The qualifications to open a Solo 401k account only have two elements:
- You must own a business
- Your business must have zero employees (defined as those working more than 1000 hours per year and receive W2 wages).
However, the Setting Every Community Up for Retirement Enhancement Act (SECURE) made an important change to the second element involving zero employees. Previously, your business remained at zero employees based on no employees working more than 1000 hours. (Important Note: this does not include 1099 contract workers.) The change brought by the SECURE Act lowers the 1000-hour threshold to 500 hours for some employees.
The new 401k definition of part-time employees are those who work either 1000 or more hours throughout the year or have three consecutive years with 500 hours of work and receive W2 wages.
That could impact the status of your Solo 401k but DON’T Panic. The earliest date this could impact your plan under this new rule is January 1, 2024.
How Part-Time Employees Could Affect Your Solo 401k
What you need to know today is that although the new definition of a part-time employee does not become effective until January 1, 2024, counting the three consecutive years did begin on January 1, 2021.
There are additional requirements that these “long-term, part-time employees” must meet to become eligible to participate in a company 401k.
- The employee must attain the age of 21 by the end of the 3-year period.
- It must be 3 consecutive 12-month periods working at least 500 hours in each of those periods.
- Union employees may be exempt depending on the union contract.
- Hours of service during 12-month periods beginning before January 1, 2021, are not taken into account for this rule.
It does not have to exactly be this. For reference, the 500-hour threshold meets criteria if employee hours meet or exceed approximately 10 hours per week all year or 40 hours per week for about 3 months.
After long-term, part-time employees satisfy these criteria, you must allow them to enter the plan for 401k deferral purposes with enrollment on a semi-annual basis. If this is going to become part of your business model, you may want to begin planning for changes. Changes can include contribution budgets, impacts on testing, plan literature, etc.
Nothing has changed regarding the previous requirement of part-time employees with 1000 hours per year and receiving W2 wages. Although, having employees exceeding 1000 hours per year or long-term part-time employees exceeding 500 hours per year does not meet the Solo 401k qualification.
Another important point is that the SECURE Act does not require you to allow long-term, part-time employees to participate in the matching or employer contribution component of the 401k plan. They could, however, if they satisfy the pre-SECURE Act eligibility criteria.
For a more detailed legal summary see the National Law Review or the full text of the SECURE Act (the most pertinent information is in section 112). The IRS has also released Notice 2020-68 with plans to provide more guidance in the future.
Long-Term Part-Time Employee Examples
Bill is a part-time employee who works less than 1000 hours per year but more than 500. He was 19 years old on January 1, 2020, when he began working for you, and is not yet 21 on January 1, 2021. But you still need to begin more closely tracking his hours worked due to the SECURE Act changes. Bill plans to work 700 hours in 2021.
You still qualify for a Solo 401k. However, as his employer, you must start tracking Bill’s time in 2021, through to 2023. This is to determine whether he becomes eligible to participate in your 401k plan in 2024.
If Bill continues to work 500 or more hours per year, you will have to include Bill in your 401k plan starting 2024. The reasons are because he will turn 21 before the end of the previous 3-year period (2021-2023) and worked between 500 and 999 hours during each of those 3 years. An important point to be aware of is Bill must work at least 500 hours per year in 3 consecutive years starting in 2021.
Additionally, you require that employees work at least 1000 hours for the year to qualify for matching contributions. So long as Bill keeps working less than 1000 hours in a year, you do not have to make matching contributions to his 401k account. However, related to vesting, any contributions Bill makes to his 401k as a part-time employee are immediately vested. The 100% of the funds immediately belong to Bill at the time of payroll deduction.
You run a bed and breakfast that you and your husband operate by yourselves most of the year, during the slow season. But you do hire part-time employees for a few months during the busy season. None of you part-time employees work more than 1000 hours a year.
However, you have been hiring the same part-time employees for several years in a row.
Starting in 2021, if you continue to have long-term part-time employees working at least 500 hours per year for 3 years and they are at least age 21, they will be eligible to participate in an employer 401k. As of 2024, you may no longer qualify for a Solo 401k if you have employees working less than 1000 hours in any given year, but at least 500 hours per year in 3 straight years starting in 2021.
Be Aware of These Other Important Points
Your Solo 401k can provide benefits to you as a business owner and your spouse, so long as the spouse is actively employed by the business. Your spouse is exempt as an employee for Solo 401k eligibility requirements.
1099 contractors are not viewed as employees and do not impact your plan qualification. You do need to be sure that a person providing services to your business legally qualifies as an independent contractor per your state laws. They are not generally a true employee of the business.
Union employees and non-resident alien employees can be excluded from plan participation and may not affect plan qualification. Also, employees under the age of 21 may be excluded from participation. And again, the 500-hour rule only applies if the employee works more than 500 hours for 3 consecutive years starting in 2021. Working 700 hours for two years but only 400 hours in another year does NOT add up to 3 consecutive years.
If you are not sure if your Solo 401k plan will be impacted, the place to begin today is with more careful tracking of part-time employee hours. You still have over two years to make any needed changes.
Additional SECURE Act Information and Resources
We expect the IRS will release more guidance on this new rule going forward. Also, here is additional information about SECURE Act changes. Some are about changes and improvements that are not related to part-time employees.
- Webinar Replay: SECURE Act and the Solo 401k
- SECURE Act Could Increase Benefits in 401k Plans
- New Law Affects You: SECURE ACT and Solo 401k
- 2020 Tax Implications for Year-End
It’s advisable to consult with a financial advisor before making any decisions.