For someone under age 591/2 who has left a job and is strapped for cash, the loan feature can be a way to get money out of a 401 (k) without facing the penalties and taxes associated with a premature retirement plan distribution. The only requirement to establish an account is that you have self-employment income, so someone who is between jobs and doing consulting work would qualify. Loans must be repaid according to IRS guidelines as they would with a corporate 401(k), or become subject to taxes and penalties.
Developing Market
Brown says that about 50 financial services firms, including "about half of market leaders," now offer solo 401(k)s under a variety of brand labels such as the Scudder Personal (k), the Pioneer Uni-K, the AIM Solo 401(k), and Waddell & Reed's Exclusive K. He predicts continued growth for such products. "Financial advisors are waking up to the benefits these plans can offer small businesses," he says. "With just 50,000 of these plans adopted to date, investment manufacturers and distributors still have an opportunity to get in during the early stages of what will be a rapidly accelerating and increasingly lucrative market."
Financial Research Corporation predicts that the adoption of 40,000 to 50,000 new plans this year, and growth in assets from $1.5 billion to $3 billion by year-end. Pioneer's Hale also sees growth opportunities. "There are 17 million people who file as owner-only businesses, so the market for these plans is huge and largely untapped," she says.
Hale says the plan is fairly easy and inexpensive for the business owner to set up and administer, since it only covers owners and spouses. Pioneer charges no set-up fee, and a fee of $100 per participant per year. Each loan is also subject to an additional $100 charge. No IRS filing is required until plan assets exceed $100,000. Once assets exceed that level, the IRS requires an annual Form 5500 filing. The IRS's Form 5500EZ is suitable for most small 401(k) plans. At Pioneer, an optional Form 5500 preparation service costs $250.
Perhaps the main drawback of these plans is that they are still in the testing stage and not widely available. The most comprehensive listing of solo 401(k) vendors, located at the web site 401khelpcenter.com, includes several recognizable names but does not list many large fund firms or brokerage houses.
Chris Brown says that because these plans are so new, some firms are taking a wait-and-see attitude to gauge how the market develops. Some of their hesitation may stem from concerns about the administration aspect of the plans, made complicated by the loan feature and multiple sources of rollover assets. While some firms will develop in-house administration capabilities, others will outsource that function, says Brown. He believes the market will see a number of new products come out in the fourth quarter of this year and the first quarter next year, the top sales periods for retirement accounts.
As it stands now, product choices and investment options offered by financial services firms remain fairly limited. At Pioneer, investors can choose from among 49 of the firm's mutual funds. But they can't invest in funds from other families, or in real estate and other nontraditional assets. And while the Pioneer's Uni-K permits loans, some other plans do not.
Third-party administration firms offer a more flexible alternative to fund company offerings, but they are also more expensive. Milberg's firm charges $1,500 to set up a solo 401 (k), a fee that includes setup, plan design, the plan document, and compliance services. After the first year, the annual fee is $850. Milberg, who specializes in custom-tailored pension and retirement plans for high-income professionals such as hospital-based physicians and real estate agents, says his clients can invest in virtually any mutual fund or security they want, or in nontraditional investments such as real estate. "I generally don't recommend putting real estate into these plans because that asset already has inherent tax advantages," he says. "I also try to discourage borrowing. A lot of times, people don't repay the loan, which creates a taxable event. It's important to remember that these are, first and foremost, retirement savings plans."