What Happens to Your Solo 401(k) if Your Business Hires Employees?
If you qualify as a self-employed entrepreneur and your business has no full-time employees, the Solo 401(k) is a fantastic self-directed retirement plan option.
A Solo 401(k) isn’t really a distinct type of retirement plan. It’s a specific implementation of a qualified employer 401(k) in an owner-only business environment.
This plan structure has the savings capacity of a true 401(k) plan, while providing you checkbook control over your assets. Plus, you can use a Safeguard Self-Directed Solo 401(k) to invest in anything IRS rules allow such as real estate, cryptocurrency, venture capital, etc.
Not only that, but a Solo 401(k) has a retirement plan structure that’s easy to manage. with limited reporting requirements in comparison to larger employer plans.
As the plan trustee, you’re only managing your own retirement savings, and not taking responsibility for the savings of others. This simplicity is what makes the Solo 401(k) format such a great self-directed investing platform.
Solo 401(k) Qualifications
To qualify for a Solo 401(k), you must have a for-profit business activity that serves as the business sponsoring the plan.
This can be a sole, proprietorship, LLC, or corporation. The entity format doesn’t matter, but the generation of earned income is required.
Your business may not have any non-owner employees working more than 1,000 hours per year (which is about 20 hours per week for the full year). Starting in 2023, long-term part-time employees working at least 500 hours per year in two consecutive years will also qualify for retirement plan benefits – meaning such employees would push you out of qualification for a Solo 401(k).
Can I Keep my Solo 401(k) if I Hire an Employee?
If the business sponsoring your Solo 401(k) hires any full-time employees or long-term part-time employees, or if any other business you control has plan-eligible employees, then those employees are entitled by law to benefits coverage under the 401(k) plan.
Once a 401(k) has non-owner employees, it’s no longer the simplified Solo 401(k) version of the plan.
So what does that mean for your plan?
There’s no need to panic: Your plan can exclude a qualifying employee for up to one year of service, so you have time to create a proper transition strategy.
There are two directions you can take your plan:
- Upgrade to a full 401(k) plan and provide benefits to the employee(s), or
- Terminate the plan and rollover your savings to an IRA.
Let’s look at the pros and cons of each option below:
Upgrading your 401(k)
If you want to continue to make significant contributions to your retirement savings each year, then maintaining a 401(k) plan is the way to accomplish that.
However, there are trade offs:
- When you upgrade your Solo 401(k) to a full 401(k), the plan must file the long form 5500 return regardless of plan value.
- You must also perform annual non-discrimination testing on the plan to ensure that contributions are reasonably proportional for rank and file employees and highly compensated employees.
- There’ll generally be a requirement to have a 3rd party administrator involved in holding and reporting on plan investments.
- There may also be restrictions on the percentage of the plan that can be invested in “non-traditional” assets such as real estate.
- If the plan will continue to allow for non-traditional investments, then that capacity must be made available to all participating employees.
- As the plan trustee, you’ll need to obtain a surety bond, and will have some liability exposure with respect to any of the plan investments made both by you and by employees.
Continuing with a self-directed strategy in a full 401(k) plan format can be a daunting path. This is why it may be easier for you to simply rollover your plan into an IRA and start fresh with a new retirement plan structure.
Safeguard Advisors does not implement or support self-directed 401(k) plans with non-owner employees.
Rollover to an IRA
If your Solo 401(k) holds non-traditional assets such as real estate, it may be simpler to terminate your plan and rollover your assets to a self-directed IRA.
This option allows you to maintain your current investments in a simplified structure.
As an individual plan, the IRA is not necessarily linked to the business. Plus, you can operate independently with your investments.
The type of IRA you choose to move to may vary depending on your situation and goals. You could simply rollover to a traditional IRA. This type of IRA does not allow for much in the way of future contributions, but would serve as a good repository for existing holdings.
And after a 1 year pause, your business could open a new 401(k) that’s a conventional plan focused on mainstream financial investments.
This could be a low-cost, easy-to-administer option that would provide the capacity for higher contributions without the complexities associated with holding non-traditional assets.
On the other hand, your business could sponsor a SEP or SIMPLE IRA. These IRA formats allow for higher contributions sourced from the employer. But they would also need to be offered to all employees.
The underlying accounts are individual in nature. So you could have a self-directed SEP capable of investing in real estate, while your employees could choose to hold their account in a mainstream brokerage, or choose to self-direct their accounts.
In the latter example, your employees’ self-direction would be their own operation. and you wouldn’t have the same kind of responsibility and exposure as an employer in a 401(k) format.
