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Solo 401k

Top Self-Directed 401k Investments & Rules

June 5, 2020 | By Mark Nolan

A self-directed 401k also known as a solo 401k is a popular retirement  plan for the self-employed with no full-time W-2 employees. What makes the self-directed 401k so popular over other self-employed plans (e.g., DBP, SEP IRA and SIMPLE IRA) is the ability to easily self-direct it into both traditional investments (e.g., stocks and mutual funds) as well as alternative investments (e.g., real estate, notes, tax liens, cryptocurrency, metals and private placements). A self-directed 401k is also the top retirement account of choice for investment diversification.

These top self-directed 401k investments and top 5 (five) rules will get you started in self-directing your self-employed 401k plan. 

The most popular self-directed solo 401k investments include the following: 

 

Real Estate

Holding real estate in self-directed 401k plan is a popular long-term investment. The 401k investor’s objective is receipt of rental income and appreciation of the property’s value. Like equities, the biggest risk associated with real estate investments are changing economic conditions.
 
Here are some important rules to understand when investing a self-directed 401k in real estate. 
  • The 401k participant cannot live in the property or rent it to herself, her business or other disqualified persons such as her parents, kids and grandparents, etc. 
  • When the property is solely owned by the self-directed 401k plan, all expenses must be paid using 401k funds, and all income must flow back to the 401k plan. 
There are generally 4 (four) methods of investing in Real Estate using a self-directed 401k.
  1. Outright purchase – just  401k funds are used to invest in real estate resulting in the self-directed 401k owning the property free and clear.
  2. Debt Financing – the 401k obtains a non-recourse loan and uses the borrowed fund along with existing self-directed 401k funds to purchase real estate.
  3. Limited Liability Company (LLC) – the 401k invests (purchases member units) in an LLC on its own or with other investors. This results in the property being  owned in the name of the LLC not the self-directed 401k plan. 
  4. Partner (Tenants in Common) – the 401k plan invests with other investors or alongside the self-directed 401k account holder; tile to the property is divided between the investors based on the amount invested by each party.

Learn more about the above various self-directed 401k real estate investment methods HERE.

Precious Metals

  • Self-directed 401k funds may be invested in certain gold, silver, and platinum coins, certain bullion, and coins issued under the laws of any state.
  • 401k investors diversify into precious metals because they think the value of metals keeps up or exceeds inflation rates.
  • Generally, only about 10% of self-directed 401k funds are invested in metals since they don’t produce current income like rental properties, and the metals market tends to be sporadic.
Following are some of the Important rules to understand when investing a self-directed 401k in precious metals.
  • Determine types of allowed vs disallowed metals that may be held in a 401k. VISIT HERE to see a list. 
  • Minimum Fineness Required:  Gold = 99.5%; Silver = 99.9%; Platinum = 99.95%; and Palladium = 99.95%
  • Store the metals with an approved depository taking institution including a bank safety deposit box. 
  • The safety box can only be used to hold assets of the self-directed 401k plan such as the metals and documents in connection with other investments held in the 401k plan such as recorded deeds for real estate.
  • Self-directed 401k investments have to be segregated (held separate and apart) from your personal or business assets.   
  • Broker/ Dealer invoice for the purchase of the the metals is issued in the name of trustee and the self-directed 401k plan, so as follows for example: Jane Do, Trustee of XYZ Town Trust .

Visit here for more information regarding investing a self-directed 401k in precious metals. 

Promissory Notes

When a self-directed 401k invests in promissory notes, the 401k assumes a lending roll similar to a bank that loans out funds. Therefore, the 401k must make the investment with the intent to receive a return; after all, the purpose if investing the self-directed 401k is to grow it for use at retirement age.

Here are important rules to understand when investing a self-directed 401k in promissory notes.

  • Don’t confuse the promissory note investment with the self-directed 401k participant loan option. When a self-directed 401k invests in a promissory note, the borrower is an unrelated third-party not the self-directed 401k participant. Whereas, when the self-directed 401k participant borrows from her 401k, this is considered a 401k participant loan. You can learn more about these differences here. 
  • The promissory note can be structured as secured–generally by real-estate, inventory or precious metals–or it can be structured as an unsecured note. If the note is unsecured, the interest rate the self-directed 401k receives is generally higher because of the higher risk. 
  • The self-directed 401k promissory note investment cannot be to a disqualified person. A disqualified person includes the self-directed 401k participant, her business, her spouse, kids, parents, to name a few. For a full list, go here. 

To learn more about investing in promissory notes under a self-directed 401k plan, go here. 

Private Placements or Private Company Investments 

  • Another top self-directed 401k investment include private placements or private company investments. 
  • A method of investing a self-directed 401k  passively in a private company is by purchasing equity as long as company is not the self-directed 401k participant’s own business or a business controlled by her relatives such as her spouse, parents and children.

Here are important rules to understand when investing a self-directed 401k in Private Placements.

  • Title to the equity investment is taken in the name of the self-directed 401k plan. 
  • If the self-directed 401k plan invests in a business that offers goods or services (an active business), the gains are subject to unrelated business income tax UBTI; however UBTI does not apply to passive, private company investments.

Visit here for more information regarding investing a self-directed 401k in private placements, and go here to learn about investing another type of 401k plan knows as a ROBS 401k in your own C-corporation.   

