A solo 401k plan has become the retirement account of choice over SIMPLE IRAs and SEP IRAs for the self employed, whether employed as a sole proprietor, independent contractor, consultant, through an LLC, Partnership or Corporation entity type.
In order to take advantage of what a Solo 401k has to offer—for example, high contributions, solo 401k participant loan, option to invest in alternative investments such as real estate, precious metals (gold and silver), tax liens, trust deeds, private company shares, etc., you first need to determine if you qualify to Open a Solo 401k.
The good news is that to qualify only the two following eligibility requirements must be met:
1) Self-employment activity: part-time or full-time
2) Without any common-law, full time employees
What Constitutes Self-Employment Activity for Participating in a Solo 401k?
Whether the self employment activity is generated through an LLC, C-Corporation, S-Corporation, Limited Partnership or Sole Proprietorship, to qualify as self employment activity the business must pursue steps to be profitable–that is generate “earned income.”
Although income derived from a partnership or sole proprietorship can be earned income, pass-through income earned by a shareholder in an S corporation is not classified as earned income. Guaranteed payments made to a limited partner is treated as net earnings from self-employment if the payment is for services to the partnership.
You should not open a Solo 401k if you are not truly planning to pursue self employment income.
Generally, the term “earned income” is defined to mean the individual’s net earnings from self-employment activities in a trade or business. (IRC 402(a)). In addition, the earned income must arise from the individual’s personal services and the personal services must be a material income-producing factor. (IRC. 401(c)(2)(A)(I); Reg. §1.401-10(c)(1). Income from the disposition of certain types of property is also deemed earned income. The purpose of the earned income rules from self-employment is to provide a solo 401k plan for the self-employed so that they can save for retirement, and to exclude inactive owners whose income is derived only from investments as investment income is not considered “earned income.”
Example 1 of Self-Employment Income
John, a former Major League baseball player, enters into a services agreement with a baseball glove maker under which he grants maker the right to use his name and signature. Also, John agrees to perform promotional services for the glove maker. The royalties he receives are “earned income” only to the extent that they represent compensation for his promotional services. The royalties derived from the use of his name and signature are not treated as earned income.
Example 2 of Self-Employment Income
Susan is a realtor and receives a 1099-MISC on an annual basis. She then files a Schedule C with her Form 1040 to report her earned income for the year.
Example 3 of Self-Employment Income
Fees received for babysitting, housecleaning and lawn cutting are all examples of taxable income, even if performed on a part-time basis for the year. Someone who repairs computers in his or her spare time is also considered to be self-employed.
Example 4 of Self-Employment Income
Linda owns multiple properties which she rents out. She actively manages them (e.g., screen potential tenants, collects rent checks, performs some of the routine property maintenance, and arranges for contractors to perform some or all of the property improvements or repairs. Lastly, Linda performs these activities continually and regularity with the intent to generate income or profit; therefore, her rental activity is a business.
What Amount of Earned Income is Required?
The IRS has not outlined the amount of revenue or profit the self-employed business must generate each year. Of course, in order to make contributions net self-employment income is required. You are not required to make annual solo 401k contributions.
You can participate in more than one qualified plan, but your contributions to all the plans cannot exceed the overall limits. For example, you can continue contributing to your day job’s 401k, establish a part-time business, subsequently open a Solo 401k for your part-time business and contribute to both 401k plans.
Full-Time Employees vs. Part-Time Employees
Even though a solo 401k is for owner-only businesses with no full-time W-2 employees, you can still qualify for a solo 401k if you have W-2 employees that fall under following:
- Employees under age 21
- Employees working part-time (working less than 1,000 hours per year)
Also, you can open a solo 401k plan even if your business employees the following:
- Union employees
- Nonresident alien employees
Business Owner’s Spouse Can Contribute to a Solo 401k
Since a Solo 401k is for business owners and their spouses, the business owner’s spouse is also eligible to participate in the same Solo 401k provided he or she is also self-employed in the business. The Solo 401k provider should not charge additional fees if the spouse qualifies to participate in same Solo 401k plan.
Minimum Dollar Amount QUESTION:
What is the minimum dollar amount for 1099 income that I have to show on my tax return to qualify to have a Solo 401K? Is there a specific number?
Trading Own Assets Eligibility QUESTION:
I work a part-time job. Do I have to have a business to open a solo401k?
If you are self-employed (i.e. you are reporting active self-employment income on your taxes earned from your personal effort such as income reported on schedule C and not income reported on schedule E) with no full-time W-2 employees working for you, you can set up our solo 401(k) plan. In fact, you don’t need to set up an LLC or other legal entity as you could simply be a sole proprietor and set up a Solo 401k. The key is that you are engaged in some type of self-employment activity such a providing goods or services & reporting this activity on your taxes.
Account for My Wife QUESTION:
I’m ready to get the ball rolling on my wife’s retirement account. can you tell which one would be best for her ? she is looking for an account where she can borrow up to 50% of the funds not to exceed 50K and re pay within 5 years. I have a question though, for the “remaining” balance in the account over the 50k loan can that be invested as well?
If your wife is self-employed ( i.e. receives self-employment reportable income) and has no full time w-2 employees working for her self-employed business, then she would be eligible to open a Solo 401(k) plan with us.
My Wife as Trustee of the Solo 401k QUESTION:
For my business entity/LLC, I am the only member/owner of this LLC. My wife currently is not an owner of this LLC. Can she still be a TRUSTEE in my SOLO-K that we are setting up?
