Speaking of solo 401k, I heard that Vanguard recently asked all its solo 401k plan customers to “amend and restate” their plan with a new package of documents. This is not unusual. Laws and regulations change. Plans are required to adopt the changes in order to stay compliant. After patching one amendment after another, amending and restating incorporates everything into one clean set of documents.
I looked at the new document in Vanguard’s Individual 401(k) New Plan Kit. It appears to me that the new document says the plan accepts incoming rollovers from IRAs.
Not accepting incoming rollovers from IRAs had been a weakness of Vanguard’s solo 401k product. This means you couldn’t consolidate your SEP-IRA with your solo 401k. You also couldn’t roll over the pre-tax money from your traditional IRA. People wanting do that had to go somewhere else such as Fidelity.
Plan Document
The new Individual 401(k) Basic Plan Document says this in section 3.07 on page 36 (bold added by me):
3.07 ROLLOVER CONTRIBUTIONS
Unless otherwise elected in the Adoption Agreement, an Employee may make Indirect Rollover and Direct Rollover contributions to the Plan from distributions made from plans described in Code sections 401(a), 403(a), 403(b), 408, and 457(b) (if maintained by a governmental entity) (excluding Nondeductible Employee Contributions and Roth Elective Deferrals except as otherwise indicated in the Adoption Agreement) unless an Employee is either an Employee of a Related Employer of the Adopting Employer that does not participate in this Plan or a member of any excluded class in Adoption Agreement Section Two and Plan Section 2.01. The Plan Administrator may require the Employee to certify, either in writing or in any other form permitted under rules promulgated by the IRS and DOL, that the contribution qualifies as a rollover contribution under the applicable provisions of the Code. If it is later determined that all or part of a rollover contribution was ineligible to be contributed to the Plan, the Plan Administrator shall direct that any ineligible amounts, plus earnings or losses attributable thereto (determined in the manner described in Plan Section 7.02(B)), be distributed from the Plan to the Employee as soon as administratively feasible.
Code section 408 means IRAs. The caveat “[u]nless otherwise elected in the Adoption Agreement” means it’s enabled by default. I looked at the Adoption Agreement in the same Individual 401(k) New Plan Kit. There’s nothing there that disallows rollover contributions.
Real World Operation
However, a member of the Bogleheads investment forums reported that Vanguard is still not accepting rollover contributions. He posted this reply from a Vanguard representative (bold added by me):
I was able to get more information pertaining to your question with the help of my colleagues that work in our Retirement team.
Qualified plans can, but are not required, to permit rollover contributions. If rollover contributions are permitted, such amounts must be accounted for separately from other types of contributions to the plan. Depending on the plan terms, rollover contributions may not be subject to the same distribution or withdrawal restrictions as other types of contributions. Due to the extra costs that would stem from the additional recordkeeping requirements, rollover contributions are not currently accepted to the Vanguard Individual 401(k) Plan.
I’m not a lawyer but I really hope this is just from some misinformed Vanguard employees, not the official position of the company. When you send documents to the IRS to get the plan qualified, the IRS evaluates the plan with the assumption that you will do what the documents say. You can’t just secretly operate the plan contrary to what’s written in the plan document. If you don’t want to do something, don’t put it in the document. It’s not acceptable to say one thing to the IRS and do another.
Another member of the Bogleheads investment forums sent me the old version of the plan document he signed in 2010. It had the same language. Nothing in the adoption agreement or amendments disallowed incoming rollovers either. Has Vanguard been operating the plan contrary to the terms of the plan document all these years?
The IRS lists not following the terms of the plan as the #2 problem for 401(k) plans: 401(k) Plan Fix-It Guide – You didn’t base the plan operations on the terms of the plan document. The way to fix it is to “[a]pply reasonable correction method that would place affected participants in the position they would’ve been in if there were no operational plan defects.” That means at the minimum accepting incoming rollovers if not doing something to compensate the participants for not being able to do it before.
Better Late Than Never
Accepting incoming rollovers from IRAs would only finally put Vanguard on equal footing with other providers in this regard. Other providers such as Fidelity and Schwab have been able to do it for years. Fidelity and Schwab are able to deal with the additional recordkeeping requirements just fine.
