satisfy the form requirement is grounds for disqualification , even if the Solo 401k plan is operated properly.

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

The qualified plan including Solo 401k Plan must be for the employees of the employer. The term employee includes a self-employed individual of a sole proprietorship or partnership.

For the rules to be met, the plan must be sponsored by an employer. The word employer has different meanings for the IRC than it does for ERISA.

Definition of Employer for Tax Qualification Purposes

For purposes of IRC 401(a), the employer is any employer (under common law principals) of the employees covered by the plan. The IRS maintains that a plan ceases to be a qualified plan if the sponsoring Solo 401k employer goes out of business, unless a successor employer takes over sponsorship of the plan. Such plan is known as an orphan plan.

A self-employed individual may be treated as an employee of the trade or business with respect to which he or she is a self-employed individual within the meaning of IRC 4019(c)(1). The trade or business is the employer that must maintain the qualified plan that covers the self-employed individual. If the trade or business is a sole proprietorship, the employer is the sole proprietor (i.e., the sole proprietor is both the employer and an employee of the employer). If the trade or business is a partnership, the individual partners are treated as self-employed individuals, but it is the partnership that is the employer, and it is the partnership that must establish the plan (i.e., the individual partners are treated as employees but the partnership is the employer).

Definition of Employer for ERISA Purposes

Pursuant to 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. For ERISA purposes, neither a sole proprietor nor a partner is treated as an employee.

Assets Must Be Held in Trust

IRC 401(a)(1) also requires 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, who is responsible for safeguarding and investing the funds for the beneficiaries.

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

A plan must be maintained for the exclusive benefit of the participant and their beneficiaries. This rule is known as the exclusive benefit rule. It prohibits the employer from diverting the assets for its own benefit. The fact that the employer receives tax benefits from the maintenance of the plan (e.g., an income tax deduction for the contributions) does not violate the exclusive benefit rule.  Almost every rule has exceptions, and the exclusive benefit rule is no different. The payment of expenses from the 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.

Payment of Plan Expenses with Plan Assets

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

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

A qualified 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 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 must not exceed the limitations on contributions and benefits that are imposed by IRC 415. The maximum Solo 401k Plan contribution for 2012 is $50,000 plus an catch-up amount of $5,500 if over age 50.

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.The maximum compensation amount that can be used to determine your Solo 401k contribution for 2012 is $250,000.

Domestic Trust

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

Treas. Reg. 1.401-1(a)(3)(I) requires that a 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).

Trustee

The trustee is the person named in the trust or who is appointed as trustee by a named fiduciary. 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, an investment manager or the plan participants.

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 are given information about the material provisions of the plan, how they make a claim for benefits and what their rights are under ERISA. The plan administrator is required to furnish the SPD to each participant covered under the plan and to each beneficiary receiving benefits under the plan.

About Mark Nolan

Each day I speak with energetic entrepreneurs looking to take the plunge into a new venture and small business owners eager to take control of their retirement savings. I am passionate about helping others find their financial independence. Having worked for over 20 years with some of the top retirement account custodian and insurance companies I have a deep and extensive knowledge of the complexities of self-directed 401ks and IRAs as well as retirement plan regulations. Learn more about Mark Nolan and My Solo 401k Financial >>

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