A Self-Directed Solo 401k is Revocable

QUESTION:

Could you please confirm that the Solo 401K is a “living, revocable trust”?

ANSWER:

A Solo 401k is a revocable trust, meaning it can be updated and often is for changes in the law (e.g., contribution limits, who can participate, distribution rules, types of contributions, allowed investments, etc.). It is not a “living” trust. Further, self-directed solo 401k trusts are not registered with the state and are considered retirement trusts under the internal revenue code.

Lending Opportunity while having outstanding solo 401k Loan

QUESTION:

I would like to use the money that I have in my Solo 401K to lend to a real estate investor short term (up to one year) for his rehab. Currently, there is about 70K in my account, but there is existing solo 401k loan that I should be paying off completely in January. Is the solo 401k loan affecting how I can use the money in the Solo 401k account?

ANSWER:

1. No outstanding solo 401(k) participant loans do not affect how the owner invests the rest of her solo 401k funds. In other words, the solo 401k owner is not required to keep funds in reserve because she has an outstanding solo 401k Loan. Therefore, the remaining solo 401k funds can be invested in investments such as promissory notes, real estate, and tax liens, to name a few.

Solo 401k Set up / Adoption Deadline is December 31

For those who are self-employed (i.e., own their own business with no, full-time, W-2 employees), an important deadline is approaching (19 days from today to be exact) that will afford the self-employed business owner(s) the opportunity to save thousands of dollars in taxable income for tax year 2015.   If you are self-employed and open a solo 401k plan by December 31, 2015, you will be able to wait until next year (2016) to contribute $53,000 plus an additional $6,000 if you turn 50 in 2015 or are already over age 50.  Yes you read this correctly. Specifically, you just need to sign the solo 401k adoption documents to be able to wait until your business tax return due date plus timely filed extensions to make both the profit sharing and employee contributions for tax year 2015.

A solo 401k is not subject to Department of Labor rules because a solo 401k is for owner-only businesses with no common-law employees. As a result the contribution deadlines are more favorable for a solo 401k. For example, as long as the solo 401k is set up/adopted by December 31, both the salary deferral and employer contributions can be made up until the due date of the self-employed business tax return plus any timely filed extensions. See the following chart found on page 3 of IRS Publication 560- Retirement Plans for Small Businesses.

When looking at the chart, look at the row labeled “Defined Contribution Plan” as a solo 401k plan falls under this umbrella.

Type of Plan Last Date for Contribution Maximum Contribution When To Set Up Plan
Qualified Plan: Defined Contribution Plan Elective deferral: Due date of employer’s return (including extensions)Employer contribution: Money Purchase or Profit­Sharing: Due date of employer’s return (including extensions). Employee contribution: Elective deferral up to $18,000, $24,000 if age 50 or over.Employer contribution: Profit­Sharing:: Smaller of $53,000 or 100% of participant’s compensation. By end of the tax year.
Qualified Plan: Defined Benefit Plan Contributions generally must be paid in quarterly installments, due 15 days after the end of each quarter. See Minimum Funding Requirement in chapter 4. Amount needed to provide an annual benefit no larger than the smaller of $210,000 or 100% of the participant’s average compensation for his or her highest 3 consecutive calendar years. By end of the tax year.

Can I loan my Solo 401k funds to my spouse’s business?

QUESTION:

My wife recently started a business (she formed an LLC if that matters) but she wasn’t approved for the business loan she applied for. Are there any tax/legal ramifications for me providing her company with a business loan from my solo 401k?

ANSWER:

That would be a solo 401k prohibited transaction because it is your wife’s business. However, you can take a solo 401(k) participant loan up to the statutory limit which is 50% of your solo 401k balance not to exceed 50,000, and you can use the loan proceeds however you wish including investing them in her business. The reason the 401k loan is allowed is because when you borrow from your own 401(k) plan the funds are no longer consider 401(k) funds.

Non-Roth after-tax contribution to a Solo 401k

I have been hearing more and more about non-Roth after-tax contributions as a way to max out Solo 401K contributions. I’m wondering if you have an answer to my lingering questions:

QUESTION 1)

If I make a non-Roth after-tax contribution to my Solo 401-K, can I then immediately make an intra-plan Roth conversion of those funds? (Assume my plan allows it)

 

ANSWER to Q1.

Yes just the after-tax solo 401k contributions can be converted (in-plan conversion) to a Roth solo 401k provided the following items are satisfied.

 

  1. i) The after-tax solo 401k contributions are made into a separate holding account not commingled with the pretax solo 401k contributions, and) ii) the plan allows for in-plan Roth solo 401k conversions.

Lastly, it is best to convert the aft-tax solo 401k funds immediately otherwise the earnings will need to be included in the conversion which will be subject to taxes.

QUESTION 2)

What is the lowest salary I can pay myself (S-corp) and still make the maximum 53K annual 401(k) contribution for 2015? Can I pay myself 53K in salary, make an 18K employee contribution, 13.25K employer contribution (53*.25 = 13.25) and the rest (21.75k) in an employee non-Roth after tax contribution?