I will still keep my plan at Fidelity. Vanguard only allows the more expensive Investor shares in solo 401k plans. No Admiral shares, nor ETFs. Fidelity doesn’t have that limitation. You can buy the less expensive Spartan funds Advantage shares if you meet the purchase minimum (typically $10k). Or you can buy ETFs, including Vanguard ETFs. You just pay $8 per trade if you want Vanguard ETFs instead of the commission-free iShares ETFs. I have the majority of my plan holdings in Vanguard and iShares ETFs. My new contributions are going into a Spartan fund. I get the best of both worlds that way.
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Don says
Helpful as always. Thanks.
Matt says
Thanks for the informative article. I was planning on rolling over my SEP (with Vanguard) to a Solo 401k at Vanguard but I guess that’s out of the question now. It’s time to look for a new home!
Nora Bethman says
A client of mine forwarded me this recent post regarding Solo 401(k) plan documents. I am a professional retirement plan Third Party Administrator (TPA) in Chicago. I have clients nationwide. There is a lot of misinformation spread by salespersons in the retirement plan industry, especially in the Solo 401(k) market, where the “do-it-yourself” plan seems to reign king. Please allow me to explain some things about Solo 401(k) plans:
1. There is no such thing in the IRS’ eyes as a Solo 401(k) plan. It is simply a 401(k) plan which has only one participant, or sometimes a business owner and spouse, or it could be several business partners and spouses. Mutual fund companies have coined the term “Solo 401(k)” or “One Person Plan” as a marketing phrase to differentiate their products. The main characteristic that separates it from “regular” 401(k) plans is what kind of information return (“tax form”) is filed, and that is governed by the number of participants and to a lesser extent, the type of plan. In a similar vein, there is another recent post on this blog about IRS notices for form 5500-EZ vs. 5500-SF, which I will not get into here. Suffice to say, in general, the entrepreneur with a “Solo 401(k) plan” for lack of a better term, will need to file one of these informational returns annually when the plan assets reach a certain amount.
2. Vanguard and most mutual fund companies offering a Solo 401(k) also provide a plan document. A written plan document is a requirement in order to establish a tax-qualified retirement plan. Most of the investment houses offer a “free” plan document in order to get the plan assets under their management. In my opinion, these documents are not very good. They are “one-size-fits-all” standardized documents which do not offer a lot of choices or features; hence the problems mentioned with rollovers in the post. Here’s something to know: Just because the IRS allows it, doesn’t mean you can do it if it’s not specifically stated in the plan document. I do not have an actual copy of the Vanguard document referred to in the November 17, 2014 post on this blog, so I cannot say for sure what is happening here, but another quirk in the language of the document is that, while there may be language stating that in general rollovers are allowed, rollovers could still be prohibited if not specifically elected for your plan in the adoption agreement.
3. What the mutual fund companies DON’T tell you is that by using their document, you are in effect agreeing to a retirement plan “package” offered by the company. And there might be better choices for your particular situation available which the mutual fund companies won’t tell you. Mutual fund companies generally limit you to certain funds and investment products when you choose their Solo 401(k) package, and you’d better believe those investments are the highest cost, biggest moneymakers for the mutual fund company offering the Solo 401(k) plan. Their documents restrict rollovers, because the laws pertaining to rollovers can be quite complex, and there needs to be oversight of the rollover process, and they don’t have qualified people to review the transactions for compliance. Loans, which can be a powerful leveraging tool for the entrepreneur, are generally not allowed in the do-it-yourself document either, for the same reason – limits, rates, amounts, timing and repayments must be monitored.
But there is an alternative. Using the mutual fund company as an investment vehicle only, and obtaining your own, independent plan documents and peripheral plan services, can, for a reasonable fee, provide you with a customized document containing all of the bells-and-whistles features you want to fit your particular business situation. And the use of a qualified Third Party Administrator (TPA) can ensure that required amendments and 5500 form filings won’t be missed, or done incorrectly. And if you do get IRS correspondence, a qualified TPA can handle it correctly so that a minor issue won’t morph into a full blown IRS audit. By being your own 401(k) plan trustee, with advice from a professional, instead of relying on the mutual fund company as trustee, you could even open several accounts at different brokerage firms – all under the umbrella of your Solo 401(k) plan. But this requires a sophisticated plan document which sanctions such activity, and annual trust accounting and reporting, something the cookie-cutter plans offered for free do not allow.
