Mid-2023 Cryptocurrency Report: A Collection of Articles

Common (Totally Wrong) Myths About Cryptocurrencies

As with any other fringe product or service, there are many myths surrounding cryptocurrencies. Cryptocurrencies aren’t just for computer geeks and drug dealers trying to avoid the government. Relieving yourself of these myths will permit the formulation of a more accurate opinion. It’s easier to make informed decisions when your knowledge is sound.

Myths regarding cryptocurrencies abound:

  1. Cryptocurrency is illegal. It depends on the country. It’s legal in the United States, but there are other countries, such as Russia, that have deemed it illegal. It’s unlikely the legal status will change anytime soon in the United States. It’s possible that it will become regulated, however.
  2. Bitcoin is the only relevant cryptocurrency. There are several other cryptocurrencies. All have their strengths and weaknesses. Bitcoin, released in 2009, is the oldest and most well-known of them. Most of the other cryptocurrencies are less than three years old:
  • Auroracoin
  • Blackcoin
  • Dash
  • Dogecoin
  • DigitalNote
  • Ethereum
  • Litecoin
  • Mastercoin
  • There are several others.

3. Only criminals have a use for cryptocurrencies. While cryptocurrencies continue to be used for illegal activity, cash is still king for illegal transactions. There are reputable retailers that accept cryptocurrencies, including Microsoft and Dell.

4. I can get rich with cryptocurrency. The potential for profits does exist. People have gotten wealthy through increases in the value of cryptocurrencies. However, just as many people have lost a tremendous amount of money, too. It might happen, but you’re unlikely to retire on your cryptocurrency purchases.

5. Cryptocurrencies are fiat currencies. Most of them are. That’s true. But so are the Euro and the US Dollar. All major world currencies have abandoned a gold standard. The US decoupled the value of gold and the US Dollar in 1933. The value of all fiat currency is based on the willingness of the public to agree that it possesses value.

6. The government can shut down cryptocurrencies. The government could make cryptocurrencies illegal, but shutting down the system would be next to impossible. There’s no central server or location that houses a cryptocurrency system. The information is stored on the computers of every user.

  • Unless the government can find a way to shut down the internet, it would be challenging to put an end to cryptocurrencies.

7. It’s easy to mine cryptocurrencies and make money. Entire companies have been built for the sole purpose of mining cryptocurrencies. It requires a tremendous amount of computer hardware and electricity to be successful. Unless you have several hundreds of thousands of dollars, you can’t even begin to compete.

8. Cryptocurrencies are subject to hacking. Bitcoin merchants and wallets have been subject to hacking activities. However, Bitcoin itself has never been hacked. Other cryptocurrencies have similar security profiles. Insufficient security is always a potential problem with cryptocurrencies and cash. Protect your wallet and you should be fine.

9. It’s impossible to trace cryptocurrency transactions. It’s not easy, but it can be done. Regarding Bitcoin, the blockchain ledger lists all the transactions that have ever occurred with Bitcoins. The challenging part is linking the wallet address with the owner.

  • With enough time and effort, the government can eventually track you down.
  • he government has seized and auctioned off millions of dollars’ worth of Bitcoins.

Have you been guilty of believing these myths? It’s easy to be led astray. Cryptocurrencies still aren’t very common, and myths are easily formed and spread. Become more knowledgeable about cryptocurrencies. They might just be the wave of the future. They’re certainly becoming more popular each year.

We ALL could learn from Dogecoin!

Bitcoin is going through another spectacular price move so far in 2021, rising from about $28,000 on January 1st to about $47,000 on May 15th. And other cryptocurrencies have come along for the ride, with Dogecoin (pronounced “dozhe-coin”), being one of the oddest of the bunch.

Why is it odd? Well, Dogecoin was originally a joke cryptocurrency, taking its name from the “doge” internet meme that showed a picture of a Shiba Inu dog talking in Comic Sans font.

Dogecoin Was Created in 3 Hours

Dogecoin was created for fun and the idea was to have a goofy cryptocurrency that was cheap enough — each coin was worth a fraction of a penny — so that fans could “tip” each other for amusing comments. Think of it as a Facebook “like” that has some monetary value, but the value is so ridiculously low that no one took it seriously. In fact, if you look at the “value” of a dogecoin, it hovered right around 1/5 of a penny — in other words, five dogecoins equaled one penny for most of its existence.

But then on January 28th, a Twitter user called WSBChairman (who claimed no affiliation with /r/wallstreetbets, the same Reddit sub-group of users that pushed GameStop to ridiculous heights), tweeted that dogecoin was the next potential asset to get behind. The price skyrocketed the very next day so that a single dogecoin was now trading at 7 cents. Then Elon Musk tweeted about and it hit 8 cents. And as of February 11th, dogecoin was trading close to that 8 cents level.

Billy Markus, the guy who spent about 3 hours making Dogecoin, posted an open letter on Reddit on February 8th. His letter is a fascinating read, as he urges the community to get back to the spirit of fun. But his closing remarks are ones that all investors should heed when he wrote:

“Keep educating yourself as much as you can on how cryptocurrency works, how these markets work, never risk more than you could safely lose, be vigilant and aware.”

Cryptocurrencies as an Investment?

If we open our history books, we can read about major occasions where the market fell or rose dramatically. Markets can (and do) rise, of course, due to strong economies. These are good market booms.

However, sometimes there are market bubbles, the unreasonable market booms. Bubbles occur when investors pour money into a specific stock or market segment, way beyond the actual value of the particular businesses and products.

“Asset euphoria” has been used to describe investor interest in a bubble stock or sector. Like soap bubbles, investing bubbles keep growing but eventually pop because there is nothing substantial holding them up.

