8726 / Can a self-employed individual participate in a retirement savings plan?

While employers are often required to include all employees in fringe benefit plans and retirement plans, the same requirement does not apply with respect to independent contractors. If an employer includes non-employees (including independent contractors) in a qualified plan, that plan may lose its qualified status by violating the “exclusive benefit” rule of IRC Section 401(a). Therefore, most self-employed individuals who operate as independent contractors will be ineligible to participate in retirement savings plans maintained by another taxpayer-entity.

For plan qualification purposes, a self-employed individual, as an owner-employee, is considered an “employee” for purposes of qualified plans established by that owner-employee.¹ An “owner-employee” is an employee who owns the entire interest in an unincorporated trade or business or, in the case of a partnership, owns more than 10 percent of either the capital interest or the profit interest in the partnership.²

Even if a partnership agreement does not specify that a “more than 10 percent interest in profits” exists for any partner, if the formula for dividing profits (e.g., based on a partner’s earnings productivity during the year) in operation produced a distribution at the end of the year of more than 10 percent of profits to a partner, the Tax Court has ruled that the partner is an owner-employee for the year.³

An individual who owns the entire interest in an unincorporated trade or business is treated as the employer.⁴ Thus, a proprietor or sole practitioner who has earned income (including “self-employment income”) can establish a qualified plan under which the individual is both employer and employee.

A partnership is treated as the employer of each partner who is an employee.⁵ Thus, partners individually cannot establish a qualified plan for a firm, but the partnership can establish a plan in which the partners can participate.

Individuals who are classified as independent contractors (see Q 8723) are able to set up their own retirement plans, including IRAs and Roth IRAs, so long as they have compensation (whether in the form of self-employment income, alimony (prior to 2019) or income earned as an employee in some capacity) and, prior to 2020, did not attain age 70½ during the year in which the account is established (the SECURE Act removed the age restriction for tax years beginning in 2020 and thereafter).⁶ To establish a Roth IRA, the same income limitations apply to self-employed taxpayers as apply to employees, so that the self-employed taxpayer must not have adjusted gross income in excess of the annual income thresholds. For 2025, those thresholds are: (a) $246,000 or above in the case of a taxpayer filing a joint return; (b) $165,000 or above in the case of a taxpayer filing a single or head-of-household return; or (c) $10,000 or above in the case of a married individual filing separately.⁷