Solo 401(k) Plan Eligibility
A Solo 401(k) plan is well suited for businesses that either do not employ any employees or employee certain employees that may be excluded from coverage. A Solo 401K plan is perfect for any sole proprietor, consultant, or independent contractor.
To be eligible to benefit from the Solo 401(k) plan, investor must meet just two eligibility requirements:
(i) The presence of self employment activity.
(ii) The absence of full-time employees.
The Presence of Self Employment Activity
Self employment activity generally includes ownership and operation of a sole proprietorship, Limited Liability Company (LLC), C Corporation, S Corporation, and Limited Partnership where the business intends to generate revenue for profit and make significant contributions to the plan.
Generate Revenue for Profit
There are no established thresholds for how much profit the business must be generated, how much money must be contributed to the plan, or how soon profits and contributions must happen. It is generally believed that the IRS will consider you eligible if the business being conducted is a legitimate business that is run with the intention of generating profits. The self-employment activity can be part time, and it can be ancillary to full time employment elsewhere. A person can even participate in an employer's 401(k) plan in tandem with their own Solo 401k Plan. In such a case, the employee elective deferrals from both plans are subject to the single contribution limit.
The Absence of Full-Time Employees
Unlike a regular 401(k) plan, a solo 401(k) plan can be implemented only by self-employed individuals or small business owners who have no other full-time employees and are not employed by any business owned by them or their spouse (an exception applies if your full-time employee is your spouse). The business owner and their spouse are technically considered "owner-employees" rather than "employees".
The following types of employees may be generally excluded from coverage:
- Employees under 21 years of age
- Employees that work less than a 1000 hours annually
- Union employees
- Nonresident alien employees
If you have full-time employees age 21 or older (other than your spouse) or part-time employees who work more than 1,000 hours a year, you will typically have to include them in any plan you set up. However, a Solo 401k eligible business can have part time employees and independent contractors.
Solo 401k Plan Advantages
The Solo 401(k) plan is unique and so popular because it is designed explicitly for small, owner only business. There are many features of the Solo 401(k) plan that make it so appealing and popular among self employed business owners.
High Contribution Limits: While an IRA only allows a $5,500 contribution limit (with a $1,000 additional "catch up" contribution for those over age 50), a plan participant of a Solo 401K Plan can make annual contributions up to $54,000 annually with an additional $6,000 catch up contribution for those over age 50.
Loan Feature: While an IRA offers no participant loan feature, the Solo 401k Plan allows plan participants to borrow up to $50,000 or 50% of their account value (whichever is less) for any purpose, including paying credit card bills, mortgage payments, personal or business investments, a car, vacation, or anything else. The loan has to be paid back over a five year period at least quarterly at a minimum prime interest rate (you have the option of selecting a higher interest rate).
"Checkbook Control": The most noteworthy cost benefit of the Solo 401k Plan is that it does not require the participant to hire a bank or trust company to serve as trustee. This flexibility allows the Plan Participant (you) to serve in the trustee role. This means that all assets of the 401(k) trust are under the sole authority of the Solo 401k participant. A Solo 401(k) plan allows you to eliminate the expense and delays associated with an IRA custodian, enabling you to act quickly when the right investment opportunity presents itself. Making a Solo 401K Plan investment is as simple as writing a check.
Flexible Contribution Options: Contributions to a solo 401(k) plan are completely discretionary. You always have the option to try to contribute as much as legally possible, but you always have the option of reducing or even suspending plan contributions if necessary.
Roth Type Contributions: With IRAs, those who earn high incomes are disallowed from contributing to a Roth IRA or, in most years, converting their IRA to a Roth IRA. The Solo 401(k) plan contains a built in Roth sub-account which can be contributed to without any income restrictions.
Cost Effective Administration: In general, the solo 401(k) Plan is easy to operate. There is generally no annual filing requirement unless your solo 401(k) Plan exceeds $250,000 in assets, in which case you will need to file a short information return with the IRS (Form 5500-EZ).
Exemption from UDFI: When an IRA buys real estate that is leveraged with mortgage financing, it creates Unrelated Debt Financed Income (a type of Unrelated Business Taxable Income) on which taxes must be paid pursuant to Internal Revenue Code Section514. A Solo 401(k) plan is generally exempt from UDFI.
Roth Conversion: The Small Business Jobs Act of 2010, signed by President Obama contained a little-known provision, which went to affect on Sept. 27, 2010, allowing for the conversion of a traditional 401(k) or 403(b) account to a Roth in the same plan if their employer offers one. However, the 401(k) Plan participant (employee) must pay income tax on the amount converted.