If you are considering cryptocurrencies as an investment, keep this in mind: the only way to make money from a cryptocurrency is to sell it to someone else for more money. And the only way they can make money is to sell it on to someone else for even more. And so on and so on.

Here are some more historical examples that fit the classic definition of “asset euphoria” and might even sound eerily similar to dogecoin:

Tulip Bulb Mania (Holland, 1630s)

Holland’s upper classes competed for the rarest bulbs, after tulips had become a status symbol. Tulip bulbs were then traded on Dutch stock exchanges, so all members of society were encouraged to speculate on them. At the height of the market, tulip bulbs traded for several times the average Dutch annual salary. However, tulip bulb prices eventually dropped. Panic selling set in, which left many investors in ruin.

Mississippi Company (France, 1719–1720)

The French economy was in dire straits, and the national debt was restructured under the auspices of the Mississippi Company, which was given exclusive trading rights for the various French colonies. Numerous continental traders rushed to buy shares in the Mississippi Company and soon the stock was worth 80 times as much as all the gold and silver in France, so the French government could not cover its debt (the shares in the company). The value of the shares plummeted, and investors took huge losses.

Dot.com Bubble (2000–2002)

The excitement of the Internet, with its promise of an international market for goods and fascinating new ways of communication, overwhelmed many investors. Investors blindly bought newly issued stock from the IPOs of internet companies as their stock prices zoomed upward. Unfortunately, these investors never bothered to look over the companies’ business plans. Unable to actually make money, many of these Internet companies reported huge losses and folded (Pets.com, Boo.com and Webvan come to mind).

Housing and Mortgage Crisis (2007–2009)

Rising home prices led to rampant real estate speculation and a housing boom. This housing boom and low interest rates led many lenders to offer home loans to people with poor credit. Investor firms bought these loans, then sold them as mortgage-backed securities to large investors. When payments began to catch up with home buyers who could not afford them, foreclosures jumped dramatically, which led to enormous losses by banks and investment firms that traded in these mortgage-backed securities. Many people lost their homes, and many banks lost lots of money. This led to a global credit crisis.

How Could Investors NOT See These Things Happening?

How could this “asset euphoria” have continued? It is obvious to us now why the busts happened and what we would have done differently, had we been there. However, even the wisest investors found it difficult to imagine the massive problems that would develop. We can quantify, analyze, and monitor market trends, but we cannot predict the future. All that investors (and their financial advisors) can do is to be ready for changes in the market, whether mild or massive.

Preparing for the Booms and the Busts

How does a wise investor prepare to enjoy any booms and protect against any busts?

To avoid falling prey to the lure of “asset euphoria,” as seen with the bubbles described above, remember the adage: “If it sounds too good to be true, then it probably is.”

To avoid losing large amounts of money due to market changes, the best move is to diversify your holdings. Diversifying your assets among various types of investments allows you to get a better risk-adjusted return. You spread the risks around.

Read this BEFORE Investing in Bitcoin

Holding Bitcoin is a bit like living in the Wild West. You never know what’s going to happen. If you’re interested in speculation, the purchase of Bitcoins may be a good idea. However, there are several reasons why holding Bitcoin can be a mistake. Bitcoin can lose value suddenly, suffer from a lack of governmental oversight, and offer no protection in the case of loss or theft.

If you’re thinking about investing in Bitcoin, ensure that purchasing Bitcoins is financially advantageous for your unique situation. You might be better off sticking to a government issued currency.

Bitcoin is disadvantageous for the average person potentially:

  • It may not be useful for your needs. While there are a growing number of merchants willing to deal with Bitcoins, there still aren’t very many. How useful is this form of currency from a practical standpoint? You can’t take it to your local big box store and load up on groceries.
  • If you’re considering purchasing Bitcoins strictly for purchasing goods or services, think again. Other forms of currency are more widely accepted and convenient.
  • There’s no advantage to using Bitcoins at most places, unless you require the anonymity that Bitcoins provide.

2. Some financial experts believe the value of Bitcoin will ultimately crash. Right now, there’s little to no government regulation of Bitcoin, and that’s exactly why many users have adopted this form of currency.

  • Many financial experts believe that governments will eventually get involved and impose some degree of regulation. When this happens, it is speculated that Bitcoin users will cash out and abandon the system. This will lead to the value of Bitcoins crashing.

Even Warren Buffett has instructed investors to stay away from Bitcoin.

3. It’s too volatile. Unless you’re interested in currency speculation, the volatility of Bitcoin could be considered a disadvantage. It’s possible to lose 50% or more of the value of your Bitcoin holdings very quickly.

  • It’s more than a little stressful to hold a currency that might drop precipitously in value over hours or days. It’s clearly not the way to store your life savings unless you enjoy playing the financial version of Russian roulette.
  • Bitcoin values are primarily based on supply and demand for the currency. Experts doubt these factors can be predicted accurately.

4. Bitcoin lacks oversight and guarantees. A complicated system exists to keep Bitcoin on the straight and narrow. However, it lacks a formal regulating body. Your bank account is safe from fire, robbery, and just about anything else you can imagine. However, if your Bitcoin wallet is lost or corrupted, you’re finished.

  • Even if you can show that someone stole your Bitcoins, the police rarely get involved. The government has been unable to define Bitcoin, much less show an interest in chasing down Bitcoin thieves.

5. Bitcoin can be difficult to maintain. Imagine carrying or storing a lot of cash. It’s worrisome and easy to lose. While Bitcoins don’t take up any space, they can be just as fragile and easy to lose. A home fire can wipe out all of your electronic devices and your bitcoin wallets.

  • Bitcoin can be easier to keep safe than cash, but it’s much less safe than keeping money in your bank account.

