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Can An Independent Contractor Participate In A 401k Plan

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Who Is Ineligible For A Solo 401k

Can you set up a solo 401k as a 1099 contractor that is paid directly? | Reddit

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 a Solo 401k. Business owners and their spouse do not apply to the 1,000 hour threshold.

A business owner is still eligible for a Solo 401k if they hire independent contractors who work more than 1,000 hours in a calendar year.

Create Your Own Retirement Plan If You Work For Yourself

By Amy DelPo, Attorney

One of the many advantages of being a freelancer, independent contractor, or other self-employed person is the ability to control your own retirement plan. This both helps ensure a secure future and, because your plan contributions will likely be tax-deductible, makes financial sense right now.

To choose the best retirement plan, first learn about the different features of the plans available to you. Here’s what you need to know.

Additional Benefits Of Owner

In addition to giving you a secure retirement savings vehicle, an owner-only 401 plan allows you to borrow from your account if you need quick access to funds as long as you specify that you want the plan to contain a loan provision.

If business is slow, you don’t have to contribute to the plan every year. You can decide from year to year how much you’re able to contribute, or if you need to temporarily suspend your 401 contributions.

Also Check: How Do I Cash Out My 401k Early

S To Set Up A Solo 401

There are specific steps that must be taken to properly open a solo 401 plan, according to the Internal Revenue Service .

First, you have to adopt a plan in writing, making a written declaration of the type of plan you intend to fund. The choices are the same as are given to an employee opening a 401 plan: you can choose a traditional 401 or a Roth 401. Each has distinct tax benefits.

A solo 401 must be set up by December 31st in the tax year for which you are making contributions.

Simplified Employee Pension Or Sep Ira

The misclassified worker and employee benefit plan ...

With a , you can contribute up to 25% of your net earnings or $57,000 per year, whichever amount is lower. Like traditional IRAs, contributions are tax-deductible and withdrawals are taxed. People who are self-employed and make less than $285,000 per year are eligible.

These accounts are easy to establish and administer, and you wont need to file annual statements. They work best for people who dont have employees. If you have workers, youll need to contribute the same percentage to their accounts as you put in your own account. For example, if you place 10% of your annual compensation in a SEP IRA per year, youll have to give each employee 10% of their earnings as well. Many online brokers offer SEP IRAs.

Also Check: What Is A 401k Vs Ira

Spending Time On Marketing Endeavours

As an independent contractor, you must devote time to promoting your services in order to maintain a steady stream of work.

While it is entirely up to you how you market your business, keep in mind that every minute you spend marketing is a minute you are not being paid for doing actual work. Concentrate on marketing strategies that tend to yield predictable results so you can devote the majority of your time to clients.

Some strategies to consider are:

  • Providing discounts or special deals to clients
  • Attendance at professional networking events and activities

Traditional & Roth Iras

While not specifically for independent contractors, these plans are options as well, particularly if youre just starting out and can only make modest contributions initially.

For both Traditional and Roth IRAs, annual contributions are capped at $5,500 or $6,500 if youre over 50.

Traditional IRA contributions are made in pre-tax dollars, while Roth IRA contributions are in after-tax dollars.

The big advantage of the Roth is that your contributions can always be withdrawn tax-free and penalty-free.

Earnings are a different story from a tax and penalty standpoint. These withdrawal rules are more complex and depend whether or not youve had the account for more than 5 years as well as whether you meet the allowable circumstances for an early withdrawal.

Recommended Reading: How To Transfer 401k Accounts

Rule # 2 $58k Per Unrelated Employer

The IRS also only allows you and your employer to put a total of $58,000 for 2021 per year into a 401. This includes the employee contribution, any match from the employer, and any employer contributions. This is the same limit for a which is technically all employer contributions. However, unlike rule # 1, this limit applies to each unrelated employer separately.

Unrelated employers means that the businesses doing the employing are not a controlled group. There are two types of controlled groups:

  • Parent-Subsidiary GroupThis is when a parent business owns 80%+ of another business.
  • Brother-Sister GroupThis is where 5 or fewer individuals, estates, or trusts own a controlling interest of two different businesses.
  • So if the two businesses you are involved in aren’t a controlled group, and they each have a 401, and a SEP-IRA) you get two $57K limits. Pretty cool, huh? There are several common examples where this could apply to a physician:

    Multiple 401k Example One

    A 40-year-old single physician is an employee of two completely unrelated hospitals. The first pays her $200K per year and matches 100% of her first $5K put into the 401. It also offers her a 457. The second pays her $100K per year and matches 50% of the first $7K she puts into her 401. What retirement accounts should this physician use in order to maximize her contributions in 2020?

