Maxing Out My Solo 401k in Addition to Fortune 500 Company 401k Plan

The 401(k) regulations allow for contributions to multiple 401(k) plans. This is especially advantageous for those who have a full-time job and participate in that employer’s 401(k), and those who also have a self-employed business and participate in that self-employed business solo 401(k).

A solo 401(k) is made up of employee and employer contributions.

The employee contribution which for 2019 is $19,000 plus $6,000 for those age 50 or older is aggregated among all 401(k) plans.

However the profit-sharing contribution (employer contribution) is not subject to this aggregation rule.

As a result, if you have a solo 401(k) plan for your self-employed business and have already contributed the $19,000 plus $6,000 to the full-time employer 401k plan, you can still contribute the profit-sharing portion to the solo 401(k) plan even though you have already contributed the maximum of $62,000 (includes the catch up amount and employer profit sharing contribution)  to the daytime job 401k plan.

For example, let’s assume that your self-employed business is an S corporation and that you want to make a contribution to the solo 401(k). Let’s further assume that you have $100,000 of W-2 income from your S corporation.

Example & The Voluntary After-Tax Solo 401k Exception

Therefore, you would be able to contribute  a profit-sharing contribution (employer) amount of $25,000 into the solo 401(k) which was calculated by multiplying 100,000 × 25%. The end result, means that you would have contributed a total of $87,000 ($62,000 plus  $25,000) in aggregate to both your daytime job employer 401(k) and your self-employed business solo 401(k) plan. However, if you also want to make voluntary after-tax contributions , you could contribute the difference up to the $56,000 ceiling to your voluntary after-tax solo 401k account since this contribution type is not subject to the aggregation rules described above. VISIT HERE to learn more about this exception.

Self-Directed Solo 401k Roth Solo 401k Recharacterization Question

QUESTION:

I am thinking about doing an in plan Roth 401k conversion of the remaining funds in the pre-tax part of my solo 401k plan (around $300K). I am with my tax advisor now and we are questioning if this could be recharacterized (undone) later in 2019 when my tax situation becomes clearer.

ANSWER:

That is a great question and the short answer is no. 401k funds including solo 401k funds that have been converted to a Roth 401k status (known as an in-plan conversion) cannot be recharacterized to pretax 401k funds once converted. If you wish to proceed with the in-plan Roth solo 401k conversion, your solo 401k provider will need to document and report the in-plan Roth solo 401k conversion to the IRS using Form 1099-R.

More Roth Solo 401k in-plan conversion tips

Tip 1: Roth 401k conversions are reported on form 1099R using code “G” not codes 2 or 7 which are the codes used to report Roth IRA conversions.

Tip 2: When converting pretax solo 401k assets such as physical real-estate to a Roth solo 401k, the property must be appraised by a third-party valuation provider to ensure the correct value being converted is reported on form 1099-R.

Tip 3: Once converted the Roth Solo 401k funds can later be transferred to a Roth IRA which is a good planning option because Roth solo 401k plans are subject to required minimum distributions (RMDs), but Roth IRAs are not.

Tip 4: The Roth Solo 401k conversion rules allow for the conversion of after-tax funds provided the solo 401k provider’s plan documents allow for it.

Co-invest with my 401k in a newly formed LLC

QUESTION:

My intent is to co-invest with my 401k in newly formed LLC, to be capitalized 24% by 401k and 76% by me. This is to enable funding of land and the design and build of building for purposes of lease to third parties and income generation. Can you explain any particular requirements for such scenario?

ANSWER:

To confirm, it will need to be a newly formed LLC which means units have not previously been issued. This is very important as it may be a prohibited transaction if the solo 401k owner also invests personal money in an existing LLC that had previously been funded with his or her solo 401k funds.