Bitcoin has a few advantages if you’re interested in currency investing. For the average consumer, however, Bitcoin provides more disadvantages than advantages. If you’re considering the purchase of Bitcoin, make a list of the reasons why. Are those reasons worth the risks? Perhaps so. Only you can decide.

There are other Cryptocurrencies besides Bitcoin?

Everyone has heard of Bitcoin, even if they don’t fully understand it. There are numerous other cryptocurrencies besides Bitcoin. There are seemingly hundreds of cryptocurrencies, and most of these were released in the last couple of years. Coinmarketcap.com lists 100 cryptocurrencies. Many experts believe the numbers will continue to climb. In fact, with creator coins now available the space could increase by the thousands soon.

Bitcoin has a considerable head start on the other offerings. Several cryptocurrencies are slight variations on the Bitcoin platform and may be more attractive to conventional financial institutions.

The first cryptocurrency to be truly welcomed by the banking industry will likely dominate the market. Which one will it be? Only the future will reveal the one that comes out on top.

Currently, these are the top five cryptocurrencies after Bitcoin:

  1. Ripple. Ripple has a market capitalization of nearly $150 million. For comparison purposes, Bitcoin is almost $5 billion. This cryptocurrency was released in 2012 and has been making strong inroads into the banking industry and payment networks.
  • A “Bitcoin Bridge” permits Ripple currency holders to make payments to Bitcoin users without ever holding Bitcoins themselves.
  • Some financial experts believe that Ripple will eventually overtake Bitcoin and become the dominant digital currency.

2. Litecoin. Litecoin is the third largest cryptocurrency with a market cap of $137 million. Charles Lee, a former Google employee, released Litecoin in 2011. This cryptocurrency is very similar to Bitcoin.

  • Litecoin offers several enhancements when compared to Bitcoin, including a higher limit on the maximum number of coins, improved user interface, and faster transaction approvals.
  • Several exchanges permit transactions of Litecoin with Bitcoin users and various conventional currencies, including US dollars, Euros, and Chinese Yuan.

3. Ethereum. The Ethereum market is half the size of Litecoin. Ethereum is challenging to understand, even for the experts. Ethereum combines the blockchain technology of Bitcoin with a programming language. This platform permits the construction of new applications to be developed.

4. Dash. Dash was started in 2014 as XCoin. You may have heard of XCoin or Darkcoin before they were rebranded to the name Dash. Dash is roughly one-tenth the size of Litcoin at $14 million. There are currently 6 million Dash coins in circulation.

  • Dash transactions are arguably more private than those of the previously mentioned currencies. Inputs from multiple users are needed to complete a transaction. Multiple identical outputs are also generated. These identical inputs and outputs shield the location and identity of the true parties.

5. Dogecoin. Dogecoin has approximately the same market capitalization as Dash. However, Dash currently has 6 million coins in circulation compared to the 102 billion coins of Dogecoin! This crypto currency started as a joke, but quickly developed a loyal following.

  • Coins are produced very quickly and have very little value, roughly $0.0001 per coin.
  • The Dogecoin community has been actively involved in fundraising for interesting causes, including the Jamaican Bobsled Team, a NASCAR driver, and building a well in Kenya.
  • Several online exchanges exist to service those that wish to use Dogecoin.
  • The cryptography technology employed is similar to that of Bitcoin and Litecoin and utilizes a private and public key system.
  • There is no limit on the number of Dogecoins that can be produced. More than 5 billion coins are expected to be produced each year.

There’s more going on in the cryptocurrency world than just Bitcoin. However, Bitcoin is the oldest and most well-known cryptocurrency in existence. The current Bitcoins in circulation are worth more than all of the other cryptocurrencies combined. It will be interesting to see what the future holds.

You may be asking, “Why would Kenner be writing an article about the cryptocurrency space?”

VastSolutionsGroup.com is keeping a diligent eye on it because it is the first third party administrator to allow for cryptocurrencies in its 401(k)s, profit sharing, defined benefit, and even captive insurance company plans. We are keeping an eye on it as should you. Cryptocurrency is here to stay and the best investment may just be something other than Bitcoin.

Cryptocurrency has gone mainstream. Yes, it has.

For example, you can use Bitcoin — the most popular cryptocurrency — to buy far more than you would think. To see, try googling “What can I buy with Bitcoin?” You will get more than 133 million hits.

But using cryptocurrencies has federal income tax implications that may surprise you.

With the price of Bitcoin having gone through the roof (before it’s recent decline), and with increasing acceptance of bitcoin and other cryptocurrencies as forms of payment, the tax implications of using cryptocurrencies are a hot-button issue for the IRS.

The new version of IRS Form 1040 (the form you recently filed or will file soon) asks whether you received, sold, sent, exchanged, or otherwise acquired — at any time during the year — any financial interest in any virtual currency. If you did, you are supposed to check the “Yes” box.

The fact that this question appears on page 1 of Form 1040, right below the lines for supplying taxpayer information such as your name and address, indicates that the IRS is getting serious about enforcing compliance with the applicable tax rules. Fair warning!

The 2020 Form 1040 instructions clarify that virtual currency transactions for which you should check the “Yes” box include but are not limited to

  1. the receipt or transfer of virtual currency for free (i.e., without having to pay),
  2. the exchange of virtual currency for goods or services,
  3. the sale of virtual currency,
  4. the exchange of virtual currency for other property, and
  5. the disposition of a financial interest in virtual currency.

To arrive at the federal income tax results of a cryptocurrency transaction, the first step is to calculate the fair market value (FMV), measured in U.S. dollars, of the cryptocurrency on the date you receive it and on the date you use it to pay something.

