While a Solo 401K offers distinct advantages over other retirement savings arrangements for small business owners, setting one up a Solo 401K does require assistance from someone with technical expertise.
While this expertise is reasonably inexpensive, it is nonetheless a cost incurred with Solo 401Ks that you do not have with other IRA-type investments.
On the other hand, the greater flexibility that Solo 401Ks afford in terms of investment options allow you to quickly recoup the setup costs.
Author: Mike Armour
Even though the tutorial examines legal and tax issues faced by small business owners, it should not be construed as legal, accounting, or tax advice. Always seek competent professional counsel in addressing issues and questions raised in this tutorial.
A Guide to Solo 401Ks
Establishing a Solo 401K for Your Business
What Is Required to Start a Solo 401K?
When you set up a Solo 401K, the program is created by and affiliated with the business, not you as an individual. Therefore, sole proprietorships cannot establish a 401K. To be eligible, the sole proprietorship must restructure itself as an LLC, an S-Corp, a C-Corp, or a husband-wife partnership.
Additionally, only the owner and the owner's spouse can be on the payroll as full time employees at the time that the plan is established. As other employees are added to the payroll, they become automatically entitled to participate in the program once they meet certain criteria in terms of the number of hours worked and their length of employment. These criteria will be spelled out in the documents that you create to govern the plan.
If your business already has full-time employees, there may still be ways for you to establish a Solo 401K. For example, you could set up a new LLC, which provides management and other services to your existing company for a fee. Your could shift some or all of your compensation from the existing company to this new entity, using the fees it collects to pay your salary. This new LLC could then set up its own Solo 401K independent of the original business.
Be sure to consult with a good CPA or tax attorney before you make this move to be sure that everything is structured legitimately. Otherwise the entire Solo 401K could be jeopardized.
How Is a Solo 401K Structured?
Compared to other IRA-type programs, such as SIMPLEs and SEPs, a Solo 401K requires you to jump through a few more hoops in setting the program in place. You will unequivocally need professional assistance in putting a Solo 401K together for your company. That's because your business must set up an affiliated trust which serves as the custodian for all employee accounts in the Solo 401K. You as the business owner will serve as the trustee for this trust. Your spouse can also serve as a trustee to provide a second party who has signatory authority to execute transactions with the funds.
Putting all of these provisions in place requires the assistance of specialists who fully understand the legal and regulatory issues which must be addressed. Moreover, because you are establishing a company-affiliated retirement program, the plan must have governing documentation which lays out the plans features in conformity with Federal regulations. This document alone is likely to approach 100 pages in length.
Fortunately, there are a number of very reputable service providers around the U.S. who specialize in creating turnkey Solo 401K programs for small businesses. They establish the Solo 401K trust in your company's home state, obtain a Federal Employer Identification Number for the trust, draw up the documents governing the plan, and provide you step-by-step guidance on what you must do to administer the plan within the requirements of Federal law.
This is one place that you do not want to cut corners by trying a "do it yourself" approach. Because you are accepting the role of custodian, you are now assuming a fiduciary responsibility that the IRS takes seriously. If an audit finds that your plan was not set up correctly from the outset or that you have failed to comply with IRS regulations in exercising your trusteeship, the entire program can be revoked. Should that happen, you and all of your employees would be taxed as though no tax-deferred contributions had ever been made to the plan.
You can Google "How do I set up a Solo 401K" and find a list of many companies who provide these turnkey services. I happened to use a company called Safeguard in Lake Oswego, Oregon (www.ira123.com) to set up my program and have been quite pleased with their support over the years.
What does it cost to set up a Solo 401K?
As I've said, setting up a Solo 401K requires the assistance of a service provider (usually a lawyer or a CPA) who is very familiar with IRS regulations and rulings related to this kind of retirement plan. The fee charged by these providers varies from firm to firm. But you should anticipate an investment of about $2000.
This may seem like a lot of money, since SIMPLE IRAs and SEP IRAs —both of them very popular choices for small business owners — can be set up quickly with virtually no out-of-pocket expense. However, your investment options with a SIMPLE or a SEP are far more restricted than they are with a Solo 401K. The wide array of investment opportunities within a Solo 401K should allow you to quickly recoup these setup costs.
Service providers who create Solo 401Ks for clients also offer an annual update service. This keeps your plan in compliance with any changes in Federal regulations. Subscribing to this service is not mandatory, but is certainly well-advised. The yearly charge for the update service is usually rather nominal — about what you would pay for an hour of a good attorney's time. And the update service may also entitle you to a certain number of free consults for questions which arise as you administer the plan.
Where are Solo 401K funds deposited?
The trust must have its own bank account which serves as the depository for employee and employer contributions. As the trustee for the custodial account, you hold the checkbook and have independent discretion in effecting transactions through the account.
The trust's bank account must be entirely separate from the company's bank account. At no time are your personal funds or funds from the business to be co-mingled with funds from the Solo 401K plan. You should therefore have this bank account in place as soon as possible once the Solo 401K is established.
Ironically, one of the biggest hurdles you may face in establishing a Solo 401K is finding a bank that knows how to set up a checking account for this type of trust. Banks, of course, are quite experienced with trusts. But a Solo 401K is not a typical trust. It is not subject to the same rules and regulations governing the types of trusts with which banks are acquainted.
When setting up my own Solo 401K, one of the biggest banks in the country was at a loss as to the mechanics for opening the kind of account that I needed. Neither the local branch nor their regional headquarters understood a Solo 401K trust. If you encounter this problem, go back to the company which set up your Solo 401K. They are usually quite aware of this issue and are likely to have a referral network of banks or particular bank officers who are equipped to help you.