Ok, so business is going well. You’ve gone from only working for yourself to now hiring your first employee. But wait! You have a solo 401(k) that you are using. What happens to the plan since only business owners and spouses can use it? First let’s talk about what a solo 401(k) is.
What is a solo 401(k)?
A solo 401(k) plan is a way for self-employed people to save for retirement. The only restriction this plan has is that it must only be used for business owners with no employees, besides a spouse.
This plan allows the participant to save up to $23,000 annually (2024), in the same way an employee can deduct money from their paychecks into their 401(k). However, since the employee is also the business owner, they determine how much to match. This match can be up to 25% of the profits up to an annual limit of $69,000. This makes for a substantial tax and retirement savings.
When do I need to change my plan?
Depending on the type of employee you hire will decide if you need to convert your solo 401k into a 401k or some other employer sponsored retirement plan.
1099 employees or contracted employees do not require you to convert your solo 401(k). These types of employees are not considered ‘eligible’ employees.
If you have part-time employees that work at least 500 hours per year but less than 1,000 and have reached 21 years of age, you need to convert but can wait 3 years.
If you have employees that are full-time or part-time and working over 1,000 hours per year you will need to convert.
I hired an eligible employee, now what?
If the employee you hired is an eligible employee, here is what you need to do. Take a look at your solo 401(k) plan documents. Typically, plans will be set at a one-year of work required for eligibility which will allow you until the next fiscal year to make the conversion. If your plan allows for immediate eligibility, you may need to act faster.
Given you have one year to make the decision, you have time to learn about plan differences and determine which route you would like to go. Questions to ask yourself fall along the lines of, do you want to match or not? Will you get any deductions or credits? Which plan is best for you and your employees.
What options do I have for retirement plans?
Choosing your retirement plan is the next battle. Below are some options as well as limitations and benefits to each:
SIMPLE IRA
Designed for self-employed people and small businesses with fewer than 100 employees. The max contributions that can be made for 2024 is $16,000, significantly less than the previous solo 401(k). As the employer you have the option to choose a dollar-for-dollar match up to 3% of a workers pay. Alternatively, you can contribute a flat 2% of workers’ compensation, whether the employee contributes or not.
As for the employee, any contribution made on behalf of the employer is vested immediately. However, there is a rule that states you cannot withdraw money or roll over your funds into another IRA until you have owned the account for 2 years. Otherwise, a 25% early withdrawal penalty will be applied.
Simplified Employee Pension (SEP) IRA
The SEP IRA is an account in which only the employer makes contributions. This can be great for companies that may have cyclical earnings. For 2024, employers can contribute up to 25% of their employee’s total compensation or a maximum of $69,000 for 2024. Keep in mind, whatever contributions are made into the employers SEP must also be made to the workers SEP.
401(k)
Although this may be the most expensive route, you can transfer your solo 401(k) to the regular 401(k). Unlike the SIMPLE IRA, the 401(k) allows contributions up to $23,000 for 2024. The employer can match a fixed percentage or a profit-sharing contribution, capped at $69,000 to both their plan and the employee’s plan.
I hope this helps as you plan for your growing business and retirement.
Five Pine Wealth Management is an Investment Adviser registered with the Securities & Exchange Commission (SEC), principally located in the state of Idaho. All views, expressions, and opinions included in this communication are subject to change. The information provided should not be relied upon as the sole factor in an investment making decision. Past performance is no guarantee of future results.