When you exchange cryptocurrency for other property, including U.S. dollars, a different cryptocurrency, services, or whatever, you must recognize taxable gain or loss just as you do when you make a stock sale in your taxable brokerage account.

  • You’ll have a taxable gain if the FMV of what you receive exceeds your basis in the cryptocurrency that you exchanged.
  • You’ll have a taxable loss if the FMV of what you receive is less than your basis in the cryptocurrency.

It is hard to imagine that a cryptocurrency holding will be classified for federal income tax purposes as anything other than a capital asset — even if you use it to conduct business or personal transactions, as opposed to holding it for investment. Therefore, the taxable gain or loss from exchanging a cryptocurrency will be a short-term capital gain or loss or a long-term capital gain or loss, depending on how long you held the cryptocurrency before using it in a transaction.

Example. You use one Bitcoin to buy tax-deductible supplies for your booming sole proprietorship business. On the date of the purchase, Bitcoins are worth $55,000 each. So, you have a business deduction of $55,000.

But there’s another piece to this transaction: the tax gain or loss from holding the bitcoin and then spending it.

Say you bought Bitcoin in January of this year for only $31,000. You have a $24,000 taxable gain from appreciation in the value of the bitcoin ($55,000 — $31,000). The $24,000 gain is a short-term capital gain because you did not hold the Bitcoin for more than one year.

Detailed records are essential for compliance. Your records should include

  • the date when you received the cryptocurrency,
  • its Fair Market Value (FMV) on the date of receipt,
  • the FMV on the date you exchanged it (for U.S. dollars or whatever),
  • the cryptocurrency trading exchange that you used to determine FMV, and
  • your purpose for holding the currency (business, investment, or personal use).

Complicating the world of cryptocurrency is that now the asset that can be a viable investment in 401(k) plans as well as other qualified plans. Why is this complicated? Crypto is unique in this type of environment. In fact, a brand new website — www.cryptoKplan.com — was started just so people could make sense of it all. That was the first service of it’s kind to allow for crypto in a 401(k) plan.

Yes, cryptocurrency is complex. It is becoming clear that professional advisors are needed to navigate the space. Reach out to your tax, financial or legal advisors as there are many strategies one can employ to help with wealth creation and tax mitigation.

A (Crypto) Solo 401(k) May Be What YOU Need

Have you procrastinated about setting up a tax-advantaged retirement plan for your small business? If the answer is yes, you are not alone. Many self employed small business owners are rushing to do the same. With the fact that 401(k) assets can now be invested in cryptocurrency they are hot right now.

For owners of profitable one-person business operations, a relatively new retirement plan alternative is the solo 401(k). They provide the potential for retirement growth and tax mitigation.

The main solo 401(k) advantage is potentially much larger annual deductible contributions to the owner’s account — that is, your account. Good!

Solo 401(k) Account Contributions

With a solo 401(k), annual deductible contributions to the business owner’s account can be composed of two different parts.

First Part: Elective Deferral Contributions

For 2022, you can contribute to your solo 401(k) account up to $22,500 of

  • your corporate salary if you are employed by your own C or S corporation, or
  • your net self-employment income if you operate as a sole proprietor or as a single-member LLC that’s treated as a sole proprietorship for tax purposes.

The contribution limit is $29,000 if you will be 50 or older as of December 31, 2021. The $29,000 figure includes an extra $6,500 catch-up contribution allowed for older 401(k) plan participants.

This first part, called an “elective deferral contribution,” is made by you as the covered employee or business owner.

  • With a corporate solo 401(k), your elective deferral contribution is funded with salary reduction amounts withheld from your company paychecks and contributed to your account.
  • With a solo 401(k) set up for a sole proprietorship or a single-member LLC, you simply pay the elective deferral contribution amount into your account.

Second Part: Employer Contributions

On top of your elective deferral contribution, the solo 401(k) arrangement permits an additional contribution of up to 25 percent of your corporate salary or 20 percent of your net self-employment income.

This additional pay-in is called an “employer contribution.” For purposes of calculating the employer contribution, your compensation or net self-employment income is not reduced by your elective deferral contribution.

  • With a corporate plan, your corporation makes the employer contribution on your behalf.
  • With a plan set up for a sole proprietorship or a single-member LLC, you are effectively treated as your own employer. Therefore, you make the employer contribution on your own behalf.

Combined Contribution Limits

For 2023, the combined elective deferral and employer contributions cannot exceed

  • $60,000 (or $66,500 if you will be age 50 or older as of December 31, 2023), or
  • 100 percent of your corporate salary or net self-employment income.

For purposes of the second limitation, net self-employment income equals the net profit shown on Schedule C, E, or F for the business in question minus the deduction for 50 percent of self-employment tax attributable to that business.

Key point. Traditional defined contribution arrangements, such as SEPs (simplified employee pensions), Keogh plans, and profit-sharing plans, are subject to a IRS mandated cap, regardless of your age.

Example 1: Corporate Solo 401(k) Plan

Lisa, age 40, is the only employee of her corporation (it makes no difference if the corporation is a C or an S corporation).

In 2023, the corporation pays Lisa an $80,000 salary.

The maximum deductible contribution to a solo 401(k) plan set up for Lisa’s benefit is $42,500. That amount is composed of

  1. Lisa’s $22,500 elective deferral contribution, which reduces her taxable salary to $57,500, plus
  2. a $20,000 employer contribution made by the corporation (25 percent x $80,000 salary), which has no effect on her taxable salary.

The $42,500 amount is well above the $20,000 contribution maximum that would apply with a traditional corporate defined contribution plan (25 percent x $80,000). The difference is due to the solo 401(k) elective deferral contribution privilege.

