If you have a full-time job, but have a side business that earns self-employment income, then you will likely be able to adopt a Solo 401(k) Plan. Having a full-time job does not affect your ability to open a retirement plan for your self-employment income. Of course, you must meet the eligibility requirements in order to fund a Solo.
- Having a full-time job does not disqualify you from opening your own Solo 401(k)
- In order to start a Solo 401(k) plan, you must meet the eligibility requirements
- The Solo 401(k) is the best plan for the self-employed, regardless if you have another full-time job
Solo 401(k) Plan Eligibility
To be eligible to benefit from the Solo 401(k) plan, an individual must meet just two eligibility requirements:
(1) The presence of self-employment activity.
(2) The absence of full-time employees.
Presence of Self-Employment Activity
As long as you have some sort of self-employment business activity that generates income or has the potential to earn income, a Solo 401(k) can be adopted by that business. In other words, there must be anticipation of business activity. The business does not have to be a huge revenue-producing business; it just needs to have the intent to generate revenues and earn a profit. For example, the business could be a start-up that is working on producing a widget or in the process of selling a service. In addition, the business can take any of the following forms – sole proprietorship, LLC, corporation, or partnership.
Absence of Full Time Employees
Prior to the SECURE Act, employers generally could exclude certain part-time employees (i.e., employees who have not satisfied a requirement that they have 1,000 hours of service in a year) when providing a plan to their employees. This is an important provision for many Solo 401(k) plans which could now be forced to adopt an ERISA 401(k) plan. The SECURE Act generally required 401(k) plans (other than collectively bargained plans) to have a dual eligibility requirement under which an employee must complete either a one year of service requirement (with the 1,000-hour rule) or three consecutive years of service where the employee completes at least 500 hours of service.
Hence, in order to establish a Solo 401(k) plan, the business could not have any full-time employees that work more than 1000 hours in a year or 500 hours in three consecutive years. A business owner or the spouse of owner is not deemed an employee for purposes of the ERISA plan testing rules.
Related: Solo 401(k) Investment Options
Solo 401(k) Plan Setup Rules
Now that you have a solid understanding of the eligibility rules for establishing a Solo 401(k), let’s spend some time discussing the rules involved in establishing a plan for a side business.
As noted above, an individual that has a side business can establish a Solo 401(k), even if they have access to a 401(k) plan through an employer. The IRS controlled group rules dictate that so long as the two businesses are not affiliated and you and/or your lineal descendants do not own more than 80% of both businesses, the two businesses will not be deemed one business for purposes of ERISA.
For example, if you have a job with Google and do landscaping on the side, the two entities are completely separate, and you are allowed to start your own Solo 401(k) for your landscaping venture.
Solo 401(k) Contribution Rules
Pursuant to Internal Revenue Code (IRC) Section 402, the 401(k) employee deferral rules are per individual and not per plan.
A Solo 401(k) plan consists of two components: (i) employee deferrals and (ii) employer profit sharing contributions. First, there is the elective deferral which is the contribution you make as the employee. The second type of contribution for a Solo 401(k) is the employer contribution, which is a percentage of your self-employment income or your schedule C if you’re a single member LLC or sole proprietor.
For 2023, the maximum aggregate Solo 401(k) plan contribution, including employee deferrals and employer profit sharing contributions, is $66,000 if under the age of 50 and $73,500 if age 50 or older.
Employee deferrals are 100% elective. The due date for making employee deferrals is based on the type of business that adopted the plan. Sole proprietors and single member LLCs have until the filing of the 1040 tax return to make deferrals. Whereas, owner/employees of partnerships and corporations must elect to make employee deferral contributions by December 31.
If one has access to a 401(k) plan at work and wishes to set-up a Solo 401(k) plan for a side business, the 2022 employee deferral limit is the maximum amount of employee deferrals that can be contributed in a given year. This is the case even if both businesses are wholly unrelated. Essentially, whatever you contribute as an employee to one plan lessens the amount you can contribute to the other.
Whereas, in the case of employer profit sharing contributions, IRC Section 404 holds that they are plan- and not individual-dependent. Thus, so long as the controlled group rules do not apply, one could benefit from employer contributions from multiple plans.
Related: Solo 401(k) and the Gig Economy
A Solo 401(k) plan is perfect for any sole proprietor, consultant, or independent contractor that operates a business with no employees. It is best suited for 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).
Having a side business or being part of the gig economy is not only a great way to make extra income but it also provides one the opportunity to establish a Solo 401(k) plan and take advantage of all its benefits, including high annual contribution options, a $50,000 loan feature, and the ability to invest in alternative assets, such as real estate.