An individual who adopts an Individual 401(k), more frequently known as a Solo 401(k) Plan, may generally fund the Solo 401(k) Plan using two methods – the rollover process or by direct contribution.
Most Solo 401(k) Plan documents will allow for the rollover of IRA or other pre-tax employer retirement funds, such as a 401(k), 403(b), or 457(b). The IRA holder or plan participant may generally fund the new Solo 401(k) Plan by either a direct or indirect rollover. It is important to remember that Roth IRA fund may not be rolled into a Solo 401(k) Plan.
Direct Rollover of Retirement Funds to a Solo 401(k) Plan
When an IRA holder or plan participant directly rolls over eligible IRA or employer plan retirement fund to a Solo 401(k) Plan, the IRA holder or plan participant must generally initiate the rollover process with the financial institution that is holding the retirement funds. Upon receiving a direct rollover request form, which is usually submitted in writing, the current retirement account custodian would issue a check to the new Solo 401(k) Plan participant in the name of the receiving plan for the benefit of the individual. The 60-day rollover rule would not apply. Also, there would be no withholding because the rollover is not considered a taxable distribution.
Reporting a Direct Rollover to a Solo 401(k) Plan
A direct rollover of retirement assets to a Solo 401(k) Plan is reported on IRS Form 1099-R using distribution Code G, in box 7. The transferring financial institution would be the party required to file the IRS Form 1099-R with the IRS. The receiving financial institution is not required to report the rollover transaction.
How Does the IRS know The Retirement Funds Were Rolled into a Solo 401(k) Plan?
In the case of a transfer of retirement funds to an IRA, the IRA custodian receiving the transfer or rollover of IRA funds is required to report the receipt of IRA funds on an IRS Form 5498, which provides the IRS with the value of the IRA holder’s IRA account. The IRS would then be able to match the 1099-R with the Form 5498 offering the IRS a road map of the movement of funds.
However, when receiving a rollover of retirement funds, the receiving financial institution, which is the custodian of the newly established Solo 401(k) Plan is not required to report the rollover. So how does the IRS know that the funds were in-fact rolled over to a Solo 401(k) Plan. Firstly, the retirement account custodian transferring or rolling over the retirement funds to the new Solo 401(k) Plan, will file an IRS Form 1099-R and include Code G in Box 7, which will notify the IRS that the funds were rolled into another retirement account. In addition, if the Solo 401(k) Plan participant has plan assets in excess of $250,000, the Solo 401(k) Plan participant is required to file an IRS Form 5500-EZ. The IRS Form 5500-EZ will provide the IRS with the annual Solo 401(k) plan account value which will allow the IRS to match-up the funds that were rolled over and identified on the IRS Form 1099-R.
In the case of a Solo 401(k) Plan participant that is not required to file an IRS Form 5500-EZ because the plan has less than $250,000 in plan assets, how does the IRS know that the plans were actually rolled over into the Solo 401(k) Plan. In this case, the plan participant would have to rely on the IRS Form 1099-R disclosing to the IRS by using Code G in Box 7, that the funds were rolled over to a retirement account. The Solo 401(k) Plan participant does have the option of filing an IRS Form 5500-EZ even if the plan assets are less than $250,000. By filing the IRS Form 5500-EZ, the plan participant would be able to disclose the value of the plan’s assets, which would correspond to the rollover amount reflected on the IRS Form 1099-R. In general, relying on the IRS Form 1099-R as the sole method of proving to the IRS that the funds were directly rolled over to a Solo 401(k) Plan is sufficient, however, if an individuals wants additional support to show the funds were directly rolled over to a retirement account, filing the IRS Form 5500-EZ could be helpful.
Indirect Rollover of Retirement Funds to a Solo 401(k) Plan
An IRA holder or retirement plan participant may generally initiate an indirect rollover by requesting a distribution. An indirect rollover means that the retirement funds are distributed first to the IRA holder or plan participant before they are ultimately rolled over to an IRA or qualified retirement plan. The indirect rollover process must be completed within 60 days. The indirect rollover is not a common method of funding a new retirement account and it can only be done once every twelve (12) months.
The check for an indirect rollover is issued in the name of the IRA holder of plan participant. The individual would then have 60 days to deposit the amount in an eligible retirement plan, such as a Solo 401(k) Plan to avoid taxation and penalties.
Reporting an Indirect Rollover to a Solo 401(k) Plan
Like an IRA distribution, a distribution that is intended to be rolled over to a retirement plan is reported on IRS Form 1099-R, generally using code 1 or 7, depending on the IRA holder’s age. The IRA holder would then have 60 days to roll the funds over to the Solo 401(k) Plan. The indirect rollover process is not recommended when it comes to rolling funds to a Solo 401(k) Plan since it could lead to IRS inquiry about the whereabouts of the rolled over retirement funds. Unlike an IRA which requires the receiving IRA custodian to report the value of the received funds on an IRS Form 5498, in the case of a Solo 401(k) Plan no such reporting is required. A Solo 401(k) Plan custodian is not required to report the value or activities of a Solo 401(k) Plan. The Plan participant would only be required to report the value of the Solo 401(k) Plan if the plan assets were in excess of $250,000.
When retirement funds are indirectly rolled over to a Solo 401(k) Plan, a withholding election is generally required, but the IRA holder may elect to waive withholding.
To learn more about the rules of rolling retirement funds to a Solo 401(k) Plan, please contact a retirement tax expert at 800-472-0646.