A significant change in the retirement plan industry is being driven by the post-COVID-pandemic increase in the overall numbers of self-employed workers. According to the Bureau of Labor Statistics, approximately 10% of working Americans, more than 16.5 million people, reported being self-employed in September 2022. Some of this is the recent growth of the “gig economy” and solopreneurs, with more people working for themself in lieu of a second job working for someone else.
These factors, combined with the national emphasis on increasing retirement savings, have increased the popularity of one-person 401k plans – sometimes called “solo k” plans or “owner-only” plans. These plans are maintained by a business that has no employees, other than the owner or the owner and their spouse.
One-person 401k plans are popular because of the greater contribution capacity than IRA-based plans. An owner’s contributions into a one-person 401k plan can potentially be $73,500 per year, given current IRS limits. In addition, it is easier to maximize contributions with lower levels of business income than under an IRA-based plan.
It is important to consider using the services of a “third party administrator” (TPA) to ensure the one-person 401k plan complies with IRS requirements. Key reasons include:
- The contributions to the plan likely consist of different types – for example, 401k deferrals and employer discretionary (i.e., profit sharing) contributions and, maybe, rollover contributions. The plan terms regarding withdrawal rights or payment options are permitted to differ among types of contributions (e.g., in-service withdrawals while employed are not legally permitted under the same terms and conditions). In order to comply with these varying rules, proper recordkeeping is necessary.
- For tax reasons and because of the Federal emphasis on ROTH (after-tax) contributions, the one-person 401k plan now is more likely to include both ROTH and pre-tax contributions. It is necessary to have separate accounting, and separate accounts, for ROTH and pre-tax balances.
- While there is a grace period before IRS annual filings (i.e., the plan’s tax return, or Form 5500) are required – no Form 5500 filing generally is required until the plan assets total $250,000 (if there never has been another retirement plan) – it will not be long before the threshold is passed because of the high annual contribution limit (potentially as much as $73,500 per year) and hoped-for good investment performance.
- If the business is jointly owned with a spouse, or the spouse is an employee, it is necessary to separately account for each plan participant’s balance. In addition, the IRS filing threshold will be quicker to reach with two plan participants.
- The IRS has placed an emphasis on reviewing Form 5500 filings to determine whether filings are being done when required and are accurate. There are potentially significant IRS penalties for noncompliance. See https://www.irs.gov/retirement-plans/financial-advisors-are-assets-in-your-clients-one-participant-plans-more-than-250000, which details mistakes the IRS commonly finds regarding one-person plans.
Please contact ACSI (www.acsi-ny.com) to learn more about the advantages of establishing a one-person 401k plan, or how ACSI can help ensure compliance with IRS requirements for your existing plan.