Following are some more important requirements:

  • Each member’s interest must be listed on the LLC operating agreement (in this case, the solo 401k and solo 401k owner’s interest);
  • The LLC operating agreement must include language pertaining to the 401(k) and IRS regulations;
  • The LLC cannot incorporate non-recourse financing or recourse financing because the solo 401k owner also invested in the LLC;
  • If the solo 401kowner is the manager of the LLC, he or she cannot receive any compensation;
  • The solo 401k owner can not perform any sweat equity work on properties owned by the LLC;
  • The bank account will need to be opened in the name of the LLC;
  • All income and expenses must flow through the LLC bank account; and
  • From a  solo 401k distribution planning perspective, once the solo 401k owner starts taking distributions from the Solo 401(k), the income has to flow from the LLC bank account to the 401(k) first and then the solo 401k owner can process distributions from the solo 401(k).

Rollovers as Business Start-Ups (ROBS) is not a Participant 401k Loan

When you take advantage of a ROBS transaction to rollover your 401k or other retirement funds to start a new business (or finance an existing business), it is not the same as taking a loan/borrowing from your 401k funds. Instead, you are investing your retirement savings in your own business by directing the 401k to by employer stock in your business–this is also known as an equity investment.

Because the Rollover as Business Startup or ROBS plan is not a loan, there are several important differences for the soon to be or existing business owner to understand, which encompass the following.

  • When the the business owner borrows funds from his or her 401k plan to finance his or her own business, he or she is required to make 401k loan payments (including interest) on a set schedule. As a result, for a new or expanding business, taking cash out of the business to make loan payments can make it difficult for the business to succeed. On the other hand, 401k loan payments are not required if the entrepreneur invests his or her retirement money in his or her own business via a ROBS transaction.
  • You can only borrow a set amount from a 401k. The IRS caps  the 401k loan amount to 50% of the balance not to exceed $50,000; however, a ROBS Business Financing strategy allows you to invest all of your retirement funds in your business because it is a not a loan, so loan payments do not apply.
  • In the case of a 401k loan, if the business fails, the loan must still be repaid, and if the business owner does not make the 401k loan payments he or she will owe taxes and penalties on the unpaid amount. On the other  hand, in the case of a ROBS plan if the business fails/goes under, 401k loan payments do not apply because a  Rollovers as Business Start-Up (ROBS 401k/PSP) is not a Participant 401k Loan.

Given these differences, the entrepreneur may prefer to rollover his retirement funds to fund his own his own business (ROBS 401k) instead of taking a 401k participant loan.

Investing Retirement Funds in Own Business vs. a Third-Party Business

The retirement account regulations allow business owners or aspiring entrepreneurs to invest their own retirement funds in their own business (known as an active investment) or a third-party business (commonly referred to as a passive investment). Both of these investment types will not subject the retirement account holder to taxes or penalties as long as the investment rules are followed.

Investing Retirement Funds in Your Own Business (known as an active investment)

The technical term to define the process of investing one’s own retirement funds in his or her own business is known as a rollover as business startup (ROBS 401k/PSP).

The following specific rules apply when investing your own retirement funds in your own business.

  • First, in the case of a new business, a new C-Corporation is established that then adopts a 401k/PSP plan.
  • The qualified retirement plan must include language that allows for investing in employer stock.
  • Once the new 401k/PSP has been adopted, it may be funded with IRA funds (Roth IRA and Roth 401k funds do not qualify) and/or former employer funds such as 401k, 401a, 403b, 457, Defined Benefit Plans and Pension plans.
  • Funds from IRAs or former employer plans are then rollover over to the new ROBS 401k/PSP.
  • After the former employer or IRA funds have been transferred, the business owner/trustee self-directs his new 401k to invest in the C-corporation’s newly issued stock shares.
  • Lastly, the business owner uses the C-Corporation proceeds from the sale of the stock to the 401k to purchase an existing or start his or her new business venture.

Investing Retirement Funds in a Third-Party Business (i.e., a business not owned by the retirement plan participant-referred to as a passive investment)

When the business owner invests his 401k retirement funds in a business that is owned by someone else, it is deemed a passive investment so the business owner cannot be active (an employee) in the third party’s business.

In order to invest 401k retirement funds in a third-party business, the investor must be self-employed so that he or she can open a self-directed solo 401k plan.

