A solo 401k requires that you have self-employment activity with no full-time W-2 employees that work over 1,000 hours in your business per year (excluding your spouse). If you do end up hiring a full-time employee, you become ineligible for a solo 401k and cannot make any further contributions. At this point, it may be time to consider closing your solo 401k plan and moving the funds to another retirement plan.
If you’re looking to terminate your solo 401k, here’s what to do (step-by-step).
Step 1: Withdraw all funds and assets from your solo 401k
The very first step is to empty out your solo 401k account of all funds and assets.
There are two ways that you can do this:
- Distribution: Withdraw assets out of your account by taking a distribution.
- Rollover: Transfer the assets to another retirement plan that you qualify for.
Take a distribution
A distribution is usually not the best option, especially if you’re under the eligible withdrawal age. If you’re under the age of 59½, any distributions taken from your solo 401k will be hit with an early distribution penalty of 10% and income taxes.
For example, if you have $500,000 worth of assets in your solo 401k and decide to empty it out through a distribution, you would owe $50,000 in penalties and income taxes on the $500,000 withdrawn. Withdrawing such a large amount at once could put you in the top tax brackets and you could end up losing close to half of your balance through taxes owed.
If you’re over the age of 59½, you wouldn’t be subject to the 10% penalty, but you’ll still owe income taxes if you’re withdrawing funds from a pre-tax solo 401k. Withdrawals from a Roth solo 401k would be tax-free.
You would need to report the distribution through Form 1099-R, and then move onto step 2.
Rollover to another retirement plan
The more popular option is to rollover your solo 401k assets into another retirement plan. Which account you transfer the funds to would need to be planned carefully so that you don’t trigger any taxable events.
Rolling over pre-tax solo 401k assets to another pre-tax retirement account (like a traditional IRA or SEP IRA) are not taxable events. However, if you rollover pre-tax solo 401k assets into a Roth retirement account like a Roth IRA, you’ll have to pay taxes since Roth contributions are made with post-tax dollars.
If you have both a pre-tax solo 401k and a Roth solo 401k, a popular option is to rollover your pre-tax solo 401k assets into a traditional IRA or SEP IRA, and your Roth solo 401k assets into a Roth IRA. In this case, no taxes would be triggered, you would simply be moving assets from one account to another.
When you complete your rollover, you may also need to file Form 1099-R to report the rollover to the IRS.
Step 2: Let your plan provider know that you wish to terminate your solo 401k
After you empty out your solo 401k, you then need to inform your solo 401k plan provider that you wish to close the account. Your plan provider will mark your plan as inactive, have you sign a cancellation agreement, and may even help you with the next step, which is filing Form 5500-EZ.
Depending on your plan provider, it may even help to let your plan provider know about your plans for termination first before emptying out your solo 401k. It doesn’t make a huge difference since they’ll have you withdraw the funds anyways, but they may help you with distributions and rollovers.
Step 3: File form 5500-EZ
As a solo 401k plan owner, you may already be familiar with Form 5500-EZ. Filing the form each year is mandatory if you have over $250,000 in assets in your solo 401k plan.
When you’re terminating your solo 401k, you’ll have to file Form 5500-EZ with the IRS even if your account value does not exceed $250,000. It’s the final step in closing your solo 401k plan.
You must file Form 5500-EZ by July 31, the year after the plan was closed.
Closing a solo 401k is simpler than you might think. All it requires is emptying your account through a distribution or rollover, notifying your plan provider, and filing a final Form 5500-EZ with the IRS.
Also read: How To Open a Solo 401k Plan