How To Set Up Your Own 401k – Self-directed 401k plans are often overlooked because the most common retirement plans for the self-employed have traditionally been SEP IRAs and SIMPLE IRAs. While IRAs are generally cheaper to adopt and manage, they typically don’t allow for higher contributions or a wider range of investment types than defined contribution plans like solo 401k plans.
While you can invest your Solo 401k (also called by other names such as Small Business 401k, Self Employed 401k, Owner Only 401k, Solo K, etc.) in a variety of alternative investments (e.g., real estate, notes, LLCs, gold, etc.) , etc.), you should still be careful not to make prohibited transactions when investing in your solo 401k. A transaction is considered prohibited if it benefits you, as a solo 401k plan trustee/participant, or another disqualified person such as a beneficiary, spouse, son, daughter, father or mother, etc.
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Simply put, any transaction that benefits not only your Solo 401k, but also you personally or someone you know who has been designated as a disqualified individual by the IRS will be considered prohibited.
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This means your Solo 401k/self-directed 401k is prohibited from making transactions that benefit you, your immediate family, or your business. Negative consequences for your solo 401k include tax penalties and loss of tax-deferred status. Simply put, a prohibited transaction is an investment or form of self-dealing that puts the government alone at risk of losing taxes on the 401k. To be clear, prohibited transactions only occur when the funds in your Solo 401k are used inappropriately. You can always withdraw from your Solo 401k, pay taxes (and penalties if you’re under 591/2 and no exclusions apply) and spend the money however you want, because now the government has gotten its hands on it. On taxes and money you don’t spend I’m alone with 401k money. They worry when you spend the money in your Solo 401k on certain items because they think you may be planning to take them out of taxes you would otherwise have to pay on Solo 401k distributions.
The rule prohibits your solo 401k / self-directed 401k retirement account from owning property that you or a disqualified person currently owns or plans to own. In other words, the property should be for investment purposes only.
Matt’s Solo 401k owns an apartment building. One of the tenants is his daughter Susan. As an interested party, Susan’s rental of the apartment was a prohibited transaction because the apartment was her only 401k asset.
Jay holds a plot of land in his self-directed solo 401k plan. He now wants to build a retirement home on the property. Send money from your solo 401k bank account to buy property. This investment would result in a prohibited transaction because Jay falls into the category of disqualified parties. You are not allowed to build your home on a plot associated with your solo 401k plan.
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Solo 401k/self-directed 401k You cannot buy personal shares (for example, shares of companies that are not traded on a public exchange such as the New York Stock Exchange or NASDAQ) in your own business or that of a disqualified person (for example eg., your son’s company, daughters, father and mother, and many others).
John personally owns 15% of the shares in the private company he manages. Two years later he decided to use his solo 401k plan to buy out 20% of Nick, another shareholder. This is a prohibited transaction because John already owns and manages the company.
You can’t loan your solo 401k or self-directed 401k funds to a disqualified person like your father, mother, son, or daughter, for example.
Tina loans $50,000 from her Solo 401k to her daughter at 10% interest per year. The transaction was prohibited because Tina’s daughter was disqualified.
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Sue’s solo 401k plan has a balance of $100,000. His father had recently started a new business and needed a short-term loan to cover his salary. Sue offers to loan $60,000 from her Solo 401k to her father in the form of a promissory note at 8 (eight) percent interest in 12-month installments. This investment is deemed prohibited because Sue’s father falls under the umbrella of an incompetent party.
While helping a family member is something you don’t have to think twice about, helping a family member with your Solo 401k plan could result in a prohibited transaction under the Internal Revenue Code (“Code”) and ERISA. Under the rules.
For example, if a son asked his mother, who is a broker-dealer consultant, to manage his self-managed 401k plan, any compensation paid to his mother would be a prohibited transaction. That is, the son causes a family member – someone who may have an interest that could influence his actual decision – to receive compensation.
This transaction is a prohibited transaction because the mother is a “family member” of the fiduciary holder (son). The Code defines family members as “for example, ancestors (eg, parents or grandparents), direct descendants (eg, children, grandchildren), and the lineal descendants of any spouse.
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However, the transaction will not violate the rules of prohibited transactions, if the consultant (mother) did not receive compensation for the consultation.
In short, advisors (and their firms) should not advise family members about rolling over their IRA or 401k plans or investing their sole 401k or IRA assets…unless they waive compensation for the advice.
Question: My sister is considering buying a vacation rental property from my father. Can my 401K loan funds to buy out my sister?
A: Although it is not prohibited to fund a solo 401k through a promissory note to a sibling of the 401k owner, it is prohibited for that sibling to go around and lend/invest funds to the parent of the solo 40k owner. Such transactions will be considered roundabout/straw-man transactions resulting in a solo 401k transaction being prohibited.
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Indirect transactions occur when a solo 401k participant/trustee makes one or more transactions with the intent to make a prohibited transaction. An incompetent person cannot do indirectly what he cannot do directly.
People who are disqualified from being directly involved may still consider the transaction prohibited. In other words, the mere exclusion of the person from the transaction and the inclusion of a third party does not make the prohibited transaction valid.
You loan money from your Solo 401k/self-directed 401k to your friend (who is not a disqualified person), and he turns around and loans the same funds to your mother. This is considered an indirect transaction and is viewed by the IRS as not only prohibited but also an attempt to break the tax rules because you cannot loan money from your mom’s solo 401k, even if you first loan it to your friend. lent (who is not. an incompetent person), who then lent it to your mother.
Thomas used his solo 401k plan funds to invest in a condo in Cabo San Lucas. Thomas has now reached retirement age and is now looking to buy a condo from his solo 401k plan. Thomas’ direct purchase of a solo 401k plan is a slam dunk prohibited transaction because Thomas is a disqualified person, and the plan cannot be sold between him and a disqualified party. Thomas sold the property to Jason Shepard, who was not related to Thomas. Jason and Thomas, however, have agreed that Thomas will immediately purchase the property from Jason when the transaction between Jason and the 401k plan is completed. This was clearly an indirect prohibited transaction because the disqualified person (Thomas) attempted to circumvent the self-directed 401k prohibited transaction rule by involving a third party (Jason) in the transaction.
What’s The Difference Between 401(k) And 403(b) Retirement Plans?
For the most part, you can invest your solo 401k / self-directed 401k in any type of investment except the following:
The collection includes works of art, tapestries, antiques, metals, gems, stamps, some coins, alcoholic beverages, and musical instruments. The US Department of the Treasury has the authority to add other qualified personal property to this list.
Defined contribution plans like the Solo 401k plan can invest in a nearly unlimited range of investments. However, the self-directed 401k plan provider may limit the types of permitted investments that can be made under the self-directed 401k plan. For example, individual 401k plan providers such as Fidelity Investments, Charles Schwab, E-Trade, Vanguard, and Oppenheimer only allow general investments such as stocks, bonds, and mutual funds. On the other hand, self-directed 401k plan document providers such as My Solo 401k Financial provide plan documents that allow for any investments that do not fall into prohibited investment categories. Examples of permitted self-directed 401k investments include debentures, options, limited partnership interests, mortgages, real estate, tax liens, crowdfunding, and life insurance. Although the list of permitted solo 401k investments is extensive, trustees of a standalone 401k should avoid prohibited transactions when selecting different investments because the responsibility for selecting solo 401k plan investments rests with the solo 401k plan trustee.
“Disqualified person” is defined
What Is A Solo 401(k)?
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