Is Your Individual 401k Compliant? Here's What You Should Know

Many investors prefer the individual 401k because it's specifically designed for small businesses with no employees. Individual 401ks offer cost effective and tax efficient investment benefits. Think of it as a Self Directed IRA made just for investors & the self employed.

It's like a dream come true right? However, a lot of individual 401ks are not correctly managed, which leads to costly penalties or even plan termination. If you have an individual 401k, you want to make sure it is managed correctly. Here's 5 things you need to ask yourself to make sure your 401(k) is compliant and keep it that way.

Has Your Individual 401k Plan Been Updated?

Your friends at the IRS require your individual 401k plan to be updated at least once every 6 years. If you’ve had your plan over 6 years and you’ve never updated it according to new IRS guidelines, it's not compliant and when that audit comes in the mail you will be subject to costly fines and even plan termination.

If your plan is out of date, the smartest thing you can do get it updated to guarantee its compliance with new IRS guidelines.

Are You Keeping Track of Your Plan Funds?

Your individual 401k plan funds must be accounted for and identify the different income sources for each member of the plan. Let's say two spouses are contributing Roth 401k employee contributions and the company is matching the contributions. In this situation, you need to be tracking these four different sources of funds, and you must have a written record documenting these different types of funds.

Are Your Plan Funds Being Separated by Both Source and Participant?

You must use separate bank accounts for the different participants’ funds and also separate traditional funds from Roth funds. You must properly track and document investments from these different fund sources so that returns to the individual 401k are properly credited to the proper investing account. Yep, there's a lot to keep track of!

Do You Need to File a Form 5500? 

Yea that's right, another form. There are two situations where you usually have to file a Form 5500 for your individual 401k. First, if your individual 401k has more than $250,000 in assets. And second, if the individual 401k plan is terminated (regardless of total assets). If either of these instances occur, then you will need to file a Form 5500 to the IRS annually.
Individual 401ks can file what is known as a 5500-EZ. The 5500-EZ is an easy to file version of the standard Form 5500. Unfortunately, the Form 5500-EZ cannot be filed electronically and must be filed by mail. Individual 401k owners have the option of filing a Form 5500-SF online through the Department of Labor (DOL).

The online filing is a preferred method as it can immediately be filed and tracked by the plan owner. Actually, if you qualify to file a 5500-EZ, the IRS/DOL allow you to file the Form 5500-SF online but you can skip certain questions so that you only end up answering what is on the shorter Form 5500-EZ.

Are You Correctly Accounting for Contributions and Rollovers? 

If you’ve rolled over funds from an IRA or other 401k to your individual 401k, you should’ve indicated that the rollover or transfer was to another retirement account. So long as you did this, the company rolling over the funds will issue a 1099-R to you, but will include a code on the 1099-R indicating that the funds were transferred to another retirement account, and that the amount on the 1099-R is not subject to tax.  If you’re making new contributions to the individual 401k, those contributions should be properly tracked on your personal and business tax returns. If you are an S-corp, your employee contributions should show up on your W-2, and your employer contributions will show up on your 1120S S-corp tax return. If you are a sole proprietor your contributions will typically show up on your personal 1040 on line 28.

Keep Your Friends at the IRS Happy

It's important to make sure you are updating your plan and complying with these rules on an annual basis. If you suspect that your individual 401k retirement plan is out of compliance, meet with your attorney or CPA immediately to make sure everything is okay. The penalty for not properly filing Form 5500 is $25 a day up to a maximum penalty of $15,000 per return not properly filed. Don’t lose your hard earned retirement dollars over a simple form folks!

Last Updated: 
November 7, 2017

Scott Royal Smith is an asset protection attorney and long-time real estate investor. He's on a mission to help fellow investors free their time, protect their assets, and create lasting wealth.

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