    • Hospital 1 401: At least $5K = $10K
    • Hospital 1 457: $19.5K

    Multiple 401k Example Two

    Multiple 401k Example Three

    What Are The Irs Rules About How Much And When The Business Owner Must Make Contributions To An Individual 401k

    Can a 1099 independent contractor have a solo 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.

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    Most service and working dogs, which are typically Labrador Retrievers, German Shepherds, and Golden Retrievers, are estimated to have an average working life of 8 years . Since most working dogs do not officially begin their careers until 2 years of age, they are typically retired at around 10 years of age.

    Can I Cover My Spouse Under My Owner

    Although self-employed 401 plan participation is limited to the business owner, the owner’s spouse may participate in the plan, as long as they earn income from the business. Given that both spouses can participate, this plan offers a great opportunity for a family to significantly increase their contributions toward retirement savings.

    Read Also: Where Can I Find My 401k Balance

    What Is The Qualified Business Income Deduction

    The Qualified Business Income deduction, or QBI, was created by the Tax Cuts and Jobs Act of 2018. It allows owners of LLCs, sole proprietorships, and other business entities but not corporations to deduct up to 20% of their business income on their individual tax return.

    Some limitations: The QBI deduction is available to individuals who earn less than $157,500 as an individual filer or $315,000 as a married couple. And it only applies to particular types of businesses.

    If you are a service business, then you will not receive any benefit once income exceeds the thresholds listed above. If you are not a service business, there is a second calculation that applies based on wages and equipment acquired, so you may still receive a benefit even if income is higher.

    Consult a CPA about whether you qualify to take the QBI deduction and whether it could reduce your tax liability. Now that its been in place for a year, tax professionals have a better sense of how this mechanism will work and who its best suited for.

    Who Is Eligible For Owner

    Solo 401k: My Favorite Retirement Plan for the Self ...

    Owner-only 401 eligibility is limited to the following:

    • The plan participant must be the business owner who has no employees.
    • The business owner’s spouse may also participate if they are employed by the business.
    • Business owners may be self-employed independent contractors, sole proprietors, corporations, limited liability companies , and partnerships.
    • The participant can be any age and make any amount of income.

    Recommended Reading: How Do I Add Money To My 401k

    Which Situation Is Right For You

    If you decide to offer independentcontractor health insurance to your 1099 workers, keep in mind that not allcompanies will allow a contractor to join a group health plan. Make sure yourcompany does provide that option or compare health insurance for your businesson the eHealthGroup Health Insurance page.

    As you compare, you may find that one of these options might fit your situation best:

    • Your company will receive more comprehensivebenefits or lower premiums by allowing 1099 employees to join the group plan
    • It would be more cost-effective for your companyto limit your group health insurance plan to your actual employees
    • You and your family may be better off with afamily health insurance plan if all your employees are 1099 contractors

    No matter which scenario fits your business best, we canhelp you compare multiple options so you can make the right choice for you.

    This article is not intended as legal or accounting advice,so check with your legal or accounting advisor instead of relying on thegeneral information in this article.

    Retirement Planning For Independent Contractors

    Independent contractors may be able to invest more in their retirement plans than their colleagues with traditional employment agreements.

    Many employees have access to a 401 or a 403 retirement plan. The maximum annual contribution to those plans is $19,000 employers might match that or pay employees out of a profit-sharing agreement.

    But independent contractors have a few other options: SEP IRAs and Solo 401s. The maximum contribution to both of these types of accounts is $56,000 annually .

    Independent contractors are still limited to $19,000 in employee deferrals, which they pay to themselves. However, they can save up to 25% of their income from the business in the form of a profit-share contribution, for up to a total of $56,000 in savings.

    There is a difference on how each account is funded. With a SEP IRA, the entire $56,000 is funded through profit share, while a Solo 401 is funded with employee deferrals plus profit share. If your strategy includes Backdoor Roth IRAs each year, a SEP IRA would create issues with that strategy, while a Solo 401 would not.

    For example, lets consider an emergency medicine physician who earns $300,000 per year working as a contractor. She set up an LLC for herself and has $50,000 in business expenses. That means she earns about $250,000 per year in profit. 25% of that profit is $62,500. Thus, she can contribute up to $19,000 as an employee, then up to $37,000 from her profits, to max out at $56,000 in savings for that year.

