The Employee Retirement Income Security Act of 1974 (ERISA) is a federal law. ERISA was created to protect employees who invest in their company retirement plan. Since a Solo 401k doesn’t have non-owner employees, many titles of ERISA don’t apply. However, it’s still important to know about the protections in an ERISA Qualified Retirement Plan.
Interestingly, it sets minimum standards for most voluntarily established pension and health plans in private business. The purpose is to provide protection for people vested in the plans. However, to qualify, a plan must be employer sponsored. That means the IRS requires plan contributions to be tax deductible.
A corporate 401k is an ERISA qualified retirement plan because it is employer defined and therefore employer sponsored.
Important: You can be the employer who sets up a Solo 401k for yourself. This is something many people don’t understand. People see the words “employer sponsored” and think they have to work for someone else. However, many owners operate their own small business. Any business owner can set up a qualified retirement plan.
However, keep in mind that Solo 401k plans are not typically classified as standard ERISA plans, because these plans are for business owners only. Solo 401k plans don’t include non-owner employees, so there are certain titles of ERISA that don’t apply to the Solo 401k.
Also Important: You can move other retirement funds into a Solo 401k account. ERISA rules allow money locked in a 401k, IRA, or other retirement account to roll over to new a retirement account. In this case, you can rollover funds without them taxable distribution. Fortunately, you also don’t have to pay taxes or penalties on these direct rollovers. You can roll ERISA accounts into a Solo 401k account. This includes company sponsored 401k funds, after your leave the employer.
Basic ERISA Requirements for a Qualified Plan
An employer or qualified vendor establishes the ERISA qualified retirement plan as an employee benefit. Other requirements include:
- Must provide scheduled information to all participating employees. (The only employees in a Solo 401k are the owner and possibly a spouse). Important information is what the plan does and where the funding comes from.
- The business must provide some funding to the plan.
- Employment length before you can participate in the plan
- It allows for the growth of benefits for each employee.
- The plan may provide/guarantee benefits for employees upon retirement, the closure of the plan, or based on a specific event.
- The plan enables employees to sue the plan and asset managers for mishandling the plan. This doesn’t generally apply to a Solo 401k, because you probably won’t mishandle funds or sue yourself!
- It bans employees from transferring their interest to someone else. This is the “anti-alienation” provision. It’s the basis for protection from creditors.
The most common ERISA plans include 401ks, deferred compensation plans, and profit sharing plans. Keep in mind that with a Solo 401k the only “participants” or “employees” are the business owners and possibly a spouse.
A Warning About Traditional, Roth IRAs, and Other Non-ERISA Plans
Many people have traditional and Roth IRAs for their retirement. However, these are not usually employer sponsored or employer defined. These are reasons the accounts are NOT ERISA qualified. There are also other non-ERISA accounts.
Interestingly, non-ERISA plans are common. However, they may not be as protected. Retirement plans that are not ERISA qualified can be attacked by creditors based on state and federal exemption laws. These are generally much less protected from creditors than ERISA plans. Non-ERISA retirement plans include:
- Traditional IRAs
- Roth IRAs
- Keogh Plans
- 403(b) plans for employees of a public school or university are ERISA exempt
- Government plans
- Church plans
SEP IRAs and SIMPLE IRAs: ERISA Qualified Retirement Plans
As a small business owner, you may have already set up a Simplified Employee Pension IRA (SEP IRA). A reason business owners go with a SEP IRA is because they might not know about the Solo 401k. But that doesn’t make the SEP is a better retirement vehicle. For instance, loans are not allowed from a SEP account the way they are from a 401k (50% or $50,000 of the vested balance).
The SIMPLE IRA is even less complex than a SEP IRA. For that reason, it may be the first ERISA plan a small business begins with.
As the value of these retirement plans grow and the investing goals change, switching to a Solo 401k can be the better option so you have more control over your investments.
ERISA Protects From Creditors, Lawsuits, and Bankruptcy
One of the biggest drawbacks of Non-ERISA accounts is the limited liability protection provided. Non-ERISA protection falls under Bankruptcy Abuse Prevention and Consumer Protection Act (BAPCPA). ERISA qualified retirement plans have different rules under the Employee Retirement Income Security Act. For example, protection for traditional and Roth IRAs is capped at $1,362,800 for bankruptcies filed between April 1, 2019, and March 31, 2022. If you have more than one traditional or Roth IRA, you can only shield a total of $1,362,800 (not per account).
A bankruptcy court can take any amount over $1,362,800 to repay creditors. The cap adjusts every three years for inflation. And there is an exception. The U.S. Supreme Court determined that inherited IRAs are not shielded unless the IRA is inherited from a spouse.
In contrast, Solo 401k protection is much safer against lawsuits. Even though the Solo 401k is not considered a traditional ERISA plan, it is typically protected under the Bankruptcy Abuse Prevention and Consumer Protection Act (BAPCPA). Typically, only the IRS or a spouse has legal rights to the assets. Better yet, private lenders such as mortgages, personal credit cards, autos, business loans, and others have no rights to your Solo 401k.
Have questions about your Solo 401k? Solo 401K experts at Nabers group will help you get your retirement funds into your control, where they belong. Contact us here.
Disclaimer: These resources are provided as a convenience and for informational purposes only. They do not constitute an endorsement or an approval by Nabers Group LLC of any of the products, services, or opinions of any corporation, organization, or individual. Nabers Group LLC bears no responsibility for the accuracy, legality, or content.
So, is then safe to say that a solo 401K as a subscriber to an investment is not an “employee benefit plan” that is subject to Part 4 of Title I of the U.S. Employee Retirement Income Security Act of 1974, as amended (“ERISA”) or a plan subject to Section 4975 of the Internal Revenue Code of 1986, as amended (the “Code”)?
And therefore does not have a class of equity interests that is 25%-owned (or more) by one or more “benefit plan investors” as defined in Section 3(42) of ERISA?
Hi JF, yes you are correct. Several of our clients have invested in hedge funds and private equity deals with their Solo 401k trust and were not counted as part of the 25% ERISA limit applicable for most hedge funds. We know plenty of attorneys who agree with this as well. Before you invest in a deal, make sure you check with their legal counsel to ensure they agree too! Happy investing!