In short, with retirement plans, as with many other things, you get out of it what you put into it in terms of time, money and effort. Free plan documents are worth exactly that.
DISCLAIMER: The information expressed herein is for informational purposes only and is not to be construed as tax or legal advice. The opinions expressed are solely those of the author.
BIO: Nora Bethman, CEBS, QKA, QPA, ERPA
President, National Employee Benefit Services, Inc.
Ms. Bethman is the owner of National Employee Benefit Services, Inc., a Third Party Retirement Plan Administration firm in Lincolnshire, IL. She has over 20 years of experience as a qualified retirement plan administrator. She has extensive experience in qualified and non-qualified retirement plan setup, administration, and problem resolution.
Harry Sit says
Thank you Ms. Bethman for your comments. The Vanguard plan document and adoption agreement are in the link provided in the article. Here’s it again: Individual 401(k) New Plan Kit. You click on the click to get a PDF. Please tell us whether you think the omission in the adoption agreement constitutes “otherwise elected” as stipulated in the plan document. For the sake of not attracting spam, I removed your contact information.
Nora Bethman says
Ok, I am in no way providing legal, tax or investment advice, but I reviewed the Adoption Agreement and document link you provided as a courtesy. I believe that the key lies in Section 3.07, in the second paragraph from the bottom of page 36, where it states, “Where the Adoption Agreement does not permit Employer designation with respect to rollover contributions, the Employer may, in a uniform and nondiscriminatory manner, allow only Employees who have become Participants in the Plan to make rollover contributions.”
The Adoption Agreement attached with the Plan Document that I saw did not allow any choice or election with respect to rollovers, so I would say that this sentence above would seem to indicate that the Employer could allow rollovers in the plan. Please note that other conditions for the acceptance of rollovers is that the rollover should be verified as being an acceptable rollover, and the rollover must be segregated in a separate account.
That being said, however, I would also think that Vanguard, being named the plan Trustee, might also have a say-so in the matter of rollovers, because under ERISA (the laws that govern retirement plans) a Trustee must act in the best interest of the plan and its participants and beneficiaries. If Vanguard does not have the capacity to verify whether a rollover contribution is valid, or does not accept the Employer’s pronouncement that a rollover is valid, they may have grounds to refuse to allow a rollover. The language in the document provides that an Employer MAY allow rollovers, not that an Employer MUST allow them.
It’s one of those (purposefully) vague concepts in the document which are open to interpretation. In a quick review of the document, I saw a lot of issues like this; that were unclear and not fleshed out within the Adoption Agreement. For example, the beneficiary form did not even require a spouse’s name to be listed on the form; instead stating that, “whoever I am married to at the time of my death” would be the beneficiary. I sure hope that Vanguard will do a more thorough verification of spouses than they do of rollover contributions, so that whichever ex-spouse who shows up first with an old marriage certificate doesn’t get the proceeds of your Solo 401(k) account when you die!
I’m not even sure that this is the most current version of the plan, or has all of the necessary and proper language, since the IRS favorable determination letter included is dated from 2010, and there’s been a few law changes since that time.
Even if you could get past these vague provisions, the document still does not allow loans, restricts investment choices, places a bigger legal liability on the Employer, and imposes higher trading fees. A custom document would provide much less exposure to legal liability and lower investment costs over the life of the plan. You could have the greatest ROI in the world for your plan investments, but one IRS penalty for compliance problems could wipe out years of gains.
M. Anderson says
I think you’ve confused two important concepts regarding 401ks. In any 401k there is THE PLAN and there is THE ACCOUNT (or the accounts if you have more than one account). In the case of Vanguard, Vanguard provides you with both THE PLAN and THE ACCOUNT for a very low price, because THE PLAN they give you for free locks you into using THE ACCOUNT.
