The solo 401(k) has become the go-to retirement plan for self-employed business owners who don’t have other employees. It allows a larger contribution at a lower income level than SEP IRA. It also provides sanctuary for pre-tax assets to those doing the backdoor Roth.
I have the Informed Delivery service by USPS. They email me every morning a scan of my incoming mail that day. This serves as both a heads-up and a security tool so that I will know if anything is missing from my mail.
When I saw a letter from the IRS with a from-address in Ogden, UT, I knew it was about my solo 401k plan. I file my Form 5500-EZ every year to that address. “Did they not receive the 5500-EZ I sent in last year?” It just so happened I couldn’t find my copy of the form. I have it for all previous years except last year. “Did I forget to file it when I was busy with my kitchen remodeling?” Because it’s just a two-page form, I just used regular first class mail. Although I think I filed it, I don’t have any proof. “What if it was lost in the mail?“
I Googled “5500-EZ late penalty.” The filing deadline was July 31 last year. The late filing penalty is $25 per day. It’s been over 200 days already. If I did forget to file the form or if it was lost in the mail but I have no proof of mailing, I would be on the hook for over $5,000! [Update in 2021: The penalty increased to $250 per day now.]
There is a Penalty Relief Program. If you come forward on your own, the penalty is reduced to $500 per offense. But, it says “If you’ve received a delinquency notice for the overdue form, you can’t use this penalty relief program for that year’s return.” It becomes a catch-22. You usually don’t know you are late until they tell you. By the time they tell you, you can’t use the Penalty Relief Program anymore.
I kicked myself all day for possibly forgetting to file a simple two-page form or not using certified mail and keeping proof of mailing. I left work a little early to get home and face the issue. The mail from the IRS turned out to be just a friendly reminder to file the 5500-EZ this year, due on July 31. Whew!
This scare shows you have to take a solo 401k seriously. It’s not just like a larger IRA.
Mainstream brokerage firms such as Vanguard, Fidelity, Schwab, TD Ameritrade, and E*Trade all offer a solo 401k for free. These solo 401k providers make you feel as if it’s just like a larger IRA when they don’t provide much help on the administration side. They just take the money you send in.
Some providers don’t care whether it’s employee contribution or employer contribution, or which plan year it’s for. They certainly don’t check whether you are allowed to contribute that much to begin with or whether your contribution is made timely. You are a business. You are supposed to know.
A solo 401k is still a 401k. There are many rules, which you are still supposed to follow even if the plan only covers yourself. There are many ways to mess up. The brokerage firms won’t stop you from messing up. Correcting the mess-up can be very expensive.
Did you know if you make employee contributions you must have a written contribution election in place before you contribute? If you are an S-Corp, you have to run payroll and deduct the contribution according to the pre-established election. You can’t just decide to contribute $1,000 this month from your personal account on a whim as you do to an IRA.
Someone paid his spouse $20k annual salary on a W-2 from his business, had her contribute $18k to the solo 401k, and then made equal-dollar profit sharing of $36k each to his and her accounts. Is that allowed? How to fix it if it isn’t?
If you have a solo 401k, treat it with some respect. Either learn the rules thoroughly or hire someone who knows the rules. Document everything. Remember to file the 5500-EZ when the value of the plan assets at the end of the year exceeds $250,000. Keep the plan as simple as possible. Don’t borrow from it. Don’t buy real estate in it. The more angles you have on the administration side, the more opportunities you have to trip on some rules. Don’t ruin a good thing.
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Brendan says
maybe a stupid question…
is a SEP-IRA like a big IRA or are there complex rules to those as well (above and beyond contribution limits, pro-rata rules)?
Harry Sit says
There are still rules. The IRS published a SEP Checklist and a SEP Fix-It Guide. The rules are simpler because a SEP doesn’t allow employee contributions, doesn’t have Roth, doesn’t allow loans, … The S in SEP stands for Simplified. After receiving the contribution, the SEP-IRA functions as an IRA whereas a solo 401k account is still part of a plan as a separate entity.
Kevin says
This…all of this. I don’t see many articles or coverage on the single 401k and the consequences if you do not file the 5500 EZ form once assets cross $250k. I took advantage of the penalty relief program in 2017 for the tax years 2014-2016 which cost me $500 per return and prepared them myself. I just missed out on the pilot period for the program because of the inadequacy of my accountant who is now no longer my accountant. I always file late yearly too because I want to take advantage of maxing all of my retirement options for the previous year. This can complicate the process.
If you don’t/cannot submit the form yourself, add another $500 for preparation yearly.
David Ann Arbor says
Wow my heart rate went up faster when I read this.
I’m not an S-corp, and when you write, “Did you know if you make employee contributions you must have a written contribution election in place before you contribute?” – how fancy of a written statement does it need to be?
I just have a text box on my contributions Excel spreadsheet that states, “For 2017: I will take the maximum Employee Salary Deferral, and the maximum Employer Contribution
I will make an estimate of employer contribution in 2017 and contribute just a few thousand shy of that in 2017.
