What is a qualifying employee?
The IRS defines a qualifying employee in the following ways:
- A full-time employee working more than 1,000 hours per year
- A part-time employee working at least 500 hours per year for three consecutive years
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Being self-employed doesn’t mean you have to forgo a retirement plan. Although you may not have the option of a big employer-sponsored 401(k) plan, you can opt for a solo 401(k) if you’re a one-person business — and you’ll get the same tax advantages. But it may not be a good fit for all business owners, especially if you plan on growing your business and hiring employees.
A solo 401(k) plan is an individual retirement account designed for business owners. Here’s what you need to know:
To be eligible for a solo 401(k), you must be self-employed with no employees except your spouse.
There are no income or age requirements to qualify. Freelancers, independent contractors and small businesses with no qualifying employees (excluding your spouse) generally qualify for a solo 401(k).
The only caveat is that your business should be legit, ongoing and regularly attempt to turn a profit. For example, if your business consistently operates at a loss every year, and you can’t show the intention to generate earned income, the IRS may classify your business as a hobby, which can impact your solo 401(k).
The IRS defines a qualifying employee in the following ways:
With a solo 401(k), you are both the employee and employer.
The total you can contribute towards your solo 401(k) in 2021 is $58,000 ($19,500 as an employee + $38,500 as an employer), along with any applicable catch-up contributions, plus $6,500 for applicable catch-up contributions, which could bring your total to $64,500 if you’re 50 or over.
Solo 401(k)s can help you save for retirement and come with distinct tax benefits:
The deadline to open a solo 401(k) is the same as your business tax return deadline, including deadline extensions. This date depends on your self-employed business entity.
|Tax status||Filing deadline||Extended deadline|
|S-corp||March 15, 2021||September 15, 2021|
|Partnership||March 15, 2021||September 15, 2021|
|C-corp||April 15, 2021||October 15, 2021|
|Sole proprietor||April 15, 2021||October 15, 2021|
Consider the following drawbacks of solo 401(k)s to see if its the right retirement account for you:
Yes, your spouse can contribute to your solo 401(k) account, even as a full-time W-2 employee in your business. As long as you both receive taxable income, you can both invest in the account.
Here’s a quick rundown on the steps to open a solo 401(k):
When completing a solo 401(k) application, you’ll need the following details handy:
|Brokerage firm||Fees||Account minimum|
While many brokers offer $0 commissions, you’re still responsible for fund expenses.
If a solo 401(k) isn’t the right fit, consider these four individual retirement account options that generally boast a larger selection of investment choices and lower administrative fees than 401(k)s:
A traditional individual retirement account (IRA) is another investment account that offers tax benefits. Your contributions may be tax-deductible, and you only pay taxes when you withdraw from your IRA.
The maximum annual amount you can contribute in 2020 and 2021 is $6,000 — or $7,000 if you’re at least 50 years old.
Roth IRAs offer similar perks to traditional IRAs, except that you fund the account with post-tax money. That means your withdrawals are tax-free.
A simplified employee pension (SEP) individual retirement account (IRA) is an employer-sponsored retirement plan. Only employers can make contributions to the account, and the amount can vary each year.
If you use self-employed income to fund the account, you’ll have a higher contribution limit than a traditional or Roth IRA. The max contribution amount $58,000 for 2021.
A defined benefit plan is a pension plan that calculates your retirement benefits based on a formula. Several factors that impact your retirement amount include your length of employment and salary.
Unlike 401(k)s and IRAs, a defined-benefit plan doesn’t depend on investment returns.
If your business is a one-man show, you can establish your own type of retirement account. But you’ll need to continually comply with the IRS guidelines for a solo 401(k), which can put a damper on things if you’re trying to grow your business.
Here are a few other popular questions surrounding solo 401(k)s:
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