If you’re utilizing the Roth features of your 401(k), any assets held in that portion of the plan would need to be rolled over to a Roth IRA.
How to Plan Ahead
If you’re considering implementing a Solo 401(k) in your business, be sure to think about what your future plans for your business, and the potential for employees may be.
If hiring employees is a strategy that’s on the horizon, it may make more sense to go with an IRA based plan to start with.
If you have a business with a Solo 401(k) and are considering bringing on employees, reach out to your CPA and plan advisor to understand your options and the relevant timelines in advance. Planning for a transition can make that process a whole lot easier.
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Quick answers to common questions
We’ll take you through a simple, step by step process designed to put your investment future into your own hands…immediately. Everything is handled on a turn-key basis. You take 100% control of your Retirement funds legally and without a taxable distribution.
YES! In 1974, Congress passed the Employee Retirement Income Security Act (ERISA) making IRA, 401(k) and other retirement plans possible. Only two types of investments are excluded under ERISA and IRS Codes: Life Insurance Contracts and Collectibles (art, jewelry, etc.). Everything else is fair game. IRS CodeSec. 401 IRC 408(a) (3)
It’s actually pretty simple. Early on, regulators let the securities industry take the lead in educating the public about retirement accounts. Naturally, brokers and banks promoted stocks, bonds, and mutual funds—giving the impression that those were the only allowed investments. That was never true... and still isn’t. You can probably guess why they kept the rest under wraps.
It is possible to use funds from most types of retirement accounts:
- Traditional IRA
- Roth IRA
- SEP IRA
- SIMPLE IRA
- Keogh
- 401(k)
- 403(b)
- Profit Sharing Plans
- Qualified Annuities
- Money Purchase Plans
- and many more.
It must be noted that most employer sponsored plans such as a 401(k) will not allow you to roll youraccount into a new Self-Directed IRA plan while you are still employed. However, some employers will allow you to roll a portion of your funds. The only way to be completely sure whether your funds are eligible for a rollover is by contacting your current 401(k) provider.
A Solo 401(k) requires a sponsoring employer in the format of an owner-only business. If you have a for-profit business activity – whether as your main income or as a side venture – and have no full-time employees other than potentially your spouse, your business may qualify. The business may be a sole-proprietorship, LLC, corporation or other entity type.
A self-directed retirement plan is a type of IRA or 401(k) that gives you greater control over how your retirement funds are invested. Unlike traditional accounts held at banks or brokerage firms that limit you to stocks, bonds, and mutual funds, self-directed plans allow you to invest in a wide range of alternative assets including real estate, private businesses, precious metals, cryptocurrency, and more.
These plans still follow the same IRS rules and maintain the same tax-deferred or tax-free benefits as conventional retirement accounts. The difference is simply in how and where you choose to invest.
No. Moving to a self-directed IRA or Solo 401(k) does not trigger any taxes, as long as your funds are eligible for rollover.
Self-directed retirement plans maintain the same tax-advantaged status as traditional plans offered by banks or brokerage firms. The key difference is flexibility—our plans are designed to give you greater control and allow for a wider range of alternative investments beyond stocks, bonds, and mutual funds.
A prohibited transaction is any action between your retirement plan and a disqualified person that violates IRS rules and can lead to serious tax consequences. Under IRS Code 4975(c)(1), prohibited transactions include:
- Selling or leasing property between your plan and a disqualified person Example: Your IRA cannot purchase a property you already own.
- Lending money or extending credit between the plan and a disqualified person Example: You cannot personally guarantee a loan your IRA uses to buy real estate.
- Providing goods or services between your plan and a disqualified person Example: You can’t use your personal furniture to furnish a rental property owned by your IRA.
- Using plan income or assets for the benefit of a disqualified person Example: Your IRA cannot buy a vacation home that you or your family use.
- Self-dealing by a fiduciary (using plan assets for their own benefit) Example: Your CPA shouldn't loan your IRA money if they’re advising the plan.
- Receiving personal benefit from a deal involving your IRA's assets Example: You can’t pay yourself from profits your IRA earns on a rental.
If a transaction doesn’t clearly fall within the allowed guidelines, the IRS or Department of Labor may review the situation to determine if it qualifies as a prohibited transaction.
Disqualified persons are individuals or entities that are prohibited from engaging in certain transactions with your IRA or 401(k). Doing so could trigger a prohibited transaction, which may result in taxes and penalties.
Here’s who is considered a disqualified person:
- You (the account holder)
- Your spouse
- Your parents, grandparents, and other ancestors
- Your children, grandchildren, and their spouses
- Any advisor or fiduciary to the plan
- Any business or entity owned 50% or more by you or another disqualified person, or where you have decision-making authority
These rules exist to prevent self-dealing and ensure your retirement plan remains in compliance with IRS regulations.