  • After the solo 401k has been opened, the self-employed business owner can transfer his or her former employer retirement funds and/or IRA funds to the new solo 401k.
  • The self-employed business owner then self-directs his solo 401k funds to purchase an equity interest in the third party business by writing a check or wiring the funds from the solo 401k bank account to the third-party business bank account.
  • All investment gains that result from the third-party investment must flow back to the solo 401k bank account.

In sum, the 401k rules vary greatly depending on whether one invests his or her retirement funds in his or her own business versus investing 401k funds in a third party’s business.

Invest Self-Directed Solo 401k in Physical Real Estate and Land

A self-directed solo 401k may own/invest in physical real estate (e.g., family homes, apartments, condominiums, commercial buildings and land), provided the 401k investment and prohibited transaction rules are satisfied. The 401k real estate investment rules are, for the most part, straight forward and pretty easy to follow. Following is a list of some of the 401k real estate investment rules.

Because the purpose of investing a solo 401k plan is to benefit the 401k plan so that you have enough money to live on when retirement distributions commence (usually at age 70 1/2), because the real estate investment is owned by the plan, you or certain relatives (e.g., spouse, children, parents, and grandparents) are restricted from using the property even if you use it for just a few days out of the year.

  • The 401k owned real estate may not be sold or exchanged to the 401k owner or his or her relatives mentioned above.
  • Improvements  or repairs on the real estate property may not be performed by the solo 401k owner or his her relatives mentioned above.
  • Expenses (e.g., property insurance, repairs and property taxes) in connection with the real estate investment must be paid with 401k funds, not the individual’s personal or business funds, unless the purchased was made under a tenants-in-common transaction which is covered below.
  • If only solo 401k funds are used to purchase/invest in the real estate property, title to the property has to be taken in the name of the 401k for the solo 401k owner’s benefit. For example:  Chestnut Solo 401k Trust F.B.O James Johnson, Trustee
  • Rental income and/or the real estate sale proceeds must flow back to the solo 401k, not the solo 401k owner’s personal or business bank account.
  • If, however, the self-directed solo 401k is invested in an LLC, title to the property is taken in the name of the LLC not the 401k, so expenses and gains flow to the LLC bank account and ultimately the solo 401k bank account. For example: Seabreeze LLC
  •  If an in-plan Roth 401k conversion includes the real estate holding, the property must be appraised (FMV) prior to processing the in-plan Roth solo 401k conversion because taxes must be paid on the value converted.
  • In the case of a tenants-in-common transaction where the solo 401k owner also invests his or her personal money in addition to solo 401k funds, the following must be taken into account:

  1. Title to the real estate property is taken both in the name of the 401k and the solo 401k owner’s name.
  2. For example,  James’ real estate agent finds a rental home in Houston, Texas that costs $300,000, so James decides to use $150,000 of personal funds and $150,000 of solo 401k to purchased the property.
  3. Under this tenants-in-common scenario, title to the rental property would be taken in the following fashion: James Johnson, an undivided 50% and Chestnut Solo 401k Trust, an undivided 50% interest
  4. Under a tenants-in-common transaction, no debt financing may be used and all investors (e.g., in the above scenario James personally and his solo 401k) must fund the real-estate investment at the same time. Also, all expenses and income must be divided based on how much money each party to the transaction invested in the property. In the above example,  it would be a 50/50 split.

Real Estate Solo 401k In-Kind Distribution Rules and Reporting

While solo 401k distributions are not mandatory until the solo 401k owner reaches age 70 1/2 (the technical IRS lingo is Required Minimum Distributions), it is not well known that solo 401k distributions can also be made in the form of a hard asset (for example,  real-estate) instead of cash.  In other words, instead of receiving a cash distribution, all or part of the real-estate holding is distributed in-kind to the solo 401k owner and taxes paid on the value of the property that is distributed. The solo 401k owner ends up personally owning all or  part of the real-estate holding over time as the in-kind distributions continue.

Items to go keep in-mind when taking in-kind distributions of real-estate from a solo 401k

1. A triggering event is required: Generally, the solo 401k owner must reach age 59 1/2 or cease self-employment in order to make solo 401k distributions.

