What type of business entity can setup an Individual 401k?
Sole proprietors such as independent contractors and self employed individuals. Also eligible business entities include partnerships, LLCs, S corporations and C corporations.
Who is eligible for an Individual 401k?
In order to be eligible to establish an Individual 401k, the business owner must have the presence of self employed activity which generally would include ownership and operation of the business. It is generally believed that the IRS will consider a business owner eligible for an Individual 401k if the business being conducted is legitimate and it is run with the intention of generating profits.
Who is ineligible for an Individual 401k?
If a business owner has salaried W-2 employees age 21 or older who work more than 1,000 hours in a calendar year they are ineligible for an Individual 401k. Business owners and their spouse do not apply to the 1,000 hour threshold.
A business owner is still eligible for an Individual 401k if they hire independent contractors who work more than 1,000 hours in a calendar year.
What are the IRS rules about when and how much profit the business must generate before setting up an Individual 401k?
There are no established thresholds for how much profit the business must generate or how soon profits must happen.
What are the IRS rules about how much and when the business owner must make contributions to an Individual 401k?
The intent of the business owner must be to make significant contributions to the Individual 401k plan, however there are no established thresholds regarding how much money is required to be contributed annually. Also there are no IRS rules about how soon contributions must be made after establishing an Individual 401k plan.
I participate in a 401k through my primary employer and I have a part time business. Can I have an Individual 401k for my part time business?
Yes. You are eligible to establish an Individual 401k for a side business even if you participate in a 401k, 403b, 457 or Thrift Savings Plan through your primary employer. It is important to note that contributions made to the employer's 401k, 403b or Thrift Savings Plan will impact the contributions for the Individual 401k. Contributions to the employer's 401k, 403b or TSP count towards the Individual 401k salary deferral limit. The 2023 salary deferral limit is $22,500 and $30,000 if age 50 or older. Contributions made into a 457 plan do not count towards the salary deferral limit. In addition to a salary deferral contribution, a business owner can also make contributions to the profit sharing portion of an Individual 401k.
Example: Jennifer is age 40 and works as a W-2 employee for ABC accounting firm and contributes $10,000 to the 401k. In addition to working at the accounting firm, Jennifer is the owner of an S corporation. She is the only employee and pays herself a $100,000 W-2 salary in 2023.
Based on this information Jennifer would be eligible to make a contribution of $12,500 in salary deferrals (the $10,000 contribution to the ABC accounting firm 401k counts toward the $22,500 salary deferral limit) plus make a profit sharing contribution of $25,000 (25% of 100,000 W-2 salary) for a total of $37,500 in Individual 401k contributions in 2023.
What are the Individual 401k eligibility rules when a business owner has part time W-2 employees?
A business owner who employs part-time W-2 employees may be able to exclude them from plan participation. Generally, under federal law you are permitted to exclude the following types of employees:
- Employees under age 21
- Employees with less than one year of service
- W-2 employees who work less than 1000 hours per year
- Certain union employees
- Certain non-resident alien employees