An Individual 401K Plan is an IRS approved plan specifically designed by the IRS for self employed individuals and small business owners. An Individual 401K, also known as a Solo 401K or Self Directed 401K, is perfect for sole proprietors, small businesses and independent contractors such as consultants. An Individual 401K Plan offers one the ability to make high contributions, take a loan up to $50,000, invest in real estate and make other non-traditional investments, as well as open the account at any local bank.
The individual 401K plan is so popular because with small business owners because it is designed explicitly for small, owner only business.
An individual 401K plan is perfect for businesses that either do not employ any employees or employee certain employees that may be excluded from coverage. An individual 401K plan is perfect for any sole proprietor, consultant, or independent contractor.
To be eligible to benefit from the Individual 401K 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 understood that a business will be eligible if the business is 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. For example, a person can even participate in an employer’s 401(k) plan and still adopt their own Individual 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, an Individual 401K plan can be adopted 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”. Also, if an individual owns more than 80% of another business that has employees, then the controlled group rules will restrict the individual from adopting an individual 401K plan for another business that does not have employees. The rational behind the controlled group rules is to protect employees from not being granted the opportunity to participating in a qualified 401(k) retirement plan.
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.