As mentioned in a previous post, there are eligibility requirements for a Solo 401k. Although not just anyone can join the party, many individuals are either eligible right now or could potentially become eligible.
Self Employment Activity
The first of the two eligibility requirements for a Solo 401k is the presence of some type of self-employment activity. Your self-employment activity can be full-time or part-time. It may be a side business. It could be consulting or freelance work you perform. You may be an independent contractor of another business that issues you a 1099. You can even be employed elsewhere full-time. What the “self-employment activity” may not be is a hobby. If you collect baseball cards and sold one of those cards to a friend a couple years ago, you don’t want to use that as the justification for adopting a Solo 401k plan. You do need to have legitimate and ongoing self-employment activity. That said, there is no predetermined minimum amount of income that needs to be generated by the business that adopts the plan. Your self-employment activity can be new and you can adopt a plan before the business has made a profit. While there is no minimum that must be contributed to the plan, you should have the intention to make contributions if you choose to adopt a Solo 401k.
Employees
The second eligibility requirement is the absence of any full-time non-owner W-2 employees. Let’s take a look at each of these descriptions individually to get a better understanding of when an employee will get your invitation to the Solo 401k party revoked.
Full-time: If you don’t have any employees that work full-time, you could still be eligible for a Solo 401k. The IRS has historically considered fewer than 1000 hours per year to be part-time. More recent legislation requires that long-term part-time employees are covered under a 401k plan as well. Those working at least 500 hours per year for three or more consecutive years may need to be covered starting in plan year 2024. Beginning in plan year 2025, employees with at least 500 hours per year for just two consecutive years may need to be covered under the plan. Any non-owner employees that are covered under the plan will remove the “Solo” from the 401k and subject it to much greater administrative requirements. What does all of this mean? If you have any W2 employees that work at least 500 hours per year, you may not be eligible for a Solo 401k plan. We recommend discussing this in more detail with a competent expert.
Non-owner: Having a partner that works for the business is ok when it comes to your eligibility. If there is another “employee” besides you in the business, but that person is an owner of the company, you can still be eligible for a Solo 401k.
W-2: If you have actual common-law employees, they likely receive W-2 income from your business and taxes are withheld from their pay. These are the type of employees that affect Solo 401k eligibility. If, on the other hand, your business hires or contracts with another business or self-employed individual to provide services, you may just have an independent contractor and not an employee. Independent contractors or “1099 workers” do no affect Solo 401k eligibility regardless of the number of hours worked or the fact that they are not an owner in your business.
Once you break down the two main components of the eligibility requirements, it’s easier to see that many self-employed individuals are eligible for a Solo 401k plan of their very own. If you’re eligible for a Solo 401k plan, consider this your official invitation to join the party. If you are unsure about your eligibility, we invite you to contact us for more information or consult with a competent tax advisor for tailored advice regarding your situation.