Introduction to Individual 401(k) plans

Introduction to Individual 401(k) plans

An Individual 401(k) is a retirement plan designed for self-employed individuals and their spouses and owner-only businesses (including corporations, partnerships, and sole proprietorships).

With an Individual 401(k), self-employed business owners can maximize annual contributions with employer contributions and both pre-tax and designated Roth salary deferrals to a combined total. This plan also offers many of the same benefits as a traditional 401(k) and is easier to manage.

Note: SECURE Act 2.0 allows for employer contributions, Schwab will not accept employer contributions into Roth I401(k) until further guidance from the IRS is received.

Eligibility

The Individual 401(k) covers small businesses with no employees, including self-employed individuals, business owners, and their spouses. Small businesses can be sole proprietorships, corporations, and partnerships. Limitations apply to corporations and partnerships.

The individual 401(k) allows contributions from the following account types:

  • Corporate
  • Doing business as
  • Limited liability company
  • Non-incorporated association
  • Partnership
  • Sole proprietorship
  • Community property
  • Community property with rights of survivorship
  • Individual
  • Joint tenant with rights of survivorship
  • Trust
  • Designated Beneficiary Plan Accounts
Key features

The Individual 401(k) is easy to administer and has many of the same benefits as a traditional 401(k) plan. Your clients can make substantial contributions and direct their investments.

Plan benefits include:

  • High contributions—Your clients can choose to fund the plan with a combination of employer contributions and both pre-tax and designated Roth salary deferrals.
  • Tax advantages—Pre-tax contributions are tax-deductible and grow tax-deferred.
  • Designated Roth (after-tax) contributions—grow tax-deferred and are tax-free if certain conditions are met.
  • Flexibility—Your clients are not required to fund the plan annually and can contribute various amounts each year.
  • 100% vesting—Contributions vest immediately.
  • Low cost—There are no service fees or minimum balance requirements because the plan is a basic plan without loan provisions.
Pricing
  • Minimum opening deposit: $0
  • $0 account open or maintenance fees
Deadlines

A business has until its tax filing deadline, plus extensions for a particular tax year to set up a plan. The plan establishment deadline is tied to the type of business entity and its associated tax filing deadline so employers should review with their tax advisor. Deadlines include:

  • Employer contributions for the previous tax year are due by their tax-filing deadline, including extensions.
  • Elective-deferral contributions must generally be made by the end of the business tax year.
  • Effective for plan years beginning after December 29, 2022, sole proprietors and single member LLCs can make employee contributions up to the employee’s tax return filing due date, determined without regard to any extensions, for the initial plan year. Existing plans have until tax filing deadline plus extensions. 
ContributionsBusiness owners can make profit-sharing contributions of up to 25% for individuals or 20% if self-employed, of annual salary plus pre-tax and designated Roth elective-deferral contributions and are subject to contribution limits. Refer to Individual 401(k) funding options to learn about the funding methods.
Tax ramifications
  • When the plan reaches $250,000 or more, your client must file an IRS Form 5500 or Form 5500-EZ, yearly.
  • Schwab reports distributions for each calendar year to the IRS on Form 1099-R.

For information about income limitations, withdrawal penalties, distribution requirements, and more, refer to the following table:

Plan limitations
  • Additional employees—This plan is for self-employed or owner-only business and their spouses. If your client adds full-time employees to their payroll, they are no longer eligible for an individual 401(k).
  • Part-time employees—Beginning in 2024, part-time employees are eligible to participate in 401(k)s when they have worked at a company for at least 500 hours for three consecutive years. And, beginning in 2025, employees can participate once they have been employed at a company for at least 500 hours for two consecutive years. 
  • Partnerships—Are only eligible when each partner owns at least 5% of the business and are actively employed by the business.
  • Corporations—Are eligible only if the sole shareholder and their spouse (if applicable) are the only employees and are actively employed by the business.
Additional features
Account administrationThis is a basic plan and does not include automatic tax filing. If your client needs a full-service plan with 5500 filing and loan provisions, contact your service team for a referral to a third-party administrator.
Roles and responsibilities
Investment advisorService teamClient
Identifies and qualifies candidatesOpens the investment accountCompletes necessary forms
Answers client questions about the planDeducts elective-deferral contributions and deposits them in the account based on plan timelinesMakes all annual contributions
Works with client to complete and submit necessary forms to the service teamAnnually reports all distributions for the year on IRS Form 1099-RCompletes and submits the IRS Form 5500 or Form 5500 EZ when account reaches $250,000
Manages investments in the accountAnswers ongoing questions about the investment account 
Rollovers

Rollover guidelines include:

Rollover to:Rules
  • Traditional IRA
  • SEP-IRA
  • SIMPLE IRA (after two years)
Pre–tax contributions
  • 401(k) plan
  • Qualified retirement plans (QRPs)
  • 403(b)(7)/457
Receiving plan can accept or reject the rollover. Roth I401(k) can be rolled into a designated Roth account if plan supports it. 
Roth IRADesignated Roth I401(k)

These distribution types are not eligible for a rollover:

  • Substantially equal periodic payments over a period of 10 years or more
  • Substantially equal periodic payments over life expectancy
  • Required minimum distributions (RMDs)
  • Hardship withdrawals
Conversions
  • All eligible distributions from an Individual 401(k) plan (not including RMD or hardships) can be converted via a direct rollover to a Roth IRA. To move assets from a QRP to a Roth IRA, the client must do a direct rollover conversion of the assets.
  • In-plan Roth conversions are not permitted in Schwab’s I401(k).  
Distributions triggering events

Normal distributions:
Participants must have a triggering event to receive distributions. Triggering events include retirement, employment termination, death, disability, or plan termination.

