Do You Need a Custodian for a Solo 401(k)? Required?

One of the hallmarks of a solo 401(k) plan is its flexibility. A plan participant can contribute as both an employee and an employer and the types of permissible investments go far beyond the options offered by a traditional IRA. But what about the management of this type of plan? Do you need a custodian for a solo 401(k)?

Author

Eddy Martinez

May 4, 2023

One of the hallmarks of a solo 401(k) plan is its flexibility. A plan participant can contribute as both an employee and an employer and the types of permissible investments go far beyond the options offered by a traditional IRA. But what about the management of this type of plan? Do you need a custodian for a solo 401(k)?

Unlike traditional retirement plans like IRAs, a solo 401(k) does not require a third-party custodian to oversee the plan’s assets. As the plan employer, you assume responsibility for and exercise fiduciary control over, the investments in a solo 401(k) portfolio.

A solo 401(k) affords self-employed individuals and independent business owners a unique opportunity to plan for their retirement using a retirement plan that puts them in the driver’s seat. Not only can you put your money in non-traditional investments like real estate, precious metals, and crypto, but as your own custodian, you call all the shots. Although there are other small business retirement plans such as a SEP or A SIMPLE, Solo 401(k) plans provide the largest benefits including higher contributions and flexibility in investing.  Here’s how it works.

Do You Need a Custodian for a Solo 401(k)?

Most retirement plans rely on the growth of funds placed into investment vehicles like stocks, mutual funds, real estate, and the like, to build a suitable nest egg for sustaining plan enrollees when they stop working for a living. 

Because there is so much at stake, the IRS has deemed it necessary to regulate the various activities that retirement plans commonly engage in and provide oversight to protect plan assets and the participants whose livelihoods depend on them.

You Do Not Need a Third-Party Custodian for a Solo 401(k)

This is where a custodian gets involved, to manage the inflow and outflow of investment funds, keep a watchful eye over plan assets, monitor transactions, and ensure that all activities comply with applicable laws, rules, and regulations. A custodian is bound by a fiduciary duty to act in the best interest of the plan and the enrollee.

But one notable exception to this requirement is a solo 401(k). Unlike traditional retirement plans like IRAs, you do not need a custodian with a solo 401(k). In fact, as the sole plan participant (with possibly your spouse), you can undertake the management and administration of a solar 401(k) plan yourself.  

According to the Employee Retirement Security Act passed in 1974, the fiduciary of the plan is the employer. This means that as the fiduciary of the plan you can also custody the assets of the plan.  

Furthermore, as the custodian, or more accurately, the trustee, of a solo 401(k), you have the power to exercise complete checkbook control, meaning that you alone decide how to invest your plan’s funds. You can execute trades and complete transactions on the plan’s behalf without the authorization of a third-party administrator.

An Exception for Liquid Funds

When it comes to self-directing a solo 401(k), there is an exception for liquid plan funds, such as money in a bank account. Technically speaking, liquid funds are in the custody of the financial institution in which they are held. 

In other words, cash and the like are in the custodial control of the bank in the sense that the bank is obligated to safeguard those funds on your plan’s behalf so long as they are held in your account.  However as the trustee you have the authority to use the funds to invest for your plan.

Understanding Prohibited Transactions

Just because you do not need a third-party custodian for a solo 401(k) does not release you from the responsibility of complying with applicable IRS regulations and other laws. As the custodian or trustee for your solo 401(k), you must ensure that every aspect of the plan you control passes legal muster. 

This responsibility includes refraining from prohibited transactions and avoiding inappropriate dealings with prohibited parties. Here is a sampling of what this includes:

  • Certain real estate transactions, such as the sale or lease of property, between your solo 401(k) and a close family member like a parent, spouse, or offspring, are strictly prohibited

  • Solo 401(k) funds cannot be loaned to a close family member - this is different than borrowing from your own account under the 401(k) plan

  • You cannot use solo 401(k) funds for personal purposes, such as using them as collateral to secure personal financing

  • Solo 401(k) funds cannot be commingled with your personal accounts, nor can you direct plan funds to be loaned to any business enterprise in which you own an interest of 50% or more

Just as a third-party custodian is bound by a fiduciary duty to act in the best interest of a solo 401(k) plan while ensuring full compliance with applicable laws, you are held by the same standards if you decide to manage an individual retirement plan yourself.

Final Thoughts

A solo 401(k) is an appealing retirement vehicle for individual participants because of its flexibility in the types of permissible investments, its dual-contribution model, and the fact that you do not need a third-party custodian to oversee its activities.