What Is 401 c for Self-Employed Retirement Plans?
As a self-employed individual, you are both employee and employer for your retirement plan. Explore how this structure guides your savings and responsibilities.
The term “401(c)” often causes confusion, as it is not a specific type of retirement account. Instead, Section 401(c) of the Internal Revenue Code is a legal definition that clarifies who qualifies as a self-employed individual. This grants them the status of an “employee” for the purpose of establishing and contributing to a qualified retirement plan. This provision enables sole proprietors and partners to access retirement savings vehicles, the most common of which is the one-participant 401(k) plan, or Solo 401(k). This article will focus on the practical application of this rule for managing a Solo 401(k).
Eligibility for Self-Employed Retirement Plans
Eligibility for these plans includes individuals operating as sole proprietors, partners in a partnership, and independent contractors like freelancers. Owners of Limited Liability Companies (LLCs) taxed as sole proprietorships or partnerships also qualify. The defining feature is having net earnings from a trade or business where your personal services are a material income-producing factor.
A primary restriction for using a Solo 401(k) is the “owner-only” rule, which means the business cannot have any common-law employees. The only individuals who can be covered by the plan are the business owner and their spouse, if the spouse also works for the business. If the business hires other employees who work more than 1,000 hours a year, it loses its eligibility for a Solo 401(k) and must consider other plan types.
Understanding Contribution Calculations
A Solo 401(k) allows the owner to contribute in two capacities: as the “employee” and as the “employer.” This dual role allows for a higher contribution total, subject to an overall limit of $70,000 for 2025.
The first component is the employee contribution, called an elective deferral. As the “employee,” the business owner can contribute up to 100% of their compensation, not to exceed the annual limit of $23,500 for 2025. Individuals age 50 or over can make an additional “catch-up” contribution of $7,500, while participants ages 60 through 63 may be able to contribute up to $11,250, if their plan allows.
The second component is the employer profit-sharing contribution. As the “employer,” the business can contribute up to 25% of the owner’s net adjusted self-employment income. To calculate this figure, you start with your net profit and then subtract one-half of your self-employment taxes. This final number is your “plan compensation” used to determine the employer contribution. For example, if your net profit is $100,000, after deducting half of your self-employment tax, your plan compensation might be around $92,350, allowing for an employer contribution of approximately $23,087.
Required Information for Plan Establishment
The first requirement for opening a Solo 401(k) is an Employer Identification Number (EIN). Even if you operate as a sole proprietor using your Social Security Number for taxes, you must obtain an EIN because the plan is sponsored by your business, not you as an individual. You can apply for an EIN for free on the IRS website.
With your EIN, the next step is to choose a plan provider, such as a brokerage firm or mutual fund company. It is important to compare providers based on their investment options, fee structures, and customer support. Some may offer platforms that allow for plan loans or Roth contributions, while others are more streamlined.
Once you select a provider, they will supply the necessary plan documents. The two core documents are the Plan Adoption Agreement and the Trust Agreement. The adoption agreement is where you formalize the plan’s specific features, and the trust agreement establishes the legal framework for holding the plan’s assets.
Step-by-Step Guide to Opening and Funding the Plan
You will submit the completed application package, including the signed Plan Adoption Agreement, to your chosen financial institution. Most providers facilitate this process through a secure online portal. Once the provider approves the documents and establishes your account, you can make your initial contribution via electronic funds transfer (EFT) or check. It is important to keep clear records distinguishing between your employee and employer contributions.
To make contributions for a specific tax year, the Solo 401(k) plan must be formally established by December 31 of that year. The deadline for funding the plan is more flexible, as you have until your business’s tax filing deadline, including extensions, to make contributions for the prior year. For a sole proprietor, this means contributions for the 2025 tax year can be made until April 15, 2026, or October 15, 2026, if an extension is filed.
Annual Reporting Obligations
Maintaining a Solo 401(k) involves one primary reporting requirement: filing IRS Form 5500-EZ, “Annual Return of One-Participant (Owners and Their Spouses) Retirement Plan.” This form provides the IRS with information about the plan’s assets and activities for the year, but most owners will not have to file it annually. The filing requirement for Form 5500-EZ is triggered by an asset threshold. You are only required to file the form if the total assets in your Solo 401(k) reached $250,000 or more at the end of the plan year.
An important exception to this rule is that you must file Form 5500-EZ for the final year of the plan’s existence, regardless of the asset value. This final return is required to officially close the plan with the IRS. The deadline for filing Form 5500-EZ, when required, is July 31 of the year following the plan year in question.