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Terminating a Solo 401k - Effective Date / Contribution Date

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  • Terminating a Solo 401k - Effective Date / Contribution Date

    My wife has a Solo 401k with a third-party professional administrator for her single member LLC (taxed as a sole proprietor). She hired her first set of employees November 2020. The solo 401k has maximum employee restrictions and provides that, once an employee has been with the company for 1,000 hours/1 year, that employee is eligible for entry into the plan on January 1 of the following year. One employee met the threshold from Nov 1 2020-Oct 31 2021 and will become eligible for participation in the plan January 1, 2022. This employee is a short-term employee and will be leaving the company shortly after she becomes eligible (going back to school).

    Assuming my wife decides to terminate the plan,

    1. What is the right termination date that would allow my wife to make the maximum contribution amount for 2021? 12/31/21? 1/1/22?

    2. Do contributions for 2021 need to be made by the termination date? My wife typically waits until our taxes are finalized before contributing, so it would be the summer of 2022 before the contribution for 2021 would ordinarily be made. But if the plan is "terminated" 12/31/21 or 1/1/22, the amounts would be pure estimates based on her financials through today.

    Many thanks in advance!

  • #2
    The termination date does not have to and practically can not be 12/31/2021. The termination date will be when the final assets are distributed or rolled over to an eligible destination. She has until her tax filing deadline including extensions to make her 2021 contributions. She will only be in non-compliance if she makes contributions for the 2022 tax year not 2021 contributions in the 2022 calendar year.

    Note: She must file her final Form 5500-EZ by the end of the 7th month following the termination of the plan. This is true regardless if she has ever had to file a Form 5500-EZ for the one-participant 401k plan's year-end balance > $250. There are significant penalties for late or failure to file the Form 5500-EZ.

    Shouldn't this be something the "professional administrator" would know.
    spiritrider
    Member
    Last edited by spiritrider; 12-02-2021, 12:47 PM. Reason: Added clarification in the second half of the last sentence of the first paragraph that I was referring to 2021 contributions.

    Comment


    • #3
      Thanks
      spiritrider
      Member
      spiritrider , the TPA is telling her that she needs to have all contributions and rollovers completed by 12/31/21 in order to terminate the plan on that date. But maybe that is putting the cart before the horse.

      1. If the termination date ends up being in 2022, then does that mean the plan will be in non-compliance since there would be an eligible employee (and the plan is not being transitioned to a formal small-business full scale ERISA 401k)? Is there a way to delay termination until 2022 without causing the plan to be in violation of federal laws?

      2. Another idea, which would be plan B, is to make the employee elective contribution and voluntary after-tax non-Roth contributions immediately (by 12/31), roll them out, and then set up a protoype-SEP plan at Schwab for 2021 and make the employer profit sharing contribution later in 2022 - there is also a liquiduity issue coming up with $58k on such short notice. But $20k is very doable. Does that work? Any issues with that approach?
      mcraepat9
      Member
      Last edited by mcraepat9; 12-02-2021, 01:52 PM.

      Comment


      • #4
        The TPA's position makes no sense.

        The employer needs declare termination of the plan effective with the end of the 2021 tax year. The mechanics of depositing the 2021 contributions and rolling over the plan balances are the orderly completion of the termination. There would be no non-compliance.

        If the TPA is to be believed wouldn't the same issues exist with making 2021 tax year SEP IRA contributions for the 2021 tax year in 2022?

        ​​

        Comment


        • #5
          spiritrider
          Member
          spiritrider I agree with you. But i had another conversation with them this morning. They seem to be sticking with their view that the "termination date" is after the date on which all the funds in the plan have been rolled out, so is telling her that it needs to be done by Dec 31 given the newly eligible employee will be eligible after that date. Seems crazy.

          In light of that, we are going to contribute the elective contribution and voluntary after-tax/non-Roth amounts immediately, and then establish a prototype SEP in 2022 and contribute the employer profit sharing slice in 2022 before Oct 15 2022.
          mcraepat9
          Member
          Last edited by mcraepat9; 12-03-2021, 08:46 AM.

          Comment


          • #6
            To make SEP IRA employer contributions for the 2021 tax year. An election of Option 2A with an effective date of 1/1/2021 will be required on the Schwab Prototype SEP IRA Adoption Agreement.

            Also:
            • 3 Part A: Elect 3 of 5 year eligibility. This will restrict the employee from SEP IRA participation until November 2023 and all future employees until they have 3 of five years off service. Note: There is no entry date and if employees have even one day of eligibility for the year, they must receive the full employer contribution on their compensation for the year. Note: All employees including the owner must meet this eligibility.
            • 3 Part B: Regardless if this employee is < age 21, this eligibility should be elected for any other employees hired.
            • 3 Part C: It is critical to elect Option 2: No. Otherwise all current employees are eligible and must receive employer contributions. If you elect Option 2: Yes, because the owner does not meet the 3 of 5 eligibility, the other employee will be eligible too.
            • 3 Part D: Elect all these restrictions.
            • 4 Part A: Option 1.
            • 4 Part B: Option 1.
            • 4 Part C: Option 1.
            • 5 Parts A: and B: as applicable/desired.
            • 7 N/A for plans adopted after 12/31/1996.

            Comment


            • #7
              spiritrider
              Member
              spiritrider very much appreciated! Your posts are always educational. Some follow up clarifications if you will indulge me:

              1. When you say in your first bullet that it will restrict the employee from SEP IRA participation until Nov 2023, maybe I am misunderstanding the rule.
              It was my understanding that you could exclude any employee that has not worked for the company in any 3 of the preceding 5 calendar years - so in 2022, since the only employee that worked for the company in 3 calendar years during the 5 calendar years preceding 2022 was my wife (the owner), she would be the only eligible employee.

              So I was evaluating the other employee's eligibility like this: employee started in 2020, so in 2023 the employee would be eligible (2020, 2021, 2022 being calendar years where the employee worked for the company). But is *November* 2023 meaningful? Does it mean my wife can contribute to the prototype SEP during 2023 but *before* November and not have to make a ratable contribution to the employee?

              2. For purposes of eligibility/3 of 5 years, does it matter if the business was previously a sole proprietorship and then became operated under an LLC? My wife operated her business as a sole proprietor for years until some regulatory issue required her to form an LLC to operate the business under. Does service time working as a sole proprietor count the same as work for the LLC since they are affiliated/controlled?

              Really appreciate your expertise and time !


              Comment


              • #8
                1. You are correct. Your wife can make SEP IRA contributions for 2021 and 2022. I was simply pointing that there is no possiblity of delayed entry after eligibility like a 401k. If an employee is eligible by even one day (assuming they meet the minimum compensation requirement), they must receive employer contributions on their full compensation for the year.
                2. The LLC has no effect. The IRS considers an LLC that has not elected subchapter S tax treatment is a "disregarded entity". The IRS considers a single member LLC a sole proprietorship. As indicated by the fact that she still files Schedule C. As far as the IRS is concerned, she has had the same business as a sole proprietorship the whole time.

                Comment


                • #9
                  Thanks again
                  spiritrider
                  Member
                  spiritrider


                  One last question:
                  • 5 Parts A: and B: as applicable/desired.
                  My wife is a sole proprietor with a single member LLC (no S-corp). For Part A, is there any difference between W-2 wages, 3401(a) wages and 415 safe harbor compensation?

                  Also, my wife's fiscal year is calendar year. For part B, does this mean she should pick the Adopting Employer's fiscal year or calendar year (does it matter)?

                  Very much appreciate your wisdom.

                  Comment

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