(Reference: IRC 4975)
Understanding and following these rules can be tricky, but it’s very doable. The best way to stay compliant is to work with professionals who specialize in self-directed retirement plans. They can help you navigate IRS guidelines and avoid prohibited transactions.
If an IRA holder is found to have engaged in a prohibited transaction with IRA funds, it will result in a distribution of the IRA. The taxes and penalties are severe and are applicable to all of the IRA’s assets on the first day of the year in which the prohibited transaction occurred.
Yes. While self-directed retirement plans allow for a wide range of investments, there are a few important restrictions.
You cannot invest in collectibles or life insurance contracts, and you must avoid prohibited transactions—activities that benefit you personally rather than the retirement plan. These include things like buying or selling property to yourself or family members, using plan assets for personal gain, or self-dealing in any way.
Violating these rules could cause your entire IRA to lose its tax-advantaged status. To protect your account, it’s essential to work with professionals who understand IRS regulations and can help you stay compliant.
This is a common misconception. In many cases, professionals may simply be unfamiliar with self-directed retirement plans, as they fall outside their usual scope of work. CPAs and tax preparers are trained to file taxes, not necessarily to advise on alternative retirement strategies. Financial advisors and brokers often work for firms that focus on traditional investments like stocks and mutual funds—and may not benefit from or support alternative options like real estate or private lending.
Self-directed retirement investing is legal under IRS rules—but like any specialized area, it requires working with professionals who understand how it works.
The IRS has rules in place to make sure your IRA is used only for the exclusive benefit of the retirement account—not for personal gain or to help family members. These rules can get complicated because there are many ways a conflict of interest can occur, even unintentionally.
For example, if your IRA buys a house and rents it to your mother, you might be reluctant to evict her if she stops paying rent. That emotional connection creates a conflict between what’s best for your IRA and your personal relationships, something the IRS aims to prevent.
These rules help ensure your retirement account stays compliant and protected. (See IRC 408)
Yes. Most tax-deferred retirement accounts—such as Traditional IRAs, old 401(k)s, 403(b)s, and TSPs—can be rolled over into a self-directed IRA or Solo 401(k), depending on your eligibility. Roth IRAs cannot be rolled into these accounts.
You can contribute directly from earned income, subject to annual IRS contribution limits. The method and amount depend on the type of plan you have (e.g., Solo 401(k) vs. IRA).
To take a distribution, you'll request funds through your custodian or plan administrator. Distributions may be taxable depending on your account type and age. Early withdrawals may be subject to penalties.
For 2025, the Solo 401(k) max contribution limit is $81,250 if age 60-63, $77,500 if age 50-59 or 69+, and $70,000 if under 50. Traditional and Roth IRAs have a limit of $7,000 ($8,000 if age 50+). Limits are subject to IRS adjustments.
Yes. IRA contributions are typically due by your personal tax filing deadline (e.g., April 15). Solo 401(k) contributions follow your business tax filing deadline, including extensions.
IRS reporting requirements vary depending on the type of self-directed retirement plan you have. Here’s a quick breakdown of what you need to know
Please note: Our team can help you understand what’s required for your specific account, but we don’t provide tax or legal advice. We always recommend working with a qualified tax professional to ensure full IRS compliance.
Self-Directed IRA (Traditional or Roth)
- Form 5498 – Filed by your custodian each year to report contributions, rollovers, and the fair market value (FMV) of your account.
- Form 1099-R – Issued if you take a distribution or move funds out of your IRA.
- Annual Valuation – You'll need to provide updated FMV for any alternative assets held in the account, such as real estate or private placements.
Solo 401(k)
- Form 5500-EZ – Required if your plan assets exceed $250,000 as of year-end. Must be filed annually by the plan participant.
- Form 1099-R – Required if you take a distribution or roll funds out of the plan.
- Contribution Tracking – Keep records of employee and employer contributions. These are not filed with the IRS but may be needed for tax reporting or audits.
SEP IRA
- Form 5498 – Filed by your custodian to report contributions and FMV.
- Form 1099-R – Filed by your custodian. Issued for any distributions.
- Employer Contributions – Must be reported on your business tax return (and on employee W-2s, if applicable).
Health Savings Account (HSA)
- Form 5498-SA – Filed by your HSA custodian to report contributions.
- Form 1099-SA – Filed by your HAS custodian. Issued for any distributions.
- Form 8889 – Must be included with your personal tax return to report contributions, distributions, and how funds were used.
