Hiring your first employee is an exciting milestone. It usually means the business is growing, you need some help, and things are moving in the right direction.
If you have a Solo(k), though, there is one more item to add to the “I need to hire” checklist:
Take another look at your retirement plan.
A Solo(k) is not actually a separate type of 401(k). It is a traditional 401(k) specifically designed to cover a business owner, or owner and spouse, with no other employees. The administrative simplicity comes largely from the fact that there are no other employees to consider.
So, what happens when you hire one?
If your Solo(k) provides for immediate eligibility, which is very common, quite a lot can happen – and quickly.
Immediate Really Does Mean Immediate
Many business owners assume they have six months or a year after hiring an employee before the Solo(k) plan becomes an issue. Not necessarily.
The eligibility provisions in the plan document dictate how the plan is to be operated. A plan can be more generous than the maximum age and service requirements permitted by law, including allowing employees to participate immediately.
So, if your document provides immediate eligibility, and your new employee is otherwise covered by the plan, there may be no waiting period at all. The employee you hired on Monday may also be your newest 401(k) participant on Monday.
That can change the conversation considerably.
Immediate Vesting Matters Too
Now add another common Solo(k) provision: 100% immediate vesting.
When the owner was the only participant, vesting may not have seemed particularly important. After all, there wasn’t much concern about the owner terminating employment and forfeiting their own employer contribution. Once employees are involved, it could matter.
If your plan provides immediate vesting, employer contributions allocated to the employee are generally theirs immediately. Traditional 401(k) plans can use vesting schedules for certain employer contributions, but a plan can also provide that those contributions are fully vested from the start.
That does not mean immediate vesting is bad. It simply means a provision that received very little attention in an owner-only plan can suddenly have a real financial impact once employees are participating.
Is It Still a Solo(k)?
Technically, the plan does not suddenly stop because an employee walks through the door. But once an employee is included, it may no longer be operating as a Solo(k) or owner-only plan.
The IRS is pretty explicit on this point: when employees are hired and satisfy the plan’s eligibility requirements, they must be permitted to participate in the plan. And the special no-testing advantage enjoyed by an owner-only 401(k) also disappears.
In other words, the retirement plan has entered a new phase right along with the business.
Don’t Wait Until Year-End
If you have an immediate-eligibility Solo(k), hiring your first employee is not something to put on the year-end retirement plan checklist. By then, you may already have missed several months of participation.
Before the employee starts, or as soon as you know a new hire is going to happen, check your plan document for:
- Who is eligible
- When participation begins
- What contribution provisions apply
- How employer contributions are vested
- Whether your current Solo(k) provider can accommodate employees
The answers may be perfectly manageable. But you want those answers before the first payroll, not several months later.
In a Nutshell
Hiring your first employee does not mean something has gone wrong with your Solo(k). It means something has changed with your business. And when the plan provides immediate eligibility, the retirement plan may need to change just as quickly.
In our next post, we’ll look at what that actually means – from payroll and employee deferrals to testing, reporting and the question of whether your current Solo(k) provider can still handle the plan.