I will similarly estimate the maximum after-tax contributions I can make to the 401k plan, and I will contribute a few thousand shy of that in 2017.
Then in 2018 I will complete the balance to contribute to reach the maximum for the employer contribution as well as the maximum for the after-tax contributions.”
Harry Sit says
When you are doing after-tax contributions, and presumably in-service distributions, I suggest that you hire an administrator at least for a couple of years to establish the workflow or have the administrator review your procedures.
Ray says
Hello Harry, always enjoy your articles which I receive via email. While a solo-401k is not relevant to me, I was not familiar with the ‘Informed Delivery by USPS’ so I tried to establish an account.
How much personal info does the USPS have on us?! I failed twice in trying to confirm my identity. I thoughtfully and accurately answered their questions but still failed! A bit scary to me. Wondering why they have so much info and obviously question their accuracy.
Harry Sit says
It’s been a while since I signed up. I forgot what they asked. Usually they draw from an ID verification service by a credit reporting agency. USPS itself doesn’t have that much info on you. There’s a FAQ on the bottom left of that page on what to do if you can’t verify your identity online.
Ray says
Thank you Harry, found it. Just seems odd we have never been presented with these type of questions while retrieving our annual credit reports. Sigh…
Jj says
hi, Harry:
Does that 250K includes Roth converted amount? for example, the balance is $255,000, but $15,000 from it converted into Roth via IRA (Fidelity does such direct conversion, and already over age 59 1/2). Does he still need to submit 5500-EZ with $240,000 balance in solo 401K?
Harry Sit says
Total balance of the plan assets for all participants at the end of the year. It doesn’t include the balance of the Roth IRA.
Jack says
I ran into this issue myself last week.
I now believe if you have a job and can contribute to a regular 401k. Just do that. The extra tax reporting and possibilities for messing up is not worth the risk.
As I no longer have a self-employed business, I amended a 2015 5500-EZ. Closed out the solo 401k.
Keep things simple.
Andrew says
“Did you know if you make employee contributions you must have a written contribution election in place before you contribute?”
Where does it say this? I cannot find this in any of the IRS documents or on any other websites or blogs that discuss Solo 401ks.
Harry Sit says
Administering a 401k plan is an industry with its own professional training programs and certification — QKA — Qualified 401(k) Administrator. I suppose the websites and blogs you read that discuss Solo 401ks aren’t written by 401k administrators.
The IRS page on solo 401k: https://www.irs.gov/retirement-plans/one-participant-401k-plans
“The one-participant 401(k) plan isn’t a new type of 401(k) plan. … … These plans have the same rules and requirements as any other 401(k) plan.”
The IRS page on 401k in general: https://www.irs.gov/retirement-plans/plan-sponsor/401k-plan-overview
“A 401(k) plan is a qualified plan that includes a feature allowing an employee to elect to have the employer contribute a portion of the employee’s wages to an individual account under the plan.”
The election triggers the 401k feature. Without it there is no basis for the employee contribution.
The IRS communicates to 401k administrators through regulations.
26 CFR 1.401(k)-1(a)(3)(iii)(B)
“(B)Contribution may not precede election. A contribution is made pursuant to a cash or deferred election only if the contribution is made after the election is made.”
The regulations further define when the election must be made and what it affects (“amounts not be currently available”).
Harry Sit says
And here’s a piece written by a professional in the industry:
Case of the Week: Salary Deferral Elections for the Self-Employed
Paul says
Is a small business Simple IRA easier to administer/run than a 401(k)?
Harry Sit says
If you have employees a SIMPLE IRA is easier than a full blown 401(k). If you don’t have employees it isn’t. Look at what you have to do to operate a SIMPLE IRA:
https://www.irs.gov/retirement-plans/operating-a-simple-ira-plan
Paul says
Is a SEP-IRA less complicated to administer than the other small business options for a husband/wife (no other employees) S Corp?
Harry Sit says
It is. See reply to comment #1. It requires a higher income to max out the contribution limit. It also doesn’t shelter the money for backdoor Roth. If you don’t care about maxing out the contribution limit or the backdoor Roth, a SEP-IRA is still a good option.
Doug says
Hi Harry,
Is there a reason you don’t use IFILE to file this electronically rather than send a form through the mail? The 5500-SF doesn’t look that much more complicated than the 5500-EZ.
William says
Wouldn’t it make sense to rollover 401K assets to an IRA, either Traditional or Roth, well before hitting the $250,000 mark?
Harry Sit says
As in a 401k with a regular employer, if you aren’t 59-1/2 yet, you can’t roll over your pre-tax or Roth employee contributions and earnings to an IRA until you terminate employment. It’s hard to terminate yourself from your own business.
William says
True, that’s a good point. I have a Solo 401K so it’s trivial for me but wouldn’t be for most people. Thanks for the quick response!
Harry Sit says
It’s the same with a solo 401k. You still have to be either 59-1/2 or terminate from your self-employed business before you can roll over pre-tax or Roth contributions and earnings from the solo 401k to an IRA.