In 2020 and prior years, solo 401k plans could exclude par-time W-2 employees who worked less than 1,000 hours from participating in a 401k plan. This all changes for both full-time employer 401k plans and owner-only solo 401k plans starting on January 1, 2021.
The SECURE Act
Stemming from the Setting Every Community Up for Retirement Enhancement Act (SECURE Act), solo 401k plans will be impacted by the three years , par-time (500 but less than 999 hours) employee rule that will allow par-time employees to choose to make employee elective contributions to the company sponsored 401k plan.
2020 and Prior
Before the passage of the SECURE Act, non-owner W-2 employees (common law employees) who worked less than 1,000 hours during the plan year could be excluded from having the option to participate in a 401k plan and thus did not impact the owner-only businesses from setting up a solo 401k plan. Only those years after 2021 are counted.
2021 and Future Years
The three year provision is effective for the 2021 plan year, but years before 2021 do not count for purposes of counting the three-year eligibility.
Long-Term, Part-Time Employee
A W-2 employee will be deemed a long-term, part-time employee once he or she completes 500 hours of service/work in three consecutive 12-month periods.
Example 1 :
Sam is the sole owner in an S-corporation that also employs one part-time, non-owner employee w-2 employee (Sarah). Sam had opened his solo 401k plan in 2019 and is now aware of the new long-term part-time employee rule described above. As a result, beginning in 2021 once Sarah works 500 hours for three consecutive years (12 month-periods), so from January 1, 2021 through December 31, 2023, Sam’s S-corporation will no longer qualify to sponsor a solo 401k plan starting January 1, 2024 regardless if Sarah opts out of participating in the solo 401k plan. Consequently, Sam will need to convert/restate his solo 401k plan to a full-time employer 401k plan or transfer his solo 401k to an IRA. Reason being, a solo 401k is only for owners of a business and their spouses provided they also work for the business.
Example 2 :
In 2021 Jane opened a solo 401k plan for her self-employed LLC business. Her LLC also employs two 1099 contractors and three part-time W-2 employees. The part-time W-2 employees work less than 1,000 hours but more than 500 hours. Fast forward to 2024 where her two w-2 employees ended up working 500 hours but less than 999 hours in each year in 2021, 2022 and 2023. Because her W-2 employees worked 500 hours but less than 1,000 hours for 3 (three) consecutive years, Jane’s LLC can no longer sponsor a solo 401k plan starting January 1, 2024, so the solo 401k plan will need to be converted to a full-time employer 401k plan or transferred to an IRA.
