Author Topic: Cutting off a solo 401k before hiring employee... illegal?  (Read 679 times)

barrelomonkeys

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Cutting off a solo 401k before hiring employee... illegal?
« on: January 26, 2019, 08:01:41 PM »
Hi everyone,

DH is the sole employee of a C corp, and will be for at least the next 6 months (if not a year or longer) until he hires a postdoc.  Seeing as it is free (for us) to open a solo 401k at Vanguard, I was hoping to go that route and funnel ~$40k/year into it ($19k into the Roth 401k option and $20k as an employer contribution). 

As I was running things by our accountant for the C corp, she thinks that it's not possible/illegal to drop a solo 401k either just before or after hiring someone.  She quotes: "No matter what the 401k plan is called by a plan provider, it must meet the rules of the Internal Revenue Code.  If you hire employees and they meet the plan eligibility requirements, you must include them in the plan and their elective deferrals will be subject to nondiscrimination testing."  In other words she says, despite its name, a solo 401k does apply to other employees, and she thinks it's illegal to drop it just because you're hiring.

I feel like I've read/seen a bunch of people on here drop their solo 401ks when hiring an employee.  Am I wrong about this?

I'm not even sure if they're going to offer the new employee retirement benefits anyway (since that's not typical for the industry), but we may offer them a SEP option if they're big savers and they're interested... 

Super frustrating since I thought I had it all in the bag until now.

Gin1984

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Re: Cutting off a solo 401k before hiring employee... illegal?
« Reply #1 on: January 26, 2019, 09:21:19 PM »
"A business owner with no common-law employees doesn't need to perform nondiscrimination testing for the plan, since there are no employees who could have received disparate benefits.

The no-testing advantage vanishes if the employer hires employees. No matter what the 401(k) plan is called by a plan provider, it must meet the rules of the Internal Revenue Code. If you hire employees and they meet the plan eligibility requirements, you must include them in the plan and their elective deferrals will be subject to nondiscrimination testing (unless the 401(k) plan is a safe harbor plan or other plan exempt from testing)."
Nothing there says that the business cannot close the 401k there.

feelingroovy

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Re: Cutting off a solo 401k before hiring employee... illegal?
« Reply #2 on: February 09, 2019, 03:44:43 PM »
 Yeah, you can't do it.

@SeattleCPA has a very nice blog post about this.

Scroll down to cost#3 in this article:

https://evergreensmallbusiness.com/hidden-small-business-pension-plan-costs/

SeattleCPA

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Re: Cutting off a solo 401k before hiring employee... illegal?
« Reply #3 on: February 11, 2019, 02:49:24 PM »
:-)

BTW I have never *personally* seen someone get beat up because they stop a plan...  but I've asked internal consultants at big financial services firms about this (so the consultant the person you deal with at, e.g., Charles Schwab, asks) ... and these folks basically say, "oh geez yes of course..."

bacchi

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Re: Cutting off a solo 401k before hiring employee... illegal?
« Reply #4 on: February 12, 2019, 11:08:38 AM »
There are provisions for terminating a solo 401k. One way is to close the company, roll over the solo money to a tIRA, and file 5500-EZ.

It might best to start a SIMPLE with a ~6 month employment requirement and a 3% match. Or a SEP with a 25% match. Both of these plans are not "indefinite" and can be terminated easily.

SeattleCPA

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Re: Cutting off a solo 401k before hiring employee... illegal?
« Reply #5 on: February 13, 2019, 02:18:18 PM »
There are provisions for terminating a solo 401k. One way is to close the company, roll over the solo money to a tIRA, and file 5500-EZ.

It might best to start a SIMPLE with a ~6 month employment requirement and a 3% match. Or a SEP with a 25% match. Both of these plans are not "indefinite" and can be terminated easily.

Yes, but just to be clear. The issue is that terminating a plan, looked at by an IRS auditor after the fact, gets viewed as discriminatory. E.g., while it was just the owner, the match was 25%... and then as soon as owner added employees, he or she terminated plan and went with a much less friendly plan that only contributes 3% and limits people to way smaller elective deferrals.

AlexMar

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Re: Cutting off a solo 401k before hiring employee... illegal?
« Reply #6 on: February 15, 2019, 11:18:37 AM »
There are provisions for terminating a solo 401k. One way is to close the company, roll over the solo money to a tIRA, and file 5500-EZ.

It might best to start a SIMPLE with a ~6 month employment requirement and a 3% match. Or a SEP with a 25% match. Both of these plans are not "indefinite" and can be terminated easily.

Yes, but just to be clear. The issue is that terminating a plan, looked at by an IRS auditor after the fact, gets viewed as discriminatory. E.g., while it was just the owner, the match was 25%... and then as soon as owner added employees, he or she terminated plan and went with a much less friendly plan that only contributes 3% and limits people to way smaller elective deferrals.

Adverse Business Conditions is an acceptable reason to terminate the plan.  Also changing to a different plan is acceptable as well as employees wanting something different. So adding new employees at the high rate made the plan adverse, thus the need for a new plan, which the employees wanted.  Adding a new employee was a substantial change in a business with 1 person, doubled the workforce and changes needed to be made. That sounds perfectly valid to me.