A periodic review of your company structure is required to confirm your business remains eligible to sponsor a Solo 401(k). As plan administrator, that review is your responsibility. Business circumstances change over time, and eligibility that existed when you established the plan is not guaranteed to continue indefinitely.
A Solo 401(k) is designed for owner-only businesses with no qualifying non-owner employees. The simplified administration that makes it practical depends on that owner-only status. Three things can change your eligibility: your employee headcount grows beyond the plan's limits, your ownership of other businesses creates a controlled group issue, or your business shuts down or stops generating earned income.
A qualifying employee is any non-owner worker over the age of 21 who works more than 1,000 hours per year. If any employee crosses that threshold, the business is no longer eligible to sponsor a Solo 401(k).
Long-term part-time employees are also a consideration. Under rules that phased in beginning in 2021, employees who work at least 500 hours per year for two consecutive years must be offered plan eligibility. Track hours for any regularly recurring part-time workers. If you have part-time employees approaching this threshold, consult a benefits professional before the eligibility window opens.
Note that 1099 contractors do not count as employees for this purpose. Union employees and non-resident alien employees may also be excluded in certain circumstances.
If you own or control more than one business, those businesses may constitute a controlled group or affiliated service group under IRS rules. Businesses under common ownership of 80% or more, or where the same five or fewer owners have more than 50% effective control, are treated as a single employer for retirement plan purposes. If any business within that group has qualifying employees, the entire group loses Solo 401(k) eligibility.
Review any ownership interests you hold in other businesses annually. Family member ownership may also be attributed to you in certain circumstances. If your business ownership picture has changed, consult a tax professional familiar with controlled group rules.
The business sponsoring the plan must remain an active, for-profit enterprise generating earned income. Passive income such as rental income or K-1 distributions from passive investments does not qualify as earned income for Solo 401(k) purposes.
If your self-employment activity has wound down significantly or is generating no income, evaluate whether the business still qualifies as an ongoing enterprise. A business that produces no earned income cannot support the plan.
If your business no longer meets the eligibility requirements, the plan must be terminated. This does not mean losing your retirement savings. You can roll the plan assets to a checkbook IRA or to another eligible retirement plan. The transition is manageable but involves proper plan termination procedures, including a final Form 5500-EZ filing if the plan ever exceeded $250,000 in value.
Do not simply abandon an ineligible plan. Contact us if your eligibility status has changed so we can help you plan a proper exit.
Can I keep the plan if I hire a part-time employee who stays under 1,000 hours?
Yes. Part-time employees who work fewer than 1,000 hours per year do not disqualify the plan under the standard rule. However, monitor hours carefully, and be aware of the long-term part-time employee rules that apply to workers logging 500 or more hours per year over consecutive years.
What if I start a new business while already sponsoring a Solo 401(k)?
The new business may be includable in your plan as a participating employer, or it may create a controlled group issue depending on its employee structure. Review the situation with a tax professional before assuming the new business is compatible with the existing plan.
Does retirement or winding down my business require me to terminate the plan?
Yes. A Solo 401(k) must have an active sponsoring business. If you retire or close the business, the plan must be terminated and assets rolled to an appropriate successor plan or distributed.
This information is provided for educational purposes only and should not be interpreted as tax, legal, or investment advice. Readers are encouraged to consult a qualified professional who can offer guidance based on their personal situation.