Example 2: Self-Employed Solo 401(k) Plan

Larry, age 40, operates his cable installation, maintenance, and repair business as a sole proprietorship (or as a single-member LLC treated as a sole proprietorship for tax purposes).

In 2023, Larry has net self-employment income of $80,000 (after subtracting 50 percent of his self-employment tax bill).

The maximum deductible contribution to a solo 401(k) plan set up for Larry’s benefit is $38,500. That amount is composed of

  1. a $22,500 elective deferral contribution, plus
  2. a $16,000 employer contribution (20 percent x $80,000 of self-employment income).

The $38,500 amount is well above the contribution maximum that would apply with a traditional self-employed plan set up for Larry’s benefit (20 percent x $80,000). The difference is due to the solo 401(k) elective deferral contribution privilege.

Also, now brand new is the fact that assets in IRAs and Roth IRAs can be invested in cryptocurrencies such as Bitcoin, Etherium, etc. In fact, cryptocurrency can be purchased in traditional 401(k)s and Roth 401(k)s. I am proud to remind people that my firm, VastSolutionsGroup.com, was the first in the industry to allow such investments in 401(k)s. The service is called Crypto(k)Plan and can be researched at www.CryptokPlan.com. Further, the advent in management of the assets via Artificial Intelligence (AI) can equal even better returns within a qualified plans as tax considerationdoes not come into play.

As you can see, in the right circumstances, the solo 401(k) can make for a great retirement plan.

These plans are complex. Consult with a professional and you will be happy you did. Below we have outlined a detailed 401(k) plan resource guide for your reference.

A Detailed 401(k) Resource Guide

Produced by VastSolutionsGroup.com in cooperation with the Employee Benefits Security Administration

Why 401(k) Plans?

401(k) plans can be a powerful tool in promoting financial security in retirement. They are a valuable option for businesses considering a retirement plan, providing benefits to employees and their employers.

Employers start a 401(k) plan for many reasons:

  • A well-designed 401(k) plan can help attract and keep talented employees.
  • It allows participants to decide how much to contribute to their accounts.
  • Employers are entitled to a tax deduction for contributions to employees accounts.
  • A 401(k) plan benefits a mix of rank-and-file employees and owners/managers.
  • The money contributed may grow through investments in stocks, bonds, mutual funds, money market funds, savings accounts, and other investment vehicles.
  • Contributions and earnings generally are not taxed by the Federal Government or by most state governments until they are distributed.
  • A 401(k) plan may allow participants to take their benefits with them when they leave the company, easing administrative responsibilities.

This publication highlights some of a 401(k) plans advantages, some of your options and responsibilities as an employer operating a 401(k) plan, and the differences among the types of 401(k) plans. For more information, a list of resources for you and for 401(k) plan participants is included at the end of this booklet.

Establishing A 401(k) Plan

When you establish a 401(k) plan, you must take certain basic actions. One of your first decisions will be whether to set up the plan yourself or to consult a professional or financial institution such as a bank, mutual fund provider, or insurance company to help with establishing and maintaining the plan. In addition, there are four initial steps for setting up a 401(k) plan:

  • Adopt a written plan document,
  • Arrange a trust for the plans assets,
  • Develop a recordkeeping system, and
  • Provide plan information to employees eligible to participate.

Adopt a written plan document

Plans begin with a written document that serves as the foundation for day-to-day plan operations. If you have hired someone to help with your plan, that person likely will provide the document. If not, consider obtaining assistance from a financial institution or retirement plan professional. In either case, you will be bound by the terms of the plan document.

Once you have decided on a 401(k) plan, you will need to choose the type of 401(k) plan that is best for you: A traditional 401(k) plan, a safe harbor 401(k) plan, or an automatic enrollment 401(k) plan. In all of these plans, participants can make contributions through salary deductions.

A traditional 401(k) plan offers the maximum flexibility among the three types of plans. Employers have discretion over whether to make contributions for all participants, to match employees deferrals, to do both, or to do neither. These contributions can be subject to a vesting schedule (which provides that an employees’ right to employer contributions becomes nonforfeitable only after a period of time). Annual testing ensures that benefits for rank-and-file employees are proportional to benefits for owners/managers.

There are several kinds of 401(k) plans that aren’t subject to the annual contributions testing required with traditional 401(k) plans. These are known as safe harbor 401(k) plans and, in exchange for avoiding the annual testing, employees in these plans must receive a certain level of employer contributions. Under the most popular safe harbor 401(k) plan (discussed in this publication), mandatory employer contributions must be fully vested when made.

An automatic enrollment 401(k) plan allows you to automatically enroll employees and place deductions from their salaries in certain default investments, unless the employee elects otherwise. This is an effective way for many employers to increase participation in their 401(k) plans.

The traditional, safe harbor, and automatic enrollment plans are for employers of any size.

Once you have decided on the type of plan for your company, you will have flexibility in choosing some of the plans features such as which employees can contribute to the plan and how much. Other features written into the plan are required by law. For instance, the plan document must describe how certain key functions are carried out, such as how contributions are deposited in the plan.

Arrange a trust for the plans assets

A plans assets must be held in trust to assure that assets are used solely to benefit the participants and their beneficiaries. The trust must have at least one trustee to handle contributions, plan investments, and distributions. Since the financial integrity of the plan depends on the trustee, selecting a trustee is one of the most important decisions you will make in establishing a 401(k) plan. If you set up your plan through insurance contracts, the contracts do not need to be held in trust.

Develop a recordkeeping system

An accurate recordkeeping system will track and properly attribute contributions, earnings and losses, plan investments, expenses, and benefit distributions. If a contract administrator or financial institution assists in managing the plan, that entity typically will help keep the required records. In addition, a recordkeeping system will help you, your plan administrator, or financial provider prepare the plans annual return/report that must be filed with the Federal Government.

