401k solo

[JT2307]

Correct me if I am wrong but my understanding is that in order to contribute to the solo you are not to have employees - even if they are your children.

Insurance agent is trying to tell my client he can still contribute to the solo even if he puts his daughter on payroll (she would be the only one)

Thank you.

[TaxGuyBill]

How old is the daughter? If she is under 21, she can be excluded from being allowed to participate in a 401k (if the plan has that restriction).

https://www.irs.gov/retirement-plans/a-guide-to-common-qualified-plan-requirements#1

"Solo 401k" is just a simplified version of a 'regular' 401k because there is only one participant. If the daughter elects not to participate, and the taxpayer ONLY makes Employee 'Elective Deferrals', with no employer contributions, I don't THINK there would be a problem.


If those don't apply (daughter is over 21 and taxpayer wants to make Employer contributions), I'm not sure, and I would need to look up the information to see what I can find.

[JT2307]

under 21

daughter is under 21 - will have to dig deeper.

The only reason they want to put her on the payroll is to get group health insurance....

[John of PA]

It is OK to have employees with a solo 401k. If the employees otherwise qualify, they have to be included in the plan (so it would no longer be solo).

[jsamans]

Additional info on solo 401(k) plans - two possibilities

It is OK to have employees with a solo 401k. If the employees otherwise qualify, they have to be included in the plan (so it would no longer be solo).

A solo 401(k) may include any number of people deemed to be owners of the same business (under controlled-group rules), but not even a single common-law employee who cannot be legally excluded from the plan makes it subject to standard testing. An owner's spouse is not considered a common-law employee, so a business owner may employ his or her spouse without extending any ownership interest and still retain the solo 401(k) treatment. Beyond age considerations that apply equally to anyone, there is no exemption for a child, so if your client adds his adult daughter to his business without an ownership interest, the 401(k) plan will probably become subject to standard testing and can no longer operate as a solo 401(k).

Depending on who administers the plan, it may not be possible to keep it where it is; for instance, Vanguard offers solo 401(k)s but doesn't offer a realistic solution for a single-employee business. Even for those that do, the costs of testing generally result in plan fees that run into the thousands of dollars per year, which is probably more than your client would reasonably want to pay.

Two feasible options to make this work cost-effectively:

1. Replace the solo 401(k) with a SEP IRA, which doesn't require testing. This is the better option if the funding for the retirement plan comes from employer-only contributions, because a new SEP IRA doesn't allow voluntary deferral.

2. Make the daughter a part-owner, which prevents her from being a common-law employee. Obviously, this works best if the business is already subject to corporate or S-Corp taxation, because of the considerably higher complexity of a 1065 versus a Schedule C.

[Rapid Robert]

daughter is under 21 - will have to dig deeper.

The only reason they want to put her on the payroll is to get group health insurance....

But she can be on his policy as a dependent through age 25 -- so how does this make sense? Or are you saying, he has to set up a bogus employee so he can (fraudently?) present himself as a group employer to the insurance company?

[jsamans]

It can be a tradeoff.

But she can be on his policy as a dependent through age 25 -- so how does this make sense? Or are you saying, he has to set up a bogus employee so he can (fraudently?) present himself as a group employer to the insurance company?

I wouldn't necessarily say there's anything shady about wanting to add a common-law employee to qualify for a group plan, provided that the daughter is of legal age to work and actually does anything (and even what she does only needs to be basically plausible), but the whole scenario sure makes more sense now that we've got this piece of the puzzle.

It's not uncommon: owner-only companies want to get insurance, either through standard group rates or the SHOP exchange, but they can't, because you need to have a minimum headcount for group coverage and SHOP plans require at least one common-law employee. But yeah, having even one common-law employee scraps the solo 401(k) unless the employee can be excluded, and in some cases, even an excluded employee isn't allowed (e.g. Vanguard doesn't make this provision).