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I would like to know if I am eligible to open a Solo 401k, and if so, what is the max amount I can contribute.

I think I meet the requirements listed on various sites:

  • I have started working on a 20 h/week 1099 contract which I believe makes me a Sole Proprietor
  • I have no full-time employees
  • I am turning a profit (by virtue of being paid for my work)

Things become confusing where same sites say that the business can have part-time employees, but they are generally excluded from coverage if they work less than 1000 hours annually.

It is not clear if this exclusion is mandatory or optional: does the the owner of the business have the option to not cover the part-time employee, or is in fact not allowed to cover the part-time employee under the Solo 401k plan?

My contract is part time (20 h/week) - am I considered a part-time employee of my own business? If so, if I end up working less than 1000 hours in 2019, am I not allowed to contribute to the Solo 401k as an employee?

At the same time I am also the employer, so am I allowed to make the so called Profit Sharing Contribution in that capacity, even if it turns out I am not eligible to contribute as a part-time employee?

Thank you.

  • How are you paid? W-2 or 1099? Are taxes withheld from your check? – Pete B. Apr 12 at 14:47
  • It will be a 1099 contract and no taxes will be withheld from my check. I haven't been paid yet btw, just started. – Ady Apr 12 at 15:31
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You qualify, and there don't need to be any additional costs.

There are special rules for solo 401(k) plans that allow sole proprietors to use them without being employed or messing with payroll. In fact you are not an employee at all, part-time or otherwise, you are eligible as the sole proprietor. If you were an employee you couldn't use the solo 401(k), you'd need a somewhat fancier plan setup.

If you set up an LLC or other liability shield, there would be costs and the 401(k) paperwork would get more complex as well as transfers from business accounts to you personally becoming formalized as payroll. But setting up a corporation is not a prerequisite to being treated as a business and having a 401(k).

You will need to get an EIN from the IRS, which you can do online for free.

The free solo 401(k) providers will provide a plan template. If you want to customize your plan documents, you'll have to pay for that. And as the balance in your plan grows, the IRS will start expecting annual filings.

1

You qualify. However, fees may preclude you from doing so. There is an important distinction between yourself and the business.

The business is being paid for 20 hours per week of work. That business can then hire as many employees they choose to perform the work that they choose to do. In your case there will be revenue but many business had employees long before they had revenue, or profit.

So your business would hire you as a full time salaried employee. Part of your duties would be to perform the 20 hours per week for this company, and the other would be whatever you choose. Part of it will be for the management of the business. So even if the business might bill for less than 1k hours in 2019, you can have yourself work 40 hours per week for 52 weeks, qualifying you as full time.

Your costs come in in that you have to run payroll, file taxes, accounting, licensing, insurance. Luckily you can find free 401Ks offered by Fidelity, Schwab, and Vanguard.

I do this myself and run about $4k per year in just costs to keep the business open and includes running payroll 4 times per year. With you being the boss and employee, you can come up with an agreement to pay yourself on any schedule you choose. I do quarterly, but I know others that do annually.

Its tricky, but if you can swing it, there are many benefits to owning and running a small business. Among them some tax advantage, but also you can decide what match will go into your 401K. The IRS places limits on the match for solo 401Ks, but you have quite a bit of flexibility.

You may want to try to find an accountant to guide you through setting this all up. Mine did, generously, and did not charge me a fee. In exchange they gained a customer for life.

Even if the fees to set this all up are a bit high, you may want to do it anyway if there is a good chance this work will increase or you can find more client(s).

  • There's no payroll for a sole proprietorship with no employees, and all the other items "file taxes, accounting, licensing, insurance" are required in order to do commercial work under contract, and have zero to do with whether it is done personally or under the auspices of a company. – Ben Voigt Apr 12 at 18:22
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    A large potion of this answer seems to be devoted to the viability of self-employment in general, rather that implementation of 401(k) specifically. – Acccumulation Apr 12 at 19:11
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Consider a SEP IRA instead of a Solo 401k. SEP IRAs are quite a bit simpler to implement and give you essentially the same benefits as a Solo 401k.

With a SEP IRA you can contribute about 20% of your yearly profit up to $56k. The actually formula is complicated so just let your accountant or tax software give you the precise number.

I believe you can contribute more or less the same amounts with a Solo 401k between your salary and profit sharing but it is more complicated.

  • Important to note that any sort of IRA interferes with back-door Roth IRA contributions, because the cost basis of all IRA accounts gets combined and conversions are taxed proportionally. – Ben Voigt Apr 12 at 18:31
  • Also, the solo 401(k) allows contributing more. Let X be the business's profit after paying expenses and self-employment tax. Then the contribution limit is pretty close to X or (19000 + 0.2 * (X-19000)) or 56000, whichever is lowest. – Ben Voigt Apr 12 at 18:33
  • Don’t IRAs have RMD at 70-1/2, but the 401(k), not? Or is the solo not excluded? – JoeTaxpayer Apr 12 at 19:40
  • @JoeTaxpayer: When is any 401(k) exempt from an RMD? I thought Roth IRAs don't require distributions, but all other combinations have them? – Ben Voigt Apr 13 at 1:22
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    @Ady: Yes, because you can't have a basis in a Traditional 401(k) account (an after-tax account is separate), you can use reverse rollover from IRA to 401(k) to separate and concentrate your basis. – Ben Voigt Apr 13 at 4:54

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