The Impact of LTPTE Rules on Solo 401(k) Plans

Call it the not so Solo 401(k). We’ve received questions from some American Retirement Association (ARA) members regarding the impact of the long-term part-time employee rules (LTPTE rules) on Solo 401(k) plans. Many sponsors of Solo 401(k) plans were given advice, and established plans with the understanding that there’s no concern with the plan if they have no employees who work over 1,000 hours during a year. That advice, unfortunately, no longer holds true.

Solo 401(k) plans are just like any other 401(k) plan and are not exempt from the LTPTE rules. If there are any employees who meet the meet the definition of a LTPTE, then those employees must be eligible to make deferrals under the plan, no different than the requirements that apply to any other 401(k) plan. For a calendar year plan, this could impact the plan as early as Jan. 1, 2024.[1]

The good news is the inclusion of LTPTEs in a Solo 401(k) plan won’t impact the plan design. LTPTEs must only be eligible to make deferrals under the plan. And, because they can be disregarded for nondiscrimination testing purposes, their participation in the plan won’t affect the benefits that can be provided to the owner and will not require that they receive an allocation of any employer contributions.

The bad news is the plan is no longer a “Solo” 401(k) plan.[2] While this has no significance under the Internal Revenue Code, it does have significance under ERISA. In general, a plan covering only owners, partners, or their spouses, is exempt from the reporting and disclosure requirements of ERISA. If a LTPTE is eligible to participate in a Solo 401(k) plan, then the plan is no longer exempt from ERISA. The plan will need a fidelity bond, need to comply with applicable ERISA notices and disclosures, need to comply with the fiduciary requirements, and no longer be eligible to file Form 5500-EZ. It will already be too late for sponsors of Solo 401(k) plans who have existing LTPTEs as of January 1, 2024, to avoid these consequences.

Going forward, sponsors of Solo 401(k) plans who employ LTPTEs will need to either allow the LTPTEs to defer and comply with the ERISA requirements, or look to alternative plan designs. Or, perhaps, follow the new advice that is being provided by some advisors—as long as no employee works over 500 hours in a year, there’s no concern for the plan.

Footnotes

[1] A long-term part-time employee is one who works more than 500 hours of service in 3-consecutive years. Years prior to 2021, however, are disregarded. The 3-consecutive year condition is reduced to 2-consecutive years beginning in 2025.

[2] A Solo 401(k) plan is not a separate type of plan recognized under the law. It is a marketing term to refer to a 401(k) plan that has been adopted by a business with no employees other than the owner and his or her spouse. Many providers offer simplified plan documents for these plans, but these are just 401(k) plans that are scaled down by eliminating optional plan provisions that aren’t necessary. For example, there is no need to offer elections to have employee class exclusions or different eligibility, allocation, and distribution provisions for different contribution sources. The plan may automatically provide for discretionary matching and nonelective contributions, provide that contributions are fully vested, and permit loans, hardships, and other in-service distributions.

Robert Richter is Retirement Education Counsel at the American Retirement Association.