What changes once an employee is eligible
A solo plan is simple because nobody else has to be considered. That ends once a common-law employee of the business, or of a related business, satisfies the plan's eligibility conditions. From then on:
- Coverage (IRC 410(b)). The plan has to benefit enough of the employees who are not highly paid. The usual test asks for at least 70% of them. A plan that covers only the owner fails once there is an eligible employee.
- Minimum participation (IRC 401(a)(26)). A defined benefit plan must benefit at least the lesser of 50 employees or the greater of 40% of employees or two employees. For an owner with one eligible employee, that means both. The IRS also expects the employee's benefit to be meaningful, not a token amount.
- Nondiscrimination. The benefits the plan gives the owner and the employee have to pass testing together. In practice that usually means a real benefit for the employee, in the cash balance plan, in a 401(k) profit sharing plan, or both.
- ERISA Title I. The plan stops being a plan without employees and comes under Title I of ERISA, with its reporting, disclosure and fiduciary rules and a fidelity bond. Form 5500-EZ is no longer available; the plan files a different version of Form 5500.
- The PBGC. Depending on the business, the plan may become insured by the Pension Benefit Guaranty Corporation, with premiums. Professional service businesses with 25 or fewer participants are generally exempt.
None of this makes a cash balance plan impossible with staff. Many businesses with employees run one. It does make it a different kind of plan, with different costs and design choices.
Who counts
The question is whether someone is an employee under the tax rules, not what you call them or how you pay them.
| Worker | Counts? |
|---|---|
| Full-time employee | Yes, once they meet the plan's age and service conditions |
| Part-time employee under 1,000 hours a year | Can be kept out while they stay under the plan's hours condition. Hours must be tracked every year |
| Seasonal employee | Yes, if they reach 1,000 hours in a 12-month eligibility period |
| Your spouse | No. A spouse can be covered without the plan losing its solo status |
| Adult child, parent or other relative on payroll | Yes. Only a spouse is treated differently |
| Genuine independent contractor paid on a 1099 | No |
| Contractor who is an employee in substance | Yes, whatever the paperwork says |
| Leased or staffing-firm worker, full-time for a year or more | May count, under the leased employee rules in IRC 414(n) |
| Employees of another business you or your family control | Yes, under the controlled group rules |
Misclassification is the quiet risk. IRS Publication 560 treats someone as a common-law employee if you have the right to control and direct both the results of the work and how it is done. A full-time "contractor" who works only for you, on your schedule, under your direction, may well be an employee, and would count.
Part-time workers need watching for a second reason. If you also have a Solo 401(k), a separate rule for 401(k) plans lets long-term part-time employees make salary deferrals after two consecutive years of at least 500 hours, even though they can stay out of the cash balance plan under a 1,000-hour condition. See using a cash balance plan with a Solo 401(k).
How long the eligibility conditions can keep someone out
The law caps how strict a plan's eligibility conditions can be (IRC 410(a)):
- Age: no older than 21.
- Service: no more than one year of service, meaning a 12-month period with at least 1,000 hours. A plan that fully vests benefits after no more than two years may require two years.
- Entry: once someone meets the conditions, they must enter the plan by the earlier of the first day of the next plan year or six months after meeting them.
For a full-time hire, that usually buys somewhere between a year and two years, depending on the plan's terms and when in the year they started. The conditions have to be written in the plan document and applied to everyone. Excluding employees by category, such as "all non-owners", is very likely to fail the coverage rules.
Until the employee meets the conditions, they are not a participant, and the plan stays outside ERISA Title I. That window is the time to decide what to do.
Your options
| Option | What it involves | When to act |
|---|---|---|
| Keep the employee out for now | Rely on the plan's age and service conditions while they apply. Track hours every year | Check the plan's conditions before you hire |
| Move to a provider that handles employees | Redesign the plan to cover staff, usually with a 401(k) profit sharing plan alongside, and take on ERISA and testing | Well before the employee's entry date |
| Freeze the plan | Stop new pay credits. The plan and its account continue but nobody earns more | Before the next pay credit is earned and before the employee enters |
| Close the plan | Terminate it and roll your balance into an IRA | Before the employee enters, if the plan no longer fits |
Which fits depends on how many people you expect to hire, what they earn, and how much of the contribution you are willing to share. A small team of highly paid professionals can often support a plan with staff; a business with several lower-paid employees may find the cost of covering them outweighs the owner's benefit.
Freezing and closing come with the same timing rules as any change that lowers benefits. See minimum contributions and lean years and closing a cash balance plan.
Plan before you hire
The decision is much easier before an offer goes out than after an employee has already become eligible. If you have a solo plan and expect to take on staff, tell your plan provider before you hire. Maxed works only with owner-only plans, so a Maxed customer who plans to hire would either move the plan to a provider that handles employees or close it, and Maxed helps with either.
If you have not set up a plan yet, check who can have a solo cash balance plan first. Existing part-time staff, related businesses and family members on payroll all affect the answer.