THE PLAN consists of an Adoption Agreement and a Plan Document. In the case of Vanguard’s Solo 401k PLAN, THE PLAN is actually written by Ascensus, a large company that specializes in writing retirement plans. THE PLAN governs your behavior as the employer and your behavior as the participant. I disagree with Nora that the Vanguard’s Plan is “not very good.” Vanguard’s Plan Document is virtually identical to the plans used by every brokerage house (which also buys their plans from Ascensus). The IRS provides samples of approved language which must be included in any approved Prototype Plan, and so most plans are materially identical. The only issue that I have with Vanguard’s plan is that it forces you to designate Vanguard as the Trustee, instead of allowing you to designate yourself as the Trustee. Etrade/Fidelity/Scwab’s plans allows you to designate yourself as the Trustee, but they force you to designate them as Custodian, which limits you to using their accounts. If they didn’t, you could adopt their plans, designated yourself as Trustee, and then open a Trust Account at any bank or brokerage in the country (or even more than one).
Under section 3.07 of YOUR PLAN, you’re absolutely free to roll-over from other plans to THE PLAN. However, Vanguard isn’t bound by most of what is written in THE PLAN. Vanguard’s only role in connection with THE PLAN is as the Prototype Sponsor, which means that they agreed to provide you with THE PLAN and to notify you when updates and restatements are required. Vanguard is also a Directed Trustee, which means that they follow your directions regarding investments that are available in THE ACCOUNT. This means that if you tell Vanguard to buy VTI, and if VTI is available in THE ACCOUNT, Vanguard has to buy it.
THE ACCOUNT you have opened with Vanguard is not THE PLAN. It is simply an account that Vanguard has created for you. Vanguard has the legal right to allow or not to allow whatever they want in connection with their account. Vanguard’s relationship with you with respect to the account is governed by Vanguard’s Terms and the account application.
You can just as easily go buy THE PLAN from one of the dozen or so providers who sell THE PLAN without an account (and without requiring you to designated them as Trustee (as Vanguard does) or Custodian (as Etrade/Fidelity/Schwab do)) , and then you can go and open a trust account for THE PLAN at any investment house or bank, and you can invest in almost anything you want (including houses, stocks, bonds, etc.). If you did that, you could expect to pay between $300 and $1,500 for THE PLAN documents that Vanguard gave you for free.
If you go that route, THE PLAN acts as a limit, but as Plan Administrator, you can decide what to accept into THE PLAN. You could open a Bank Account at Bank of America, and then refuse to accept transfers of stocks, since BofA cannot accept stock for deposit into a bank account.
Whenever you sign up a for Solo 401k with a brokerage house, you are adopting a plan that has been deliberately crippled. It is limited to investments in the brokerage house’s accounts, even though there is no legal requirement for THE PLAN to do so.
Think of it as like when you buy a mobile phone from AT&T. AT&T locks that phone to its service so that you cannot take the phone to T-Mobile, even though it might work perfectly on T-Mobile. Even if the phone supports Tethering, AT&T might choose to disable that feature.
In the case of a Solo 401k, THE PLAN is like the phone. THE ACCOUNT is like the service. The PLAN may allow roll-overs from IRAs, just as the phone may allow tethering. However, if THE ACCOUNT doesn’t allow roll-overs from IRAs, just as the mobile phone service might not allow tethering, then you cannot do it.
I hope this clears things up.
Harry Sit says
As the Plan Administrator, you are legally obligated to operate THE PLAN as it’s written. Doesn’t using THE ACCOUNT that limits you from things THE PLAN says you must allow put you in trouble? Vanguard isn’t helping you fulfill your legal obligation.
Kara says
I am in the throws of this with Vanguard right now. Their retirement team directed me to open a 401k(i) so that I could re-distribute my rollover IRA to my individual 401k. After I created the the 401K, and requested the redistribution, I could told they couldn’t do it due to their “systems limitations. ” I’m currently trying to determine the best place to move my retirement funds to. I’m super frustrated and dissapointed in Vanguard, whom I’ve been loyal to for almost 20 years. Also not looking forward to the hassle of moving the funds to a new company