2. Age 70 1/2 Solo 401k required minimum distribution: Whether the solo 401k owner wants to, he or she is required to start making distributions once he or she reaches age 70 1/2. Why? Well, Uncle Sam needs to start collecting tax revenue from your solo 401k.

3. Assignment of real-estate property (for example, a house) to the solo 401k owner: When a partial solo 401k distribution is made to the solo 401k owner in the form of real restate, part of the property is assigned in-kind to the solo 401k owner; however, the property first must be appraised by a third-party valuation provider not the solo 401k owner in order to determine the value that the solo 401k owner will need to pay taxes on. It is imperative that an independent third-party values the real property to demonstrate to the IRS that taxes were paid on the correct value not a deflated value because the IRS wants to collect its due tax revenue.

4. Titling the real-estate property after the in-kind distribution: The property deed must be recorded to list the solo 401k owner and the solo 401k as the new owners. The new ownership percentages will be based on the third-party valuation as well as the in-kind distribution amount.

For example: Let’s say that Nolan Ryan is self-employed, has reached the magical age of 701/2 (see item 2 above) so is required to start making required minimum distributions (RMDs) from his solo 401k , his solo 401k owns a 5 bedroom house in Houston, TX, and he decides to satisfy his RMD by processing a partial in-kind solo 401k distribution of the solo 401k owned house.  Next, in order to satisfy the IRS rules, he gets the property appraised by a third-party valuation professional who values the house at $300,000. Subsequently, Nolan Ryan has his solo 401k provider run a calculation to determine his RMD and the calculation requires that he must take a distribution of $18,400.00. Therefore, after the distribution, the property deed will need to be recorded to show that Nolan Ryan now personally owns 6% of the property and his solo 401k owns the remaining 94%. Finally, the solo 401k provider will issue a 1099R to report the in-kind distribution.

5. A Form 1099-R still applies: To report the real estate in-kind distribution from the solo 401k to the IRS, a Form 1099R must be issued by January of the year following the in-kind distribution.

6. Paying expenses when a real-estate asset is co-owned by the 401k owner and his or her solo 401k: After the partial in-kind distribution of real estate from the solo 401k to the solo 401k owner has been processed, expenses in connection with the real-estate asset will still continue; however, instead of only using solo 401k funds to pay the expenses (e.g., property taxes, repair costs, etc.), these expenses are now shared by the solo 401k owner and the solo 401k based on the new ownership percentages.

More Solo 401k Distribution Information

https://www.mysolo401k.net/making-solo-401k-distributions/

https://www.mysolo401k.net/solo-401k-hardship-distributions/

https://www.mysolo401k.net/solo-401k-beneficiary-distribution-questions/

https://www.mysolo401k.net/solo-401k-common-distribution-triggers/

https://www.mysolo401k.net/solo-401k-in-kind-distribution-tax-obligations-vs-direct-rollover/

https://www.mysolo401k.net/top-items-to-consider-when-taking-solo-401k-distribution-including-in-kind-distributions/

https://www.mysolo401k.net/in-kind-solo-401k-distribution-to-satisfy-required-minimum-distribution-rmd/

https://www.mysolo401k.net/can-i-satisfy-solo-401k-required-minimum-distribution-with-real-estate/

https://www.mysolo401k.net/partial-in-plan-roth-solo-401k-conversion-of-real-estate-held-in-pretax-solo-401k-account/

Can I Use a Stock Bonus Plan Like a ROBS 401k (Business Financing 401k)

QUESTION:

I have a former employer 401k and old IRA that I would like to use to for the 401k business funding structure. Can I rollover my 401k and IRA to a stocks bonus plan and then use the stock bonus plan for the 401k business funding structure?

ANSWER:

No. The 401k business funding structure, referred to as rollover as business startup by the IRS, only works in conjunction with a 401(k) profit sharing plan. Note that while both a Stock Bonus Plan and a 401k / profit sharing plan fall under the defined contribution category of retirement plans, a stock bonus plan allows the employer to make contributions in the form of employer stock. This is quite different from the 401k business funding structure or rollover as business startup (ROBS) arrangement whereby the 401k uses funds rolled over from a former employer 401k or from an IRA (or other approved retirement funds) to buy newly issued C-corporation shares, not for contributing existing employer stock.

