Solo 401(k) Plans — Common Law Employees (Part 2)

In the previous blog post we addressed what types of employees must be included in a company’s 401(k) plan.  Or, more correctly, we noted exceptions to individuals being required to be enrolled into the 401(k).  These exceptions generally include:

–  Employees who, as a general class, never work more than 1,000 hours per year;

–  Employees who are seasonal and, as such, would/should not meet the 1,000 hours per year;

–  Employees who are not age 21; and,

–  Individuals who are truly 1099 independent contractors

With any of these conditions, the plan documents for the 401(k) will always dictate how these rules are to be administered.

But, Wait, They Don’t Meet any of these Exceptions?

Well, then we go back to your three potential options:

1)  Include the Employee in the Plan — Okay, this blog shouldn’t be interpreted that the business owner shouldn’t want to include their employee(s) in the 401(k), just that you will have financial considerations.  But, if you are an employer who wants to help your employee (at the same time helping yourself), by all means include that person in the plan.  Just keep in mind that even when you want to include them, their inclusion has to comply with the 401(k) plan documents which will dictate when they can enter the plan.

2)  Terminate the Plan? — Before you even make final considerations to employing an individual, you can terminate the plan.  While the IRS considers 401(k) plans, generally, to be an on-going retirement plan arrangement, it may be in the best interests of the business to terminate the plan.  The IRS does not require an employer to maintain a 401(k) plan, but it does have rules affecting you and your employees IF you have a 401(k) plan.  So, keeping this in mind, there would be nothing stopping you from terminating your plan even before you hire an employee.  Now, you ask, well what about the assets of the plan?  Can I still self-direct my investments?  Do I need to formally terminate the plan with the IRS?  Are there any other considerations?

a) Assets of Plan — First, and should go without saying, you would need to make plans to terminate the plan.  You cannot just keep a plan active for yourself.  So, in rolling over assets (traditional or non-traditional) to another plan (e.g., IRA) you would rollover the assets as any other rollover.  You could also rollover the assets to a self-directed IRA (of course, provided you qualify for that particular IRA) and still self-direct.  Further, if you were one who decided to no longer self-direct and the assets were traditional assets, you don’t even need to worry about rolling over non-traditional assets (e.g., real estate) in kind and retitling the assets.

b)  Can I Still Self-Direct? —  Yes, as noted above, you could still self-direct.  You would just be self-directing through another type of plan (e.g, IRA).

c)  Do I Terminate the 401(k) Plan? — Yes, not only would you need to terminate the plan through the plan document sponsor (PGI), you would also (as Trustee of the plan) need to distribute assets of the plan in compliance with IRS regulations.  This would also include filing a final Form 5500 for financial reporting and distribution of the plan’s assets.

d)  Other Considerations? — Another consideration is that once you terminate a 401(k) plan, you would not be able to able to re-start another 401(k) plan (where you are a majority owner) for at least 12 months.  So, don’t go thinking that you could terminate the one plan and start a new one the following month…ain’t going to work.

3)  Amend the Plan Documents to Specify Participant Enrollment Dates — Most PGI clients who have had their plan documents re-stated have had their plan documents amended to legally exclude a participant from joining the plan:

a)  Until the employee has been employed by the employer for at least one (1) year; and,

b)  The employee can then enroll into the plan at the next semi-annual enrollment date.

This option is understandable for most businesses as they want to make sure the employee is a committed employee who, after a probationary period, is now eligible for the plan.  No one would want to have an employee be a participant for a short period of time only to quit their job.  And, let’s use a couple of examples:  Let’s say you added a full-time employee on June 1, 2015.  Prior to employment of the individual, the plan documents could be amended to require one (1) year or service with a semi-annual enrollment.  So, if an employee commenced employment on June 1, 2015 with the aforementioned plan enrollment conditions, the  plan documents exclude that individual from participating in the plan for one year (takes you to May 31, 2016), and then not permit enrollment until the next semi-annual enrollment date (July 1, 2016).   In another example, if an employee commenced employment on February 1 of a given year, the employee could be excluded for one year and then not be able to enroll in the plan until the next semi-annual enrollment (July 1).   You cannot require a probationary period of more than one year (in most cases).

Thinking of adding an employee to your business?  You may find it wise to consult your plan documents and consult with your tax professional.

As always, the information provided is intended to be educational in nature.  It is not intended, nor should it be interpreted as, any form of tax, legal, financial or investment advice.  You must always consult with your respective professional in all such matters.