On a recent episode of ChooseFI, I stated my then-held view that it is unlikely a distribution from a Solo 401(k) qualifies for the Rule of 55. My concern was this: once the Schedule C solopreneur retires, there does not appear to be an “employer” remaining in the picture to sponsor the Solo 401(k).
If that is the case, the Solo 401(k) should be rolled over to an IRA and there’s no ability to use the Rule of 55.
Until now, I’m not aware that anyone has done a deep dive to validate or disprove that concern. So I decided to do it myself. My research took me as close to the year 1962 as one can get without a flux capacitor, a DeLorean, and 1.21 gigawatts of electricity.
I’ve now changed my view on the Solo 401(k) Rule of 55 issue. The analysis is too complicated to write adequately in a blog post. Thus, I’m self-publishing an article, Solo 401(k)s and the Rule of 55: Does the Answer Lie in 1962? (accessible here), on the topic.
Of course, the article is not legal or tax advice for you, any other individual, and any plan.
For those of you who read my book, Solo 401(k): The Solopreneur’s Retirement Account (thank you!), please know the article is written differently. The book is a “101” and “201” level discussion of tax planning for the self-employed with some beginning and intermediate tax rule analysis. The article is much more akin to a “501” level discussion of a complex and somewhat uncertain tax issue emerging from ambiguities in the Internal Revenue Code
Enjoy the article and let me know what you think in the comments below.
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This post and the linked-to article are for entertainment and educational purposes only. They do not constitute accounting, financial, investment, legal, or tax advice. Please consult with your advisor(s) regarding your personal accounting, financial, investment, legal, and tax matters. Please also refer to the Disclaimer & Warning section found here.
Thank you for the phenomenal research and article! I’m with Fidelity and their solo 401k withdrawal form (https://www.fidelity.com/bin-public/060_www_fidelity_com/documents/customer-service/retirement-plan-single-withdrawal-form-payment-form.pdf) includes the rule of 55, so it appears to be allowed. The rule of 55 would be more convenient to use than a 72t and I’m optimistic.
I’m 51 this year and realize things will likely change in the next four years. Even though I’m a W2 employee again this year with a workplace 401k, I’ll likely contribute $5,000 annually to my solo 401k just in case the IRS adopts safe harbor rules as you propose.
A thought popped into my head after posting the initial comment. After a quick internet search where this topic comes up, the probability seems high to me that at least one person with a solo 401k has used the rule of 55 to avoid the 10% penalty on withdrawals. Assuming this is true, does the lack of case law or associated IRS rulings mean that the IRS supported using the rule of 55 with solo 401k withdrawals? Or am I assuming too much?
Vince, many thanks for your comments and kind words. Outside of a private letter ruling (PLR) or court case, we don’t know the resolution of any particular individual’s tax matter (a PLR is a taxpayer info redacted IRS ruling on one particular taxpayer’s case, it isn’t binding on the IRS but at least they ruled that way in one case).
Further, the IRS does not examine all taxpayers and all tax returns. Thus, the fact that something has occurred does not mean the IRS agrees with that something. Only if the IRS and Treasury have issued binding guidance (a regulation, a Revenue Ruling, etc.) do we know for certain that the IRS has a definite view on the topic.
Also, keep in mind that nothing I’m writing is individualized advice for you or anyone else.
Thanks so much for another excellent explanation! Understanding the processes the IRS uses is interesting. This is another great option for early retirement folks.
Great stuff, Sean.
I had also come to this conclusion, that the entity sponsoring the Solo 401(k) lives on specifically for the purpose of sponsoring the plan after the retirement of the solepreneur, thus allowing for the Age 55 rule to apply. But I had not documented the process I went through to come to this result – thank you for the effort! You’ve done a great service (as always) with your research.
Jim, thanks for reading and your very kind words!
Hi Sean,
Fantastic piece of work, the history lesson alone explained a lot to me on why the rules around the various retirement accounts are as they are, they were built over many decades and represent different intents and compromises on what could be passed into law at the time. I expect it will contribute a lot to those in the FI + small business space, which are a lot of folks who could stand to benefit including me!
I particularly appreciated the distinction you made on page 17 of the PDF article, that the “separation of service” is a Section 72(t) question and not a Section 401(c) question. That insight alone contributed tremendously to the discussion.
Thank you for the time, effort, thought, and writing it took to create this, I sincerely appreciate it.
Aubrey
Aubrey, you’re welcome. Many thanks for taking the time to read the article and for your kind words. I also greatly appreciate your pointing me in the direction of the Gubmints blog post.
Great job on the article!
My professional career was in the employer sponsored retirement plan industry, so I spent a lot of time with these regulations. Your conclusions seem reasonable to me.
I could certainly come up with a hypothetical scenario in which a self employed person would not meet your proposed safe harbor, but would still be legit. For example, a person leaves a large employer planning to strike out on their own in their early 50s. After a few years of self employment, they find that they simply earned far less than they did in their time with the large employer. During those self employed years they opened a Solo(k) and rolled their old 401k into the Solo(k). Given that their old 401(k) had decades to grow, their Solo(k) ends up comprised primarily of those rollover funds. This does not deligitimize their retirement from self-employment at age 55 or later.
If that self-employment comes from Lyft driving, it’s just as legit as it would be from consulting or any other business that is operated with the intent to earn a profit.
Nice work!
I know that you started down this path by asking about Solo 401(k)s and the Rule of 55. And in order to answer that question, you had to first answer the question of whether or not a retired owner-employee could still sponsor a plan after retirement.
But I think you buried the lead — or at least you have not one but _two_ deeply researched conclusions. One paper is about the Ro55. But the other topic, at least as important and maybe more so, is about keeping existing Solo 401(k)s in retirement even in later tax years when new contributions wouldn’t be permitted due to zero business income.
I’m much more interested in that latter question, which I think you conclusively answered in the affirmative. IOW, “once an employee-owner, ALWAYS an employee-owner,” at least with respect to keeping an existing plan open after retirement.
I know several single-member LLC owners who have used Solo 401(k)s for years who have built up large balances. These are people who worked for themselves for decades and used Solo 401(k)s as their primary retirement savings vehicles.
Your work now makes it clear they can keep those Solo 401(k) accounts right up into and beyond RMD age.