Provide plan information to employees eligible to participateYou must notify employees who are eligible to participate in the plan about certain benefits, rights, and features. In addition, a summary plan description (SPD) must be provided to all participants. The SPD is the primary vehicle to inform participants and beneficiaries about the plan and how it operates. The SPD typically is created with the plan document. (For more information on the required contents of the SPD, see Disclosing Plan Information to Participants below.)

You also may want to provide your employees with information that discusses the advantages of your 401(k) plan. The benefits to employees such as pretax contributions to a 401(k) plan (or tax-free distributions in the case of Roth contributions), employer contributions (if you choose to make them), and compounded tax-deferred earnings help highlight the advantages of participating in the plan.

Operating A 401(k) Plan

Once you have established a 401(k) plan, you assume certain responsibilities in operating it. If you hired someone to help in setting up your plan, that arrangement also may have included help in operating the plan. If not, another important decision will be whether to manage the plan yourself or to hire a professional or financial institution such as a bank, mutual fund provider, or insurance company to take care of some or most aspects of operating the plan.

Elements of operating 401(k) plans include:

  • Participation
  • Contributions
  • Vesting
  • Nondiscrimination
  • Investing 401(k) plan monies
  • Fiduciary responsibilities
  • Disclosing plan information to participants
  • Reporting to government agencies
  • Distributing plan benefits


Typically, a plan includes a mix of rank-and-file employees and owners/managers. However, a 401(k) plan may exclude some employees if they:

  • Have not attained age 21;
  • Have not completed one year of service;
  • Are covered by a collective bargaining agreement that does not provide for participation in the plan, if retirement benefits were the subject of good faith bargaining; or
  • Are certain nonresident aliens.

Employees cannot be excluded from a plan merely because they are older workers.


In all 401(k) plans, participants can make contributions through salary deductions. You can decide on your business contribution to participants accounts in the plan.

Traditional 401(k) Plan

If you decide to contribute to your 401(k) plan, you have further options. You can contribute a percentage of each employee’s compensation for allocation to the employees account (called a nonelective contribution), or you can match the amount your employees decide to contribute, or you can do both (within the limits of the tax law).

For example, you may decide to add a percentage say, 50 percent to an employee’s contribution, which results in a 50-cent increase for every dollar the employee sets aside. Using a matching contribution formula will provide employer contributions only to employees who make deferrals to the 401(k) plan. If you choose to make nonelective contributions, the employer contribution goes to each eligible participant, whether or not the participant decides to make a salary deferral to his or her 401(k) plan account.

Under a traditional 401(k) plan, you have the flexibility of changing the amount of employer contributions each year, according to business conditions.

Safe Harbor 401(k) Plan

Under a safe harbor plan, you can match each eligible employees’ contribution, dollar for dollar, up to 3 percent of the employees compensation, and 50 cents on the dollar for the employees contribution that exceeds 3 percent, but not 5 percent, of the employees compensation. Alternatively, you can make a nonelective contribution equal to 3 percent of compensation to each eligible employees account. Each year you must make either the matching contributions or the nonelective contributions. The plan document will specify which contributions will be made and this information must be provided to employees before the beginning of each year.

Roth Contributions

401(k) plans may permit employees to make after-tax contributions through salary deduction. These designated Roth contributions, as well as gains and losses, are accounted for separately from pretax contributions. However, designated Roth contributions are treated the same as pretax contributions for most aspects of plan operations, such as contribution limits.

A 401(k) plan may allow participants to transfer certain amounts in the plan to their designated Roth account in the plan.

Contribution Limits

Employer and employee contributions and forfeitures (nonvested employer contributions of terminated participants) are subject to a per-employee overall annual limitation. This limit is the lesser of:

  • 100 percent of the employees compensation, or
  • The stated amount annually by the IRS ($60,000 for 2023).

In addition, the amount employees can contribute under any 401(k) plan is limited to the stated amount via the IRS ($22,500 in 2023). This includes both pre tax employee salary deferrals and after-tax designated Roth contributions (if permitted under the plan).

All 401(k) plans may allow catch-up contributions of $6,500 for employees age 50 and over.

Vesting Employee salary deferrals are immediately 100 percent vested that is, the money that an employee has contributed to the plan cannot be forfeited. When an employee leaves employment, he or she is entitled to those deferrals, plus any investment gains (or minus losses) on the deferrals.

In safe harbor 401(k) plans, all required employer contributions are always 100 percent vested. In traditional 401(k) plans, you can design your plan so that employer contributions become vested over time, according to a vesting schedule.


To preserve the tax benefits of a 401(k) plan, the plan must provide substantive benefits for rank-and-file employees, not just business owners and managers. These requirements are called nondiscrimination rules and compare both plan participation and contributions of rank-and-file employees to those of owners/managers.

Traditional 401(k) plans are subject to annual testing to ensure that the amount of contributions made for rank-and-file employees is proportional to contributions made for owners and managers. In most cases, safe harbor 401(k) plans are not subject to annual nondiscrimination testing.

Investing 401(k) Plan Monies

After you decide on the type of 401(k) plan, you can consider the variety of investment options. One decision you will need to make in designing a plan is whether to permit your employees to direct the investment of their accounts or to manage the monies on their behalf. If you choose the former, you also need to decide what investment options to make available to the participants. Depending on the plan design you choose, you may want to hire someone either to determine the investment options to make available or to manage the plans investments. Continually monitoring the investment options ensures that your selections remain in the best interests of your plan and its participants.

