A Solo 401(k) is more than the name might imply. While these plans have been marketed as Solo plans or Individual plans, the more apt description is “owner-only”.
What makes the Solo 401(k) special is the simplicity of administration and operation as compared to a full-blown employer 401(k) plan in a company with employees. Because there are no non-owner employee participants eligible for benefits, many of the complexities attendant with managing other people’s retirement savings don’t apply.
But the Solo 401(k) can be for more than one person. Any owners and their spouses can participate in the plan, provided certain criteria are met.
General Eligibility for a Solo 401(k)
A Solo 401(k) is an employer sponsored retirement benefit plan. In order to setup a plan, you must have a for-profit enterprise in the form of an active business that generates earned income.
The type of business entity does not matter. Sole proprietorships, LLCs, and corporations can all act as a plan sponsor.
The nature of the income does matter. A business creates earned income which qualifies to sponsor and contribute to a Solo 401(k). Passive investment earnings such as rentals or K-1s from passive partnership holdings are not considered employment income, and do not qualify for a Solo 401(k).
It is important that the business be an owner-only business, meaning there are no qualifying non-owner employees eligible to participate in the plan. If a business has full time employees working more than 1,000 hours per year, or long-term, part-time employees working more than 500 hours for 3 consecutive years, then the Solo plan is not an option.
If owners of a business have other businesses with qualifying employees, that may prohibit the use of a Solo 401(k).
Eligibility to Participate
In order to participate in a Solo 401(k) plan, an owner – or employee/owner as the case may be – must have earned compensation income from the business.
Any business owner with at least a 5% share of the business is eligible to participate.
An owner’s spouse is eligible, so long as they are a compensated employee of the business. A spouse can be employed by the business on a part-time or full-time basis.
Simply being an owner without compensation does not enable a person to participate in a business’s 401(k) plan.
Common Structures to Include a Spouse
If your business is a sole proprietorship or single-member LLC treated as a pass-through for taxation, then you will need to issue W-2 wages to your spouse to make them a compensated employee. This is one of the more common arrangements, especially if the spouse’s role in the business is minimal.
In a business where both spouses are active it may make sense to operate as a partnership or form a partnership LLC. Each spouse will receive a share of partnership income on a K-1 that will be considered compensation.
It is also possible to utilize a qualified joint venture. This structure allows spouses who co-operate a business to report on two schedule c returns rather than be required to report as a partnership.
In a corporation, each spouse will receive W-2 wages from the company.
If you and your spouse are both self-employed, but have separate businesses, that is OK too. You can establish your Solo 401(k) as a multi-employer plan. Your two businesses can jointly sponsor a single plan, but you can each contribute based on income from your respective business.
Short-Term Spousal Employment for Rollovers Only
Sometimes only one spouse is active in a business, but the other spouse has existing eligible retirement savings they would like to rollover into the Solo 401(k) so it can be self-directed.
So long as the spouse is legitimately employed by and compensated by the business, they can join the plan, setup an account within the plan, and rollover funds.
Once the rollover has been completed, the employment arrangement can be terminated. Whether you choose to fire your spouse, or they tell you to “take this job and…” is up to the two of you to sort out.
Either way, once the funds have been rolled into the plan, they can remain there and be invested under your control so long as the 401(k) itself remains valid.
Of course, if your spouse is no longer employed by the business, they cannot make new contributions to the plan.
Keep Separate Plan Accounts
Being able to house funding belonging to you and your spouse in your Solo 401(k) can have many advantages.
In an IRA-based structure, you would each need your own entirely separate plan, which costs more to setup and takes more work to administer.
With both sets of funds in the Solo 401(k), you can operate more simply and have access to the pooled savings for making investments.
You do need to accurately track the values of your separate accounts over time. Maintaining separate bank accounts is one way to make this job easier.
You and your spouse can both contribute to the Solo 401(k) based on the compensation you receive from your business.
Employee contributions to the Solo 401(k) are discretionary. That means each spouse can determine independently if they want to contribute.
If either spouse is also employed by another employer offering a 401(k) or similar employer sponsored retirement plan, the individual cap for that person is shared across plans.
Employer profit-sharing contributions must be made in the same percentage to all eligible plan participants based on their share of the business income. You cannot choose to contribute to only one spouse or contribute at different levels to each spouse.
Consult with Your Licensed Advisor
While we are glad to be able to share some of the potential power and benefit of a Solo 401(k) plan, we caution that these are topics to discuss with your licensed tax advisor or business counsel. There are many concerns with having business partners and spouses in your business that reach far beyond the 401(k) plan.