A solo 401k, which is a defined contribution plan designed by the government for owner-only businesses with no full-time non-owner W-2 employees to save for retirement, will eventually need to be closed.
Three scenarios will result in the business owners having to close their solo 401k plan, which are the following:
Instance 1: Permanently Cease Self-Employment Activity
Once you permanently cease self-employment activity, the solo 401k plan will need to be closed and transferred to an IRA or to another employer plan (e.g., your day-time employer’s 401k plan)
Instance 2: Hire a Full-Time Non-Owner W-2 Employee
Once you hire a full-time W-2 employee, you will need to close your solo 401k plan. The solo 401k is designed for self-employed individuals without any full-time employees. Once you have a full-time W-2 employee who works 1,000 hours or more during the year, you are no longer eligible to maintain a solo 401k plan. The First 12-month period commences on the W-2 employee’s date of hire. To learn more about this 12-month event, VISIT HERE.
Here are the consequences:
- Eligibility Change: The presence of a full-time W-2 employee disqualifies you from continuing with a solo 401k plan.
- Plan Closure: You will need to formally close the solo 401k plan. This involves transferring the assets to an IRA or another qualified retirement plan (e.g., your day-time employer’s 401k plan) or converting the solo 401k plan to a full-time employer 401k.
- Transfer to an IRA: If the solo 401k only holds cash or traditional investments such as stocks and index funds, then the solo 401k can be transferred to a regular IRA (non-self-directed).
- Transfer to a Self-Directed IRA: For solo 401k plans that hold alternative investments such as real estate, private placements, notes, crypto, etc., an option is to transfer the solo 401k and the investments to a self-directed IRA.
- Convert to a Traditional 401k: As your self-employed business grows and you hire full-time W-2 employees, another option is to convert/restate the solo 401k to a traditional 401k, which we do not offer. To learn more about his option, VISIT HERE.
Instance 3: Employ Qualifying Long-Term Part-Time (LPT) W-2 Employees
A W-2 employee will be deemed a long-term, part-time employee once he or she completes 500 hours of service/work in 2 (two) consecutive 12-month periods.
Eligibility Computation Period: The first year computation period starts on the W-2 employee’s date of hire and ends on the anniversary date of the date of hire. The second eligibility computation period also uses the anniversary date of hire.
The LTPT Employee Date: The LTPT employee must be allowed to enter the 401k plan the earlier of:
- the first day of the first plan year beginning after the date the employee satisfies the eligibility requirements, or
- six months after the date the employee satisfies the eligibility requirements.
Since a solo 401k plan does not allow for common-law W-2 employees to participate in the solo 401k plan, the self-employed business owner will need to close the solo 401k plan and transfer it to an IRA, or convert the the solo 401k plan to a full-time employer 401k plan.
In summary, upon hiring a full-time W-2 employee, you must take action to close your solo 401k plan and explore other retirement savings options.
The following can always be excluded from a solo 401k plan
Those under age 21
Union employees ; and
Independent contractors