Fiduciary Responsibilities

Many of the actions needed to operate a 401(k) plan involve fiduciary decisions. This is true whether you hire someone to manage the plan for you or do some or all of the plan management yourself. Controlling the assets of the plan or using discretion in administering and managing the plan makes you or the entity you hire a plan fiduciary to the extent of that discretion or control. Hiring someone to perform fiduciary functions is itself a fiduciary act. Thus, fiduciary status is based on the functions performed for the plan, not a title.

Some decisions for a plan are business decisions, rather than fiduciary decisions. For instance, the decisions to establish a plan, to include certain features in a plan, to amend a plan, and to terminate a plan are business decisions. When making these decisions, you are acting on behalf of your business, not the plan, and therefore, you would not be a fiduciary. However, when you take steps to implement these decisions, you (or those you hire) are acting on behalf of the plan and thus, in making decisions, may be acting as fiduciaries.

Basic Responsibilities

Those persons or entities that are fiduciaries are in a position of trust with respect to the participants and beneficiaries in the plan. The fiduciary’s responsibilities include:

  • Acting solely in the interest of the participants and their beneficiaries;
  • Acting for the exclusive purpose of providing benefits to workers participating in the plan and their beneficiaries, and defraying reasonable expenses of the plan;
  • Carrying out duties with the care, skill, prudence, and diligence of a prudent person familiar with such matters;
  • Following the plan documents; and
  • Diversifying plan investments.

These are the responsibilities that fiduciaries need to keep in mind as they carry out their duties. The responsibility to be prudent covers a wide range of functions needed to operate a plan. Since all these functions must be carried out in the same manner as a prudent person would, it may be in your best interest to consult experts in various fields, such as investments and accounting.

In addition, for some functions, there are specific rules that help guide the fiduciary. For example, the deductions from employees paychecks for contribution to the plan must be deposited with the plan as soon as reasonably possible, but no later than the 15th business day of the month following the payday. If you can reasonably make the deposits in a shorter time frame, you need to make the deposits at that time.

For plans with fewer than 100 participants, salary reduction contributions deposited with the plan no later than the 7th business day following withholding by the employer will be considered contributed in compliance with the law.

For all contributions, employee and employer (if any), the plan must designate a fiduciary, typically the trustee, to make sure that contributions due to the plan are transmitted. If the plan and other documents are silent or ambiguous, the trustee generally has this responsibility. As part of following the plan documents in operating your plan, the plan document will need to be updated from time to time for changes in the law.

Limiting Liability

With these responsibilities, there is also some potential liability. However, there are actions you can take to demonstrate that you carried out your responsibilities properly as well as ways to limit your liability.

The fiduciary responsibilities cover the process used to carry out the plan functions rather than simply the end results. For example, if you or someone you hire makes the investment decisions for the plan, an investment does not have to be a winner if it was part of a prudent overall diversified investment portfolio for the plan. Since a fiduciary needs to carry out activities through a prudent process, you should document the decision making process to demonstrate the rationale behind the decision at the time it was made.

In addition to the steps above, there are other ways to limit potential liability. The plan can be set up to give participants control of the investments in their accounts. For participants to have control, they must have sufficient information on the specifics of their investment options. If properly executed, this type of plan limits your liability for the investment decisions made by participants. You can also hire a service provider or providers to handle some or most of the fiduciary functions, setting up the agreement so that the person or entity then assumes liability.

Providing Information in Participant-Directed Plans

When plans allow participants to direct their investments, fiduciaries need to take steps to regularly make participants aware of their rights and responsibilities under the plan related to directing their investments. This includes providing plan and investment-related information, including information about fees and expenses that participants need to make informed decisions about the management of their individual accounts. Participants must receive the information before they can first direct their investment in the plan and annually thereafter. The investment-related information needs to be presented in a format, such as a chart, that allows for a comparison among the plans investment options. A model chart is available. If you use information provided by a service provider that you rely on reasonably and in good faith, you will be protected from liability for the completeness and accuracy of the information.

Prohibited Transactions and Exemptions

There are certain transactions that are prohibited under the law to prevent dealings with parties that have certain connections to the plan, self-dealing, or conflicts of interest that could harm the plan. However, there are a number of exceptions under the law, and additional exemptions may be granted by the U. S. Department of Labor, where protections for the plan are in place in conducting the transactions.

One exemption allows the provision of investment advice to participants who direct the investments in their accounts. This applies to the buying, selling, or holding of an investment related to the advice as well as to the receipt of related fees and other compensation by a fiduciary adviser. Please check dol.gov/ebsa for more information.

Another exemption in the law permits you to offer loans to participants through your plan. If you do, the loan program must be carried out in such a way that the plan and all other participants are protected. Thus, the decision on each loan request is treated as a plan investment and considered accordingly.


Persons handling plan funds or other plan property generally must be covered by a fidelity bond to protect the plan against loss resulting from fraud and dishonesty by those covered by the bond.

Disclosing Plan Information to Participants

Plan disclosure documents keep participants informed about the basics of plan operation, alert them to changes in the plans structure and operations, and provide them a chance to make decisions and take timely action about their accounts.

The summary plan description (SPD) is a basic descriptive document that is a plain-language explanation of the plan and must be comprehensive enough to apprise participants of their rights and responsibilities under the plan. It also informs participants about the plan features and what to expect of the plan.

Among other things, the SPD must include information about:

  • When and how employees become eligible to participate in the 401(k) plan;
  • The contributions to the plan;
  • How long it takes to become vested;
  • When employees are eligible to receive their benefits;
  • How to file a claim for those benefits; and
  • Basic rights and responsibilities participants have under the Federal retirement law, the Employee Retirement Income Security Act (ERISA).