    Recommended Reading: When Leaving A Company What To Do With 401k

    When I Retire Do I Have To Convert My 401k

    Generally speaking, retirees with a 401 are left with the following choices: Leave your money in the plan until you reach the age of required minimum distributions convert the account into an individual retirement account or start cashing out via a lump-sum distribution, installment payments, or

    Benefits Of A Solo 401

    Solo 401k Retirement Plans for Sole Proprietors and Contractors

    Solo 401s provide some advantages over other types of retirement accounts available to you.

    One big advantage is the availability of the Roth option as well as the traditional version. Only the traditional option can be used by those who invest using the SEP IRA, a Keogh plan, or a SIMPLE IRA. The plain-vanilla IRA that is available to all who have earned income is available in Roth or traditional versions but the annual contribution limits are far lower.

    One of the main advantages of the solo 401 is that it can accept contributions from both an employee and an employer. That is, if you have a solo 401, you wear both hats and can make contributions in both roles.

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    Employee Or Independent Contractor: A Rose By Any Other Name

    USA Today recently ran an article describing how many companies are using alternative work arrangements to adapt to an ever-changing business environment. Some may rely on more part-time workers, while others may choose to work with independent contractors. There are also leased employees, seasonal employees, and interns. All of these types of workers are often referred to as contingent workers.

    Regardless of the reason a company gravitates to contingent workers, alternative work arrangements present some unique challenges, and it takes careful planning to ensure benefit plans properly reflect the companys intentions. That analysis generally requires a company to answer three key questions:

  • Which workers are legally considered to be my employees?
  • What does my plan document say about the employees who are covered and when they become eligible for benefits?
  • Will my plan be considered discriminatory if I exclude certain workers?
  • This article focuses on the first question, with questions 2 and 3 covered here and here, respectively.

    Controlled Group Rules And The Solo 401 Plan

    Adam Bergman is the President of IRA Financial Group & IRA Financial Trust Company – a leading provider of self-directed retirement plans


    One of the most common questions I get from business owners is how they can set up their own individual 401 plan, without offering plan benefits to their employees. On its face, this question seems somewhat unkind and insensitive, but as a tax attorney, I understand the basis for it. It all comes down to benefits.

    An individual 401 plan, also known as a solo 401, allows a business owner to contribute almost three times as much as a regular plan. Therefore, becoming eligible to set up a solo 401 plan has many tax and retirement benefits. Higher contributions generally translate into higher tax deductions and greater potential for tax deferral and retirement wealth.

    What Is A Solo 401 Plan?

    Basically, a solo 401 is a retirement plan for the self-employed. When you work for yourself, you are in charge of your retirement planning. In addition to high annual plan contributions, the advantage of establishing a solo 401 plan is that the plan is not subject to ERISA rules and regulations, which can create complexities and add costs for the business owner.

    Therefore, it is in the interest of a business owner who is seeking to maximize their retirement benefits, as well as minimize business costs, to attempt to set up a solo 401 plan for themselves through a separate business or entity.

    The Controlled Group Rules


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    What Are The Individual 401k Eligibility Rules When A Business Owner Has Part Time W

    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

    Who Is Ineligible For An Individual 401k

    Are Independent Contractors Covered by Workers Compensation?

    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.

    Also Check: Where To Put 401k After Retirement

    Can You Have Multiple 401ks

    Here’s the deal. Many physicians work for multiple employers or work as an employee and either an independent contractor or a consultant. Many others have a side job of another type. Their incomes are far higher than they require for their current spending needs, but they’re behind on their savings or otherwise have a desire to maximize the amount of money they can put into retirement accounts, especially tax-deferred retirement accounts.

    Obviously, these types of accounts minimize tax, maximize returns, increase asset protection, and facilitate estate planning. Who wouldn’t want to get more money into them? However, most of these doctors are surprised to learn that they can have more than one 401. That’s right,

    Who Is A 1099 Employee

    In view of the current pandemic, startups are going virtual and recruiting contractors across international borders.

    But the question is:

    Who is a 1099 Employee?

    A 1099 employee is someone who isn’t classified as a regular employee under the law. Independent contractors are classified as 1099 employees. This means that instead of hiring a permanent employee who works under the guidance of the startup, the startup hires an independent contractor who is self-directed.

    The distinction between a 1099 employee and others is generally obvious. For example, a painter hired to paint your home is an example of an independent contractor. After the job is completed, they would no longer be your employee.

    The 1099 label is inaccurate if you require a permanent employee. A conventional employee is someone who must:

    • Report to work
    • Adhere to a workplace dress code
    • Always report to their boss

    Bottom line?

    Employees with a 1099 status are self-employed independent contractors. They are paid according to the terms and conditions stated in the contract and receive a 1099 form on which to report their income on their tax return.

    Image credit: Unsplash

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