Breakdown of the ROBS 401k (Business Financing 41k) Funding Steps

Formation of a New C-Corp

The corporation documents are drafted and filed with the secretary of state.

Adoption of a New 401k Business Financing Plan

The 401k plan allows for the purchase of employer stock (i.e., shares of stock in a C-Corporation).

IRS Employer Identification Numbers (EIN)

Obtain employer identification numbers (EINs) for the corporation and the new 401k business financing retirement plan.

Bank and Brokerage Accounts

Set up the 401k brokerage account for holding the retirement funds and a business bank account for holding the Corporation funds.

Fund the 401k Business Financing Plan

Fund the 401k business financing plan by transferring former employer retirement funds (former employer 401(k), 403(b), TSP, IRA, etc.) to the new brokerage account.

Purchase Employer Stock

The funds are wired from the 401k business plan to the Corporation bank account and stock certificates are subsequently issued along with the rest of the corporation documents (e.g., bylaws, meeting minutes, etc.).

 

Solo 401k In-Kind Distribution Tax Obligations vs Direct Rollover

QUESTION:

I’m closing down my self-employed business and then my solo 401k. What are the next steps for this? If I wanted to take a full distribution and not set up an IRA LLC, how would that work and what would be my tax obligations? I have money in the solo 401k account at the bank as well as physical gold assets.

ANSWER:

By closing down the self-employed business that is sponsoring the solo 401k trust, the severance from employment requirement is met; therefore, the solo 401k plan can be terminated.

Taxes and 10% Early Distribution Penalty

Because you do not want to transfer the solo 401k assets to an IRA or another retirement plan, the solo 401k distribution will be subject to federal taxes and possibly state taxes if you live in a state that requires payment of state taxes. Also, you will have to pay a 10% early distribution penalty if you are under age 59 ½. This taxable distribution is reported on Form 1099-R by the solo 401k provider.

With respect to processing a distribution of the physical gold assets held inside a solo 401k, the gold is assigned in-kind to you (the solo 401k participant), with the fair-market value determined on the day the in-kind distribution is processed. The value of the Gold and any other cash remaining in the solo 401k bank account is listed on the distribution form.

No Taxes and Penalties if Transferred to an IRA

After understanding the solo 401k distribution ramifications, you may decide to process a direct-rollover of the cash and the gold holdings to an IRA instead which is a non-taxable event. You can transfer most distributions except for:

  • A distribution that is one of a series of payments based on life expectancy or paid over a period of ten years or more,
  • A required minimum distribution,
  • A corrective distribution,
  • A hardship distribution, or
  • Dividends on employer securities.

The Once-Per-Year IRA Rollover Rule Quick Guide

Here is a quick guide to help you understand the new once-per-year rollover rule and how it affects your IRA rollover plans.

Don’t process an IRA rollover IF:

You already made one tax-free rollover from an IRA to another (or the same) IRA within the last 12 months.

Key Items:

  1. The once-per year rule means once every 365 days, not once per calendar year.
  2.  The limit applies to ALL IRAs in aggregate, including Traditional IRAs, Roth IRAs, SIMPLE IRAs and SEP IRAs.
  3. The IRS cannot allow you to fix violations of the once-per-year rollover rule like they can for some 60-day rollover violations.

A Few Exceptions to this New Rule:

  • IRA to a Roth IRA conversions
  • IRA rollovers to and from company retirement plans such as 401(k)s including a ROBS 401k and a Solo 401k
  • IRA first-time home buyer distributions when the purchase is delayed or cancelled.
  • Qualified reservist distributions that are timely repaid
  • IRA-to-IRA or Roth IRA-to-Roth IRA direct transfers
  • IRA direct rollover to a Solo 401k or Rollover as Business Startup 401k/PSP

Compliance Note:

One solution to avoiding the new once-per-year rollover rule is to move IRAs via a direct transfer. The regulations allow unlimited direct (trustee-to-trustee) transfers between IRAs because they are not considered rollovers.

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