Per our initial conversation, you need to be self-employed with no full-time employees. Moreover, the key in demonstrating that you are self-employed is that you are reporting self-employment activity (e.g. w-2 wages from your S-corp, activity on Schedule C, etc).
Your wife can be co-trustee (but not participate) in the Solo 401k even if she is not an owner of the LLC and not reporting self-employment activity. Having her as co-trustee will have the benefit of providing you both with signing authority.
You need to report at least some self-employment activity for the year that you open establish the solo 401k plan on your taxes and going forward. This could be in the form of w-2 wages, activity on Schedule C, etc. Please note that you don’t necessarily need to be profitable to receive self-employment income (i.e. you could be breaking even).
Compliance Requirements QUESTION:
Do you advise in terms of what we must do to stay in compliance?
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Make Different Contributions by Solo 401k Participants QUESTION:
Does your plan allow for the respective shareholders to make varying contributions and to receive varying company contributions to their respective accounts (e.g., 10% of salary for me and 25% for my partner and his wife)?
Yes the plan allows for different solo 401K participants to make different contribution amounts. Because this is a solo 401k, it is not subject to the general 401k testing requirements which would require contributions to be made at the same percentage amounts.
Receiving Disability Retirement QUESTION:
I retired early from a government job through a disability retirement. The plan allows me to work part-time as long as I don’t exceed a certain limit. My question is: Can I open a solo 401-K when I am receiving retirement income? I will be 60 years old next month.
Good question and the answer is yes you can open a solo 401k plan from a solo 401k qualifying perspective, regardless if you are receiving disability income, as long as you perform at minimum part-time self-employment activity and do not have any full-time W-2 employees working under your self-employed business.
Which is Better for Me QUESTION
I’m interested in opening either a SDIRA or a Solo 401K, but I don’t know which would be better suited for my situation. I want to use it for commercial real estate investments.
While they both allow for investing in real estate including commercial real estate, not everybody qualifies for a self-directed Solo 401(k) plan because to qualify you have to be self-employed (at least on a par-time basis) and not have any full-time W-2 employees. With the self-directed IRA you are not required to be self-employed; however, and advantage of the solo 401k over the IRA when investing in real estate where debt financing will be utilized is that unrelated debt finance income tax (UDIF) does not apply to solo 401k plans but does to IRAs. To learn more about the differences and similarities between the solo 401k and IRA, please click here.
Returning to W-2 Employer Full-Time Employer QUESTION
I will be returning to full-time W2 employment in June which is why I will be getting the max contribution to my solo 401k plan in while I’m still self-employed. Once I have the W2 job, can I still keep my solo401k active and contribute as usual as long as I make some sort of part-time income with my LLC ? If so what is the minimum amount of income I must make in my self-employed business to still qualify ?
To answer your first question, yes provided that your ability to contribute is always a function of your self-employment income. For your second question, there is no minimum (e.g. you could be “breaking even” in your self-employed business) but of course your ability to contribute is based on your self-employment income (e.g. if you have no self-employment income then you can’t contribute).
LLC Required QUESTION
Do I need to also create an LLC or entity for the sake of the Solo 401K, or just give it a “name”?
No you don’t need to create an LLC for the Solo 401k. You need to be self-employed but you don’t have to have a legal entity for your self-employed business. For example, you can be a contractor and file a schedule C.
Funding Source QUESTION
To open a solo 401k will I need to have some sort of wages or earned income, or can it be opened and funded only with funds I move from a 401k at an employer that I am leaving?
While in order to open a solo 401k plan you merely need to be pursuing self-employment activity and not have any full-time W-2 employees, you generally have to continue to perform self-employment activity in order to continue with the solo 401k plan. Therefore, if would not be prudent to open a solo 401k plan, fund it with a transfer from a former employer 401k or IRA if you do not intend to pursue self-employment activity or to continue to perform self-employment activity in subsequent years.
Independent Contractors QUESTION
Are independent contractors considered as employees (and must work less than 1000 hours/year to qualify) or not, and it doesn’t matter how many hours they work, yet as a sole manager of an LLC, I’d still be eligible for a solo 401k?
If legitimate independent contractors, it doesn’t matter as they will never be eligible to participate in your solo 401k plan regardless of the number of hours worked.
I am a financial professional considering using your services for my client’s solo 401k administration. And, I have a question: the spouse of the owner of an S corp has recently changed their primary job. They are not being paid by the S-corp and for now assume they will not be paid a salary from the S-Corp. Can the spouse be a participant in the plan and rollover their existing 401k balance as well as a traditional IRA into the solo 401k? I understand they cannot contribute without being paid as an employee from the S-Corp.
Good question. No because in order to participate in the Solo 401(k) plan you have to be doing self-employment activity. By virtual of being the spouse does not qualify you to participate in the plan. Therefore, if the spouse is not deemed a participant in the owner-only solo 401k plan, not only can he or she not make annual contributions to the solo 401k plan but also cannot transfer IRAs are former employer money into the solo 401k plan.
I am looking at solo 401k’s and SDIRAs. Is a real estate investor with mostly passive but some active income from flips etc. considered self employed?
New Solo 401k Adoption Deadline Due to the SECURE Act QUESTION
My self-employed business is a sole proprietorship, so can I wait to establish my solo 401k plan in 2021 for 2020?