Hardship withdrawals:
Certain rules apply when determining eligibility for a hardship withdrawal. Advise your client to review the plan document and consult with their tax advisor prior to requesting a hardship withdrawal.

  • Hardship withdrawals are subject to federal tax.
  • If client is not at least 59 1/2 years of age, a 10% withdrawal penalty is due unless an exception applies.
  • Withdrawals are not loans. Repayment is not required or permitted.
  • Hardship is defined as an immediate and heavy financial need of the participant, where the participant lacks other available resources.

In-service withdrawals:
In-service withdrawals Tooltip  are available subject to certain restrictions. Refer to the basic plan document for rules and regulations.


Required minimum distributions (RMDs):

  • Participants must begin taking RMDs annually if they own 5% or more of the business, beginning the year in which the participant reaches the federal RMD age. 
  • Participants who do not fulfill the annual distribution requirement, risk being assessed a 25% IRS penalty on the undistributed amount. If the distribution is corrected within a timely manner (within two years), the excise tax on the failure is further reduced to 10%.
  • Effective January 1, 2024, designated Roth accounts are not required to take a RMD.  
Pre-tax Individual 401(k)Any earnings and contributions are taxed at the time of withdrawal if not rolled over. Distributions eligible to be rolled over are usually subject to a mandatory 20% in federal withholding.
Roth Individual 401(k)
  • Qualified Distributions: If you are over age 59½ and have held for over 5 years, distributions are tax-free.
  • Non-Qualified Distributions: Earnings on non-qualified distributions are taxable and a 10% penalty may apply if taken before you reach age 59½. 
Withdrawal penalties

The IRS may impose a 10% penalty on early withdrawals, before age 59 1/2 absent an applicable penalty exception. * Those exceptions include:

  • Termination of employment at or after age 55
  • Withdrawals due to disability or death
  • Non-reimbursed medical expenses of adjusted gross income.
  • Birth and Adoption (can be repaid within 3 years)
  • Federally declared disaster areas (can be repaid within 3 years)
  • Domestic Abuse (can be repaid within 3 years)
  • Emergency Expenses (can be repaid within 3 years) 

*Schwab will not determine if a distribution qualifies for an exception. Clients should consult their tax advisor.

ERISAIndividual 401(k) plans are not subject to the Employee Retirement Income Security Act (ERISA).
BeneficiariesClients can designate beneficiaries when opening the plan. After the account is opened, they should evaluate their beneficiary designations regularly.

What is the difference between an individual 401(k) and a traditional 401(k)?
An individual 401(k) is a traditional 401(k) plan that covers business owners with no employees and spouses. Schwab's Individual 401(k) plans do not offer loan provisions and are not subject to ERISA rules.

How should my client report their contributions for tax purposes?
Contributions are generally reported through the client's tax return; however, tax reporting depends on how your client's business is structured, so Schwab recommends they consult with a tax advisor.

My client requires loan provisions, how can I help them?
If your client requires loan provisions, Schwab may refer you to a third-party administrator who can set up a full-service plan using our company retirement account. Contact your service team for more information.

My client may be adding additional employees in the future. Should I refer them to another plan?
A different retirement plan may be considered, or they will need to prepare to establish another retirement plan, since the Individual 401(k) plan will become disqualified once they add employees.

Can I trade options in my client's Individual 401(k)?
Covered options and protective strategies only. Uncovered options are not allowed in retirement plans.

Are Individual 401(k) accounts eligible for paperless enrollment?
Yes. Clients with Schwab Individual 401(k) accounts are eligible. See How to set up clients with paperless documents for more information.

Can I401(k) have standing letter of authorization (SLOA) to move money?
Yes. Clients may authorize advisors to move money for eligible transaction methods on their behalf via an SLOA.

How to open an individual 401(k) plan
How to roll over assets to a Schwab Account
Introduction to cash options and investments
Introduction to qualified retirement plans (QRPs)  
Introduction to required minimum distributions (RMDs)
Introduction to Retirement Plan Solutions
Introduction to tax reporting
Retirement Account Contribution Method Matrix 

Schwab Individual 401(k) Account Agreement
Account Agreement Amendments
Charles Schwab Pricing Guide
Cash Features Disclosure Statement
Small Business Retirement Plans
I401(k) – SEP Contributions Cheat Sheet
irs.gov