ANSWER to Q2.

It is important to understand that the after tax solo 401k contribution are part of the overall limit. The overall limit for solo 401k plans including solo 401k plans for 2015 is $53,000, or 100% of compensation, whichever is less.

After-tax solo 401k contributions are based on net-income, so because your self-employment entity type is an S-corp, you will need at least $53,000 of w-2 income from self-employment to do the following.

  1. Treat $18,000 as your pretax contribution
  2. Treat the remaining $35,000 as your after-tax solo 401k contribution (make sure it is deposited in its own separate bank account and don’t commingle the funds with your pretax contributions) which you can then turn around and convert to a Roth solo 401k.

Equipment Lease investments for solo 401k Trust

QUESTION:

Do you know if a solo 401k can invest in equipment leases?

ANSWER:

Yes a solo 401k can invest in equipment leasing. Here is a brief summary of how it works.

The solo 401k is the owner and lender of the equipment. The solo 401k would then lease the equipment to the third-party. Once the lease is up the solo 401k sells the equipment to the lessee or keeps leasing the equipment to the same business or a different business.

The paperwork in connection with the equipment lease would list the solo 401k as the lessor. For example, if the name of John’s Solo 401K is Core Solo 401k Trust, the lessor would read as John Doe, Trustee of Core Solo 401k Trust.

The lease payments would flow back to the solo 401k bank account and so would the proceeds from the sale of the equipment if the solo 401k owner decided to sell the equipment.

Solo 401k Provider Customer Review

With a list of over a hundred solo 401k providers, I narrowed it down and interviewed the top seven companies during my search for a solo 401k provider. After many days of research and conference calls, I decided to go with My Solo 401k Financial because they provide the greatest value especially in the areas of expertise, customer service, and price. Not experienced in setting up retirement accounts, I had a long list of questions during the set up process. I really appreciate that they were always very patient and answered all my questions in a timely manner. As an entrepreneur who will only accept service from the best professionals, I am very happy with my decision and highly recommend My Solo 401k Financial to anyone looking to establish their self-directed retirement plan.

Jason Nguy, Chicago, Illinois

Self-Directed Solo 401k compatibility with Scottrade Advisor

QUESTIONS: I am a CFP and RIA using Scottrade as my custodian. I’d like to establish a self-directed solo 401k for myself, and perhaps do the same for some of my clients. I’d like to incorporate a Scottrade brokerage account into my 401k to facilitate traditional investments as well as checking writing for alternative investments. Is that an option?

ANSWERS: While Scottrade will open a brokerage account for a self-directed solo 401k using Scottrade’s Brokerage Account Application, they will not issue a checkbook. As a result, our clients that want to still use Scottrade will open a brokerage account with Scottrade for trading equities and will also open a local bank account for check-writing, thus resulting in multiple holding accounts under the same self-directed solo 401k.

Self-Directed Solo 401k vs. Self-Directed IRA

The most popular self-directed retirement accounts include the solo 401k and the self-directed IRA. Both pretax and Roth after tax contributions can be made to both. Pretax contributions are tax deductible, and the gains grow tax free until distributions begin. Roth IRAs and Roth solo 401k contributions are not tax deductible when made, but the gains grow tax free.  Following are the similarities and differences between the solo 401k and the self-directed IRA.

The Self-Directed IRA and Solo 401k Similarities

  • Both were created by congress for individuals to save for retirement;
  • Both may be invested in alternative investments such as real estate, precious metals tax liens, promissory notes, private company shares, and stocks and mutual funds, to name a few;
  • Both allow for Roth contributions;
  • Both are subject to prohibited transaction rules;
  • Both are subject to federal taxes at time of distribution;
  • Both allow for checkbook control for placing alternative investments;
  • Both may be invested in annuities;
  • Both are protected from creditors;
  • Both allow for nondeductible contributions;
  • Both are prohibited from investing in assets listed under I.R.C. 408(m); and
  • Neither may be invested in your own Retirement funds business startup.

