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Is ERISA Testing Required for a Solo 401(k) Plan?

Is ERISA Testing Required for a Solo 401(k) Plan?
3 Minute Read

A business owner with no common-law employees, who adopts a Solo 401(k) plan, is generally not required to perform ERISA nondiscrimination testing for the plan. This is because there are no non-owner employees. In fact, one of the requirements to opening a Solo 401(k) is the absence of full-time employees, other than a spouse or other owner.

Key Points
  • ERISA testing was put in place to protect all employees of a business
  • Owners and highly compensated employees should not have an unfair advantage over those earning less
  • A Solo 401(k) plan is designed for owner-only businesses and, therefore, ERISA testing is not reequired

What is ERISA?

The Employee Retirement Income Security Act (ERISA) is a 1974 federal law that oversees how employers provide benefit plans to employees. ERISA is administered by the Department of Labor (DOL). ERISA set forth rules and procedures for employers and benefit plan managers, trustees, and certain other service providers involving employer-sponsored retirement plans.

ERISA generally confirms minimum standards are set for most of the private industry retirement and pension plans. Rules under ERISA provide that eligible plan participants must be notified of benefit plan terms, including funding, coverage, and costs. Employees are also offered protections against fiduciary misconduct.

ERISA Testing – Quick Summary

Employer-sponsored 401(k) plans that cover non-owner employees are subject to ERISA law.  ERISA was created to ensure that highly compensated employees (HCEs) or key employees do not receive or are provided with greater benefits than are available to lower paid workers. Therefore, ERISA has included certain compliance tests in order to compare benefits paid to lower paid employees to the HCEs.

The ERISA 401(k) plan annual compliance tests are the following:

  • General Nondiscrimination Test (IRC 401(a)(4) (ADP & ACP)
  • The Minimum Coverage Tests (IRC 401(b))
  • Top Heavy Test (IRC 416)
  • 402(g) limit test (i.e. employee deferral limit – $20,500 for 2022 – $27,000 if age 50+)
  • 415 limits (i.e. $61,000 for 2022 – $67,500 for those age 50+)

ERISA & the Solo 401(k)

A Solo 401(k) plan is essentially a 401(k) plan adopted by a business that has no full-time employees (over 1000 hours during the year) other than the owner(s) or spouse(s) of the owner(s).  Under ERISA law, a spouse is not deemed an employee for testing purposes.

In other words, because a Solo 401(k) plan is not subject to the ERISA rules, as the adopting employer has no full-time employees other than the owner(s) or spouse(s), it is not required to perform any nondiscrimination testing.  This makes a ton of sense since a business with no full-time employees is not in need of supervision by the DOL since they are in control of the plan.

The Solo 401(k) no-testing advantage vanishes if the employer hires employees. No matter what the 401(k) plan is called by a plan provider, it must meet the rules of the Internal Revenue Code. If employees are hired and they meet the eligibility requirements of the plan and the Code, they must be included in the plan and their elective deferrals will be subject to nondiscrimination testing (unless the 401(k) plan is a safe harbor plan or other plan exempt from testing).

Conclusion

If you are self-employed or own a business with no full-time employees, the Solo 401(k) plan is the best retirement plan you can open. ERISA was put into place to protect the “little man.” One would hope every business owner would do right by all their employees (not just the owners or HCEs). Obviously, some business owners put their bottom line over that of the best interests of their employees. Hence, why the ERISA laws were created.

Obviously, when a business owner does not have other employees to worry about, they will choose the plan that is best suited for them. Because of this, the complicated ERISA non-discrimination testing is not needed. It’s also one of the deciding factors when choosing a retirement plan when you are self-employed.

As mentioned above, as soon as you do hire any non-owner full-time employees, your plan will be subject to ERISA. You must ensure the plan benefits not only you, as the owner, but everyone who works for you. After all, the better benefits you offer your employee, the better employees you will attract, and retain.

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[10:44 PM] Valerie Marszalek-Boik