Key Solo 401(k) Rules Under SECURE Act 2.0

SECURE Act 2.0 is the most significant piece of retirement legislation since the original SECURE Act of 2019.  The latest version is part of the larger $1.7 trillion Omnibus Bill that was signed into law by President Biden in December 2022.  The bill is over 4,000 pages and has over 400 pages, and 90+ provisions relating to retirement accounts. This article will explore the key provisions in SECURE Act 2.0 as they relate to the Solo 401(k) plan.

What is a Solo 401(k) Plan?

Briefly, a Solo 401(k) is a regular 401(k) plan that has been adopted by a sole proprietor or any entity that does not have any full-time employees. It is the perfect retirement plan for any sole proprietor, consultant, or independent contractor. To be eligible to benefit from the Solo 401(k) plan, one must meet just two eligibility requirements:

1. The presence of self employment activity.
2. The absence of full-time employees.

The Solo 401(k) plan has become the most popular retirement plan for the self-employed or small business owner for a number of reasons. First, one can make pretax or Roth annual contributions of up to $66,000 or $73,500 if at least age 50 for 2023.  Secondly, you can borrow the lesser of $50,000 of 50% of the plan account value tax-and penalty-free and use the loan for any purpose.  Thirdly, as trustee of the plan, you can invest in both traditional and alternative assets, such as real estate. In addition, you have the ability to use a nonrecourse loan to acquire real estate without triggering the UBTI tax.

SECURE Act 2.0 – Solo 401(k)-Related Provisions

As part of the SECURE Act 2.0 (download the PDF), there are four key provisions that will impact Solo 401(k) plan owners as follows.

Allow first-year elective contributions to new 401(k) plans of sole proprietors or single member LLCs to be made by due date for tax return.

The original SECURE Act included a provision that allowed an employer to establish a 401(k) plan in a current year and allow the plan participant to make certain 401(k) contributions for the prior year.  For example, one could establish a plan in 2023, for the 2022 taxable year.  However, the provision only allowed for employer profit sharing contributions to be made for the previous taxable year.

Unlike the elective deferral, which can be made as the employee of a 401(k) plan on a dollar-for-dollar basis, the amount you may contribute as the employer is based on a percentage of the business’s income. This hinders one’s ability to max out his or her contributions for that year.

This provision in SECURE Act 2.0 will allow a sole proprietor or a Schedule C Single Member LLC to establish a plan in 2023 and make both employee deferral and employer profit sharing contributions for the previous taxable year.  Unfortunately, this provision does not apply to a W-2 employee, which is a business that is established as a C or S corporation.  The same would apply to a partnership where the partners receive guaranteed payments.

Note – if a sole proprietor or single member LLC established a plan in 2022, they would have been able to make both types of contributions in 2023 for the 2022 taxable year.  This provision simply allows the individual to have more flexibility to set-up a plan.

Overall, this is a very positive provision because it will encourage more self-employed and single member LLC businesses to establish a plan in order to receive prior year benefits, which should diminish their appetite to delay the establishment of the plan.  This provision is effective for the 2023 plan year.

Long-term part-time workers: three years to two years. 

Prior to the SECURE Act, employers generally could exclude certain part-time employees (i.e., employees who have not satisfied a requirement that they have 1,000 hours of service in a year) when offering a 401(k) plan to their employees.  It added a rule that would treat an employee as full-time and, thus, eligible to participate in a 401(k) plan, if they worked 1,000 hours during a year or three consecutive years of service where the employee completes at least 500 hours of service.

SECURE Act 2.0 reduces the three-year requirement to two years.  In addition, the bill would include the “two consecutive years” rule not only in the Code, but also in ERISA, and would broaden it to apply to ERISA-covered 403(b) plans in addition to 401(k) plans. For purposes of ERISA, an individual’s service prior to 2023 would be disregarded. This provision only becomes effective for the 2025 taxable year.

This might make it more difficult for small business owners to set up a Solo 401(k) since the new requirements make it easier for an employee to be considered full-time. As mentioned earlier, that would prohibited a business from setting up a Solo.

Increase in required beginning date for mandatory distributions.

This is one of the provisions that will have an immediate impact on taxpayers. Under current law, under the required minimum distribution (RMD) rules, participants are generally required to begin taking distributions from their retirement plan at age 72, increased from age 70 ½ in 2020. The SECURE Act 2.0 provision would increase the RMD age from 72 to 73 in 2023 and to age 75 in 2033.

RMDs have always been a thorn in the side of retirement savers. The IRS won’t let you defer taxes forever, so they “require” to start withdrawing from the plan at a certain age. Any time that age is increased is a win for savers. This allows one an immediate one year reprieve for those have not reached their required beginning date. Plus, it benefits younger savers with an extra two years to save unhindered.

Obviously, if you are turning 72 in 2023, you can breathe a sigh of relief in that you want have to start taking RMDs this year if you don’t need those funds.

RMD treatment of plan Roth amounts.

This provision addressed an oddity in the Roth 401(k) RMD rules which were inconsistent with those of the Roth IRA. Roth IRAs are exempt from the “pre-death” required minimum distribution rules. However, Roth 401(k) plans were, for some reason, not exempt. Under SECURE Act 2.0, the Roth IRA RMD exemption would be extended to Roth amounts in 401(k) plans. This provision would be effective for 2024.

However, until 2024, there is an easy workaround for Roth 401(k) plan individuals that do not want to take an RMD.  Those individuals would simply need to rollover all funds in the Roth 401(k) to a Roth IRA tax-free before December 31, so that the value of the Roth 401(k) would be zero at the time the RMD needs to be calculated. Obviously, this “loophole” will no longer be necessary beginning next year.

Conclusion

The 90+ provisions in SECURE Act 2.0 are generally focused on increasing access to retirement plans for more individuals and small businesses.  For the self-employed and small business owners with a Solo 401(k) plan, it contains a number of important rules that need to be carefully considered in the coming years. As usual, most retirement-related provisions in the Act will benefit a number of savers. Of course, there are always a few outliers that may hinder you. SECURE Act 2.0 is, overall, a good bill for retirement savers across the board.