When Is a Solo 401(k) an ERISA Plan?
Understand when your Solo 401(k) is an ERISA plan and the crucial implications for compliance and administration.
A Solo 401(k) plan offers a retirement savings vehicle designed for self-employed individuals or business owners without common-law employees. This structure allows a business owner, and their spouse if actively involved in the business, to contribute to both the employee and employer portions of a 401(k) plan. This article clarifies when a Solo 401(k) falls under ERISA regulations and its implications.
Understanding ERISA
The Employee Retirement Income Security Act (ERISA) is a federal law that sets minimum standards for most voluntarily established retirement and health plans in private industry. Its primary purpose is to protect the interests of participants and their beneficiaries. ERISA requires plans to provide participants with information about their plan, including important features and funding.
The law also establishes fiduciary responsibilities for those who manage plan assets, mandating they act in the best interest of plan participants and beneficiaries. ERISA covers employer-sponsored retirement plans, such as 401(k)s, pension plans, and other welfare benefit plans that include common-law employees. The Department of Labor is the federal agency responsible for enforcing ERISA’s provisions.
Determining Solo 401(k) ERISA Coverage
A Solo 401(k) plan operates outside the scope of ERISA when it covers only the business owner and their spouse, and no common-law employees participate. The Department of Labor considers a plan non-ERISA if it benefits only the owner-employee, or the owner-employee and their spouse, and does not cover any other employees.
A common-law employee is someone whose work is controlled by the employer, both in terms of what work is done and how it is done. This distinguishes them from independent contractors or partners. If a business hires even one common-law employee, the Solo 401(k) plan becomes subject to ERISA.
When a business owner brings on a common-law employee, the Solo 401(k) plan’s status changes. The plan must then comply with ERISA’s requirements.
Practical Implications of ERISA Status
For Solo 401(k) plans that are not subject to ERISA, the administrative burden is lighter. These non-ERISA plans are exempt from many stringent reporting and disclosure requirements. For instance, a non-ERISA Solo 401(k) plan is not required to file an annual Form 5500-EZ with the IRS unless its plan assets exceed $250,000 at the end of the plan year.
When a Solo 401(k) becomes ERISA-covered, administrative and compliance obligations significantly increase. The plan must adhere to ERISA’s regulatory framework, which includes specific fiduciary duties. These duties require plan administrators to act solely in the interest of plan participants and beneficiaries, with prudence, loyalty, and diversification of investments.
An ERISA-covered Solo 401(k) must also file an annual Form 5500-EZ with the IRS, regardless of its asset size. This filing provides detailed information about the plan’s financial condition, investments, and operations. Failure to comply with ERISA’s requirements, including proper reporting and adherence to fiduciary standards, can result in significant penalties, potential audits by the Department of Labor, and legal action from plan participants.