The Self-Directed IRA and Solo 401k Differences

  • In order to open a solo 401k, self-employment, whether on a part-time or full-time basis, is required;
  • To open a self-directed IRA, self-employment income is not required;
  • In order to gain IRA checkbook control over the self-directed IRA funds, a limited liability company (self-directed IRA LLC) must be utilized;
  • The solo 401k allows for checkbook control from the onset;
  • The solo 401k allows for personal loan known as a solo 401k loan;
  • It is prohibited to borrow from your IRA;
  • The Solo 401k may be invested in life insurance;
  • The self-directed IRA may not be invested in life insurance;
  • The solo 401k allow for high contribution amounts (for 2015; the solo 401k contribution limit is $53,000, whereas the self-directed IRA contribution limit is $5,500);
  • The solo 401k business owner can serve as trustee of the solo 401k;
  • The self-directed IRA participant/owner may not serve as trustee or custodian of her IRA; instead, a trust company or bank institution is required;
  • When distributions commence from the solo 401k a mandatory 20% of federal taxes must be withheld from each distribution and submitted electronically to the IRS by the 15th of the month following the date of each distribution;
  • Rollovers and/or transfers from IRAs or qualified plans (e.g., former employer 401k) to a solo 401k are not reported on Form 5498, but rather on Form 5500-EZ, but only if the air market value of the solo 401k exceeds $250K as of the end of the plan year (generally 12/31);
  • When funds are rolled over or transferred from an IRA or 401k to a self-directed IRA, the amount deposited into the self-directed IRA is reported on Form 5498 by the receiving self-directed IRA custodian by May of the year following the rollover/transfer.
  • Rollovers (provided the 60 day rollover window is satisfied) from an IRA to a Solo 401k or self-directed IRA are reported on lines 15a and 15b of Form 1040;
  • Pre-tax IRA contributions on reported on line 32 of Form 1040;
  • Pre-tax solo 401k contributions are reported on line 28 of Form 1040;
  • Roth solo 401k funds are subject to RMDs;
  • A Roth 401k may be transferred to a Roth IRA (Note that from a planning perspective, it may be advantageous to transfer Roth Solo 401k funds to a Roth IRA before turning age 70 ½ in order to escape the Roth RMD requirement applicable to Roth 401k contributions including Roth Solo 401k contributions and earnings.);
  • Roth IRA funds are not subject to requirement minimum distributions (RMDs);
  • The fair market value (FMV) of assets held in a self-directed IRA is reported on form 5498;
  • The fair market value of assets held in a solo 401k are reported on Form 5500-EZ;
  • At termination, the solo 401k is required to file a final Form 5500-EZ and 1099-R; and
  • At termination, the self-directed IRA is only required to file a form 1099-R.

Exceptions to Early Solo 401k & IRA Distribution Tax Penalties

In addition to being subject to federal and state taxes, most IRA or solo 401k plan distributions are subject to an additional 10% tax.

Usually, the amounts an individual withdraws from a solo 401k or an IRA prior to reaching age 59½ is called ”early” or ”premature” withdrawals. Unless an exception applies, solo 401k participants and IRA holders must pay an additional 10% early withdrawal tax and report the amount to the IRS for any early distributions.

The following chart is a good guide to follow regarding the 10% early penalty when making solo 401k or IRA distributions.

The distribution will NOT be subject to the 10% additional early distribution tax in the following circumstances: Exception to 10% Additional Tax
Qualified Plans
(Solo 401(k), etc.)
IRA, SEP, SIMPLE IRA* and SARSEP Plans Internal Revenue Code Section(s)
Age
after participant/IRA owner reaches age 59½ yes yes 72(t)(2)(A)(i)
Automatic Enrollment
permissive withdrawals from a plan with auto enrollment features yes yes for SIMPLE IRAs and SARSEPs 414(w)(1)(B)
Corrective Distributions
corrective distributions (and associated earnings) of excess contributions, excess aggregate contributions and excess deferrals, made timely yes n/a 401(k)(8)(D),
401(m)(7)(A),
402(g)(2)(C)
Death
after death of the participant/IRA owner yes yes 72(t)(2)(A)(ii)
Disability
total and permanent disability of the participant/IRA owner yes yes 72(t)(2)(A)(iii)
Domestic Relations
to an alternate payee under a Qualified Domestic Relations Order yes n/a 72(t)(2)(C)
Education
qualified higher education expenses no yes 72(t)(2)(E)
Equal Payments
series of substantially equal payments yes yes 72(t)(2)(A)(iv)
ESOP
dividend pass through from an ESOP yes n/a 72(t)(2)(A)(vi)
Homebuyers
qualified first-time homebuyers, up to $10,000 no yes 72(t)(2)(F)
Levy
because of an IRS levy of the plan yes yes 72(t)(2)(A)(vii)
Medical
amount of unreimbursed medical expenses (>7.5% AGI; after 2012, 10% if under age 65) yes yes 72(t)(2)(B)
health insurance premiums paid while unemployed no yes 72(t)(2)(D)
Military
certain distributions to qualified military reservists called to active duty yes yes 72(t)(2)(G)
Returned IRA Contributions
if withdrawn by extended due date of return n/a yes 408(d)(4)
earnings on these returned contributions n/a no 408(d)(4)
Rollovers
in-plan Roth rollovers or eligible distributions contributed to another retirement plan or IRA within 60 days yes yes 402(c), 402A(d)(3), 403(a)(4), 403(b)(8), 408(d)(3), 408A(d)(3)
Separation from Service
the employee separates from service during or after the year the employee reaches age 55 (age 50 for public safety employees in a governmental defined benefit plan) yes no 72(t)(2)(A)(v),
72(t)(10)

NOTE: Governmental 457(b) distributions are not subject to the 10% additional tax except for distributions attributable to rollovers from another type of plan or IRA.

The penalty is 25% instead of 10% for a  SIMPLE IRA if made within the first 2 years of participation

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