Question: I am self-employed and several years ago, upon the advice of my financial advisor, I opened a “Solo 401(k)” retirement plan. This plan allows me to save more before-tax money each year than the SEP IRA plan I had before. I still have my SEP IRA account, but no longer contribute to it. I recently read that owners of solo 401(k) plans with values exceeding $250,000 must file a tax return for the plan. Is this correct? Is my SEP IRA balance included in the $250,000 limit?
Answer: Your advisor gave you good advice. With your SEP IRA you are able to contribute 20% of your net self-employment income up to $52,000. With your solo 401(k) you can contribute the same 20% of your net income plus an additional $17,500 up to a combined total of $52,000. And if you are age 50 or over you can contribute an additional $5,500 in 2014.
Solo 401(k) plans are great for self-employed taxpayers who have no employees, have net incomes of less than $260,000, and who want to shelter more than 20% of their net income from taxes. For example, if your self-employed compensation is $100,000 in 2014, your maximum SEP-IRA contribution is $20,000. With a solo 401(k) you could contribute $20,000 plus $17,500 of salary deferral for a total of $42,500. If you are 50 or over, you could contribute and defer taxes on a total of $48,000.
Question: Must I file a tax return for my solo 401(k) retirement plan?
Answer: When your solo 401(k) plan exceeds $250,000 you are required to file a tax return for the plan using IRS Form 5500-SF or Form 5500-EZ. The $250,000 does not include the money in your SEP-IRA and there is no requirement for you to file a tax return for your SEP-IRA regardless of the amount in the account.
If your solo 401(k) plan value exceeds $250,000 at the end of the year and you fail to file a tax return for the plan, you are subject to a penalty of $25 per day up to $15,000. Solo 401(k) plan owners who should have filed and did not can take advantage of a recent IRS temporary pilot program that provides relief from penalties by submitting all required forms for each plan year for which relief is requested. The pilot program ends on June 2, 2015. If you should have filed and didn’t, you should have your tax professional file the appropriate forms as outlined in IRS Revenue Procedure 2014-32.
Question: Is there a way to avoid the requirement to file tax returns for my solo 401(k)?
Answer: Yes, but only if your 401(k) plan documents allow you to make distributions while you are still actively working. If that’s the case, you can make direct rollovers of funds from your solo 401(k) to an IRA account (including your SEP IRA) to keep your solo 401(k) plan balance below the $250,000 reporting threshold.
Question: Can I borrow money from my solo 401(k)?
Answer: Yes, you can borrow from your account if the plan documents allow it.
Kenneth B. Petersen CFP®, EA, MBA, AIFA® is an investment manager and Principal of Monterey Private Wealth, Inc., a Wealth Management Firm in Monterey. He welcomes questions that you may have concerning investing, taxes, retirement, or estate planning. Send your questions to: Ken Petersen, 2340 Garden Road Suite 202, Monterey, CA 93940 or email them to firstname.lastname@example.org.