Who can contribute to a 401k?

A 401(k) plan is an effective way for workers to contribute to their retirement on a tax-advantaged basis. 401(k) participants can choose how much to contribute, and set aside part of their salary to their 401(k) account. However, there are several types of 401(k) plans, and each plan has different rules on who can contribute.

Both full-time and part-time employees can contribute to a 401(k) plan. While full-time employees may be eligible to contribute to a 401(k) immediately, long-term part-time employees must work 500 to 999 hours per year for three consecutive years to be eligible to contribute to the 401(k) plan. If you are a self-employed individual or business owner, you can contribute to a solo 401(k) both as an employee and employer.

Parties that can contribute to 401(k)

Full-time employees

Full-time employees can contribute to an employer-sponsored 401(k) plan. Most companies allow new employees to join the 401(k) immediately after hire, or after working for a defined period of time.

Employees can make tax-deferred contributions to the 401(k) account, and the money grows tax-deferred over the years. Earnings from 401(k) investments also grow tax-deferred, and you won’t pay taxes until you withdraw funds from the account.

Some employers may also offer a 401(k) match as an additional benefit to employees. The employer matches employees’ contributions up to a specific limit, and the money grows tax-deferred until when the employee takes a distribution from the account.

Part-time employees

Hourly employees may also be eligible to join a 401(k) plan. Under the SECURE Act, non-union part-time workers may be eligible to participate in a 401(k) plan if they work at least 500 to 999 hours in the previous three consecutive years. The part-time employees must be at least 21 years to participate in the plan.

The expected participation period for long-term, part-time employees is 2024, and employers can start tracking the hours worked by part-time employees starting from January 1, 2021.

Before the Secure Act, part-time employees were ineligible to participate in the plan if they worked less than 1000 hours yearly. This requirement prevented many part-time employees from enrolling in their employer's 401(k) plan.

Employer

Employers can make matching or non-elective contributions to employees' 401(k) accounts. For traditional and Roth 401(k), employers can make matching contributions to employees’ 401(k) accounts up to a specific limit. However, 401(k) matching is not mandatory, and some employees may opt not to offer a 401(k) match.

However, some 401(k) plans make it mandatory for employers to contribute to each employee’s plan. For example, safe harbor plans require employers to match 401(k) contributions for all eligible employees. The employer contributions must be fully vested and guaranteed to employees. A simple 401(k) plan also requires employers to match employees’ contributions.

Self-employed individual

If you are a business owner or a self-employed individual with no employees other than you or your spouse, you can contribute to a solo 401(k). This type of 401(k) is also known as a one-participant 401(k) or solo-k.

A business owner can contribute to the solo 401(k) account both as the employee and employer to boost retirement savings. As an employee, you can make elective deferrals of up to 100% of your compensation or up to $20,500 in 2022. As an employer, you can add up to 25% of your compensation to the retirement account as profit-sharing contributions.

A self-employed individual who is also an employee of a second company should consider the annual limit for elective deferrals. The elective deferrals are considered by person, and not by plan. Hence, the amount you contribute to the solo 401(k) and traditional 401(k) should not exceed $20,500 in 2022, or $27,000 if you are 50 or older.

Partners

When the business is structured as a partnership, partners can contribute to a solo 401(k) plan. Where the partnership has two or more partners, the partners can participate in the same solo 401(k) plan.

The partnership makes annual contributions to the solo 401(k) plan based on the partner's net earned income. Earned income is the income a partner receives for their services to materially produce that income, and it must be calculated for each trade or business. However, not every partner may have earned income, since some partners are merely investors and they do not provide services to the partnership.

Where the partnership makes matching contributions to each partner’s solo 401(k) account, these contributions are considered guaranteed payments. Hence, they will be subject to self-employment taxes, and not income taxes.

401(k) contribution limits

The IRS caps the amount that 401(k) participants can contribute to their 401(k) plans. These restrictions ensure that highly compensated employees do not benefit to the disadvantage of other employees. The annual contribution limits are updated each year to account for inflation.

The IRS limits for the different types of 401(k)s are as follows:

Traditional 401(k)

Employees can make elective deferrals to the 401(k) plan up to $20,500 per year in 2022. Older employers above age 50 can contribute an extra $6,500 in catch-up contributions annually.

The traditional 401(k) contribution limits are the same for Roth 401(k), Safe Harbor, and Solo 401(k) plans.

SIMPLE 401(k)

Employees can contribute up to $14,000 in elective deferrals to a SIMPLE 401(k) in 2022. Employees above age 50 can contribute an extra $3,000 to the account.