Can a Solo 401k Have More Than One Employee?

For individuals who are self-employed or own a small business, a solo 401k represents more than just a nest egg for their golden years, it provides invaluable peace of mind. But like other retirement plans, a solo 401k has specific eligibility rules and one of the most often-asked questions relates to the allowable size of the business. In other words, can a solo 401k have more than one employee?

The general rule for a solo 401k is that it cannot have any employees other than the owner-operator. There is, however, one exception to this rule: the spouse of the proprietor can contribute to a solo 401k in the same manner as the business owner, meaning as both an employee and an owner.

One of the biggest concerns of self-employed individuals is how to provide financial security for themselves and their families when their working years have come to an end. For independent business owners, a solo 401k offers unique benefits, but only under the right circumstances. Keep reading to learn about its one-employee rule as well as the singular exception to this requirement.

Can a Solo 401k Have More Than One Employee?

A solo 401k is a retirement plan geared specifically toward individuals who are self-employed or operate their own businesses. It is often referred to as an individual 401k or a one-participant 401k, and as all of these terms suggest, this is an investment vehicle intended for a single stakeholder.

In no uncertain terms, a solo 401k prohibits a proprietor from having any employees to qualify for this plan. The business owner, however, is allowed to contribute in two ways: as an employee of the operation and as its owner. It is this duality of contributions that make a solo 401k so attractive to independent participants. For 2023, contribution limits for a solo 401k work out thusly:

• In the role of an employee, a business owner can contribute up to $22,500 and this amount is boosted to $30,000 for individuals over 50

• As an employer, the same participant can contribute up to 25% of net business income (after certain reductions)

• The allowable sum of employee and employer contributions is capped at $66,000 for business owners 50 years and younger and at $73,500 for those over 50

Thus, even though a solo 401k prohibits the inclusion of anyone other than the business owner, the fact that the proprietor can wear two hats with respect to contributions makes this retirement plan very appealing. And there is one additional detail about a solo 401k that married couples may find particularly noteworthy.

The Exception to the One-Employee Rule of a Solo 401k

There is one glaring exception to the otherwise hard and fast rule that a solo 401k cannot have any employees other than the business owner: the spouse of the proprietor can also work for the operation or be a part-owner. What’s more, the spouse can contribute in the same manner as the business owner, i.e., as an employee and an employer.

Under the right circumstances, a married couple can essentially double up on the contribution amounts to a solo 401k, making this retirement plan a very effective way to put away money for those golden years.

What Happens When a Solo 401k Has Too Many Employees?

With the dual contribution channels that a solo 401k allows and the great flexibility in investment options that it provides, it is an attractive retirement plan for small business owners and self-employed individuals. However, to reap these benefits, a participant must abide by very strict requirements.

The most restrictive element of a solo 401k is the fact that it is limited to operations that have only one employee. The sole exception to this rule is that the spouse of the proprietor can work for the business or be a part-owner.

This limits a solo 401k to small operations comprising just one individual or a married couple who work together. Should a participant’s business grow and the need to hire additional employees arises, the consequences are very clear cut:

• Either a solo 401k has to be reworked into a traditional 401k to accommodate the larger workforce, or

• A solo 401k will need to be wrapped up and closed out

An independent proprietor who is enrolled in a solo 401k while operating a thriving venture may find that acquiring a larger workforce is the only way to keep up with the increasing demands of the business. However, while hiring more employees may improve the operation’s bottom line, it will also disqualify the business owner from participating in a solo 401k.

Final Thoughts

A solo 401k is an extremely attractive retirement plan for small business owners who are looking to maximize their contribution opportunities while exploring a variety of investment options. But such flexibility comes at a price, and, in the case of a solo 401k, it comes in the form of a very cut-and-dry cap on the number of employees.