The SPD should include an explanation about the administrative expenses that will be paid by the plan. This document must be given to participants when they join the plan and to beneficiaries when they first receive benefits. SPDs must also be redistributed periodically during the life of the plan.

A summary of material modification (SMM) apprises participants of changes made to the plan or to the information required to be in the SPD. The SMM or an updated SPD must be automatically furnished to participants within a specified number of days after the change.

An individual benefit statement (IBS) shows the total plan benefits earned by a participant, vested benefits, the value of each investment in the account, information describing the ability to direct investments, and (for plans with participant direction) an explanation of the importance of a diversified portfolio. Plans that provide for participant-directed accounts must furnish quarterly individual benefit statements. Plans that do not provide for participant direction must furnish statements annually.

As noted above, for plans that allow participants to direct the investments in their accounts, plan and investment information, including information about fees and expenses, must be provided to participants before they can first direct investments and generally annually thereafter — with information on the fees and expenses actually paid provided at least quarterly. The initial plan-related information may be distributed as part of the SPD provided when a participant joins the plan as long as it is provided before the participant can first direct investments. The information provided quarterly may be included with the IBS.

A summary annual report (SAR) is a narrative of the plans’ annual return/report, the Form 5500, filed with the Federal Government. It must be furnished annually to participants.

A blackout period notice gives employees advance notice when a blackout period occurs, typically when plans change recordkeepers or investment options, or when plans add participants due to corporate mergers or acquisitions. During a blackout period, participants rights to direct investments, take loans, or obtain distributions are suspended.

Reporting to Government Agencies

In addition to the disclosure documents that provide information to participants, plans must also report certain information to Government entities.

Form 5500 Annual Return/Report of Employee Benefit Plans

Plans are required to file an annual return/report with the Federal Government, in which information about the plan and its operation is disclosed to the IRS and the U.S. Department of Labor. Plans that must file the Form 5500 must do so electronically. These returns/reports are made available to the public.

Depending on the number and type of participants covered, most 401(k) plans must file one of the following forms:

  • Form 5500Annual Return/Report of Employee Benefit Plan,
  • Form 5500-SFShort Form Annual Return/Report of Small Employee Benefit Plan, or
  • Form 5500-EZAnnual Return of One-Participant (Owners and Their Spouses) Retirement Plan

Form 1099-R

Distributions From Pensions, Annuities, Retirement or Profit-Sharing Plans, IRAs, Insurance Contracts, etc. is used to report distributions (including rollovers) from a retirement plan. It is given to both the IRS and recipients of distributions from the plan during the year.

Form 8955-SSA

Form 8955-SSA Annual Registration Statement Identifying Separated Participants with Deferred Vested Benefits, is used to report separated participants with deferred vested benefits. It is filed with the IRS. The information reported is generally given to the Social Security Administration who provides the reported information to the participants when they file for Social Security benefits.

Distributing Plan Benefits

The amount of benefits in a 401(k) plan is dependent on a participant’s account balance at the time of distribution.

When participants are eligible to receive a distribution, 401(k) plans typically provide that participants can elect to:

  • Take a lump sum distribution of their account,
  • Roll over their account to an IRA or another employers retirement plan, or
  • Take periodic distributions.

More employers are offering annuity or other lifetime income distribution options in their defined contribution plans for employees who want to ensure that they do not outlive their retirement savings. You may want to look into what other employers are doing.

Terminating A 401(k) Plan

401(k) plans must be established with the intention of being continued indefinitely. However, business needs may require that employers terminate their 401(k) plans. For example, you may want to establish another type of retirement plan instead of the 401(k) plan.

Typically, the process of terminating a 401(k) plan includes amending the plan document, distributing all assets, and filing a final Form 5500. You must also notify your employees that the plan will be discontinued. Check with your plans financial institution or a retirement plan professional to see what further action is necessary to terminate your 401(k) plan.


Even with the best intentions, mistakes in plan operation can still happen. The U.S. Department of Labor and IRS have correction programs to help 401(k) plan sponsors correct plan errors, protect participants’ interests, and keep the plans tax benefits. These programs are structured to encourage early correction of the errors. Having an ongoing review program makes it easier to spot and correct mistakes in plan operations.

A 401(k) Plan Checklist

Now that you are ready to get started, here are some tips:

  • Have you determined which type of 401(k) plan best suits your business?
  • Have you decided to hire a financial institution or retirement plan professional to help with setting up and running the plan?
  • Have you decided whether to make contributions to the plan, and, if so, whether to make nonelective and/or matching contributions? (Remember, you may design your plan so that you may change your nonelective contributions if necessary due to business conditions.)
  • Have you adopted a written plan that includes the features you want to offer, such as whether participants will direct the investment of their accounts?
  • Have you notified eligible employees and provided them with information to help in their decision making?
  • Have you arranged a trust for the plan assets or will you set up the plan solely with insurance contracts?
  • Have you developed a recordkeeping system?
  • Are you familiar with the fiduciary responsibilities?
  • Are you prepared to monitor the plan’s service providers?
  • Are you familiar with the reporting and disclosure requirements of a 401(k) plan?

For help in establishing, operating, or closing a 401(k) plan — look to VastSolutionsGroup.com for resources, contact us at Admin@VastSolutionsGroup.com or call 888–808–8278 x 710.

This guide was published with cooperation between VastSolutionsGroup.com and the Employee Benefit Securities Administration.

This guide is not all inclusive. All plans are not equal and some require more reporting, etc. than outlined here. Please consult with a professional.

Copyright 2023

All articles courtesy of R. Kenner French; In addition to being a Forbes.com business contributor, the northwest native is the CIO of VastHoldingsGroup.com, an executive at VastSolutionsGroup.com, real estate and venture investor, and one with a tax and IRS strategy that truly is second to none.

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