These top 5 self-directed 401k investment rules will get you started in self-directing your self-employed solo 401k plan. 

Rule 1 (One): Understand the allowed self-directed 401k investments under the IRS Rules.

  • There are relatively few limits on the types of investments that are permissible under a self-directed 401k plan.
  • Solo 401k plans cannot invest in S-Corp stock, collectibles, such as art, antiques, gems, coins, or alcoholic beverages, and they can invest in certain precious metals only (e.g., American gold and silver Eagle coins minted after September 30, 1986))  if they meet specific requirements. (IRC Section 408(m)). All other types of investments are allowed.

Rule 2 (Two): Make sure the self-directed 401k plan allows for the particular investments.

  • Once you have an idea of the types of investments that you would like to make under the self-directed 41k plan  or prior to opening the 401k plan, make sure the plan provider’s self-directed 401k plan allows for the type of investments that you are planning to make.
  • Not all self-directed 401k plans allow for investing in real estate, for example.
  • While self-directed 401k plan providers are permitted to impose restrictions on investments, the 401k law does not prohibit investing in the following types  of investments listed above as well as other investment types such as tax liens, cryptocurrency, annuities, Futures, life insurance, and equities. 

Rule 3 (Three): Understand who is a disqualified person for purposes of placing self-directed 401k investments.

  • The IRS prohibits transactions between self-directed 401k plans and certain individuals known as “disqualified persons.”
  • A disqualified person is the self-directed 401k participant, or anyone who has control over the assets or who has the ability to influence investment decisions.
  • Members of the self-directed 401k participant’s family (i.e., a spouse, an ancestor, any lineal descendant, or any spouse of a lineal descendant) also are considered disqualified persons. 

Rule 4 (Four): Understand roundabout prohibited transactions.

  • Under the self-directed 401k prohibited transaction rules, a disqualified person may not indirectly do what cannot be done directly.
  • If a self-directed 401k transaction directly violates the prohibited transaction rules, simply altering the transaction to remove the disqualified person from the direct involvement is insufficient. In other words, merely insulating that person from the transaction and enlisting a third party does not make a prohibited transaction permissible. 
EXAMPLE: 
 
Jason’s parents own a primary residence and they want to retire, so they sell the house to Jason’s self-directed 401k plan. The purchase of the home by Jason’s self-directed 401k plan is a slam dunk prohibited transaction because the solo 401k owner’s parents are disqualified parties, and the self-directed 401k plan cannot have a sale between itself and such a party. So Jason’s parents sell the house to Jason’s friend Sal, a person unrelated to Jason. Sal and Jason, however, have agreed that Jason will have his self-directed 401k immediately purchase the house from Sal after the transaction between Jason’s parents and Sal is completed. This type of situation illustrates an indirect prohibited transaction where a disqualified person attempts to circumvent the prohibited transaction rules by bringing a third party into the transaction. 
 

Rule 5 (Five): Consider not doing the investment or get an Advisory Opinion. 

  • If you think the self-directed 401k investment may be prohibited, either don’t proceed or apply for an individual prohibited transaction exemption.
  • The Department of Labor (DOL) grants advisory opinions if the transaction is allowed.

 

401k Business Financing

ROBS 401K – 3 Considerations Regarding Using a Home Office

June 3, 2020 | By George Blower

In the current COVID crisis, many states are requiring non-essential workers to work from home.  If you funded your business with a ROBS 401k business financing plan, your CPA or tax advisor may suggest that you take a home office deduction or charge your business rent.

For a ROBS-funded business, below are 3 important considerations with regards to using a “home office”:

Don’t Charge Rent

The C-corporation that is funded with your retirement funds can’t pay you rent to use part of your home as a home office (nor can you take a deduction on your personal income taxes) since you can’t personally benefit from the ROBS 401K investment.

Business License

If you will operate your business across a geographic area that includes multiple municipalities that each require a business license, consider whether such municipalities provide license reciprocity to a central city, and if so, whether such central city has an address requirement. 

For example, let’s assume that you will operate a bread route in metro Las Vegas and that each suburb of Las Vegas requires a business license, and further, that the suburbs will recognize a business license issued by Las Vegas but not by the other suburbs.

In that case, you may wish to obtain a single business license in Las Vegas rather than separate business licenses in each suburb in which you will operate. 

In that case, if Las Vegas requires that you provide in an address in the City of Las Vegas in order to obtain a business license you will need an office address in Las Vegas if you reside in the suburbs.

Privacy

For the sake of privacy, consider whether you wish to rent office space that will allow you to provide an address other than your home address in your business dealings.

Uncategorized

Solo 401k Setup FAQs

June 3, 2020 | By Mark Nolan

BACKGROUND:

Solo 401k plans are for self-employed individuals. In order to setup a solo 401k plan, the business cannot employee any full-time W-2 employees who are not owners of the business. The business owners may spouses may also participate in the solo 401k plan provide they also employees of the business.

QUESTIONS:

To clarify, if I want the option for real estate investment and I also want a separate Roth account, I would need to open two separate checking accounts for the self-directed 401K correct? So I would need the solo 401K plan that includes both bank and brokerage accounts? My current 401K plan from a previous employer is with Fidelity so I was planning on using Fidelity for my new solo 401K account through your company. Is there a preferred bank that Fidelity does business with? Would you help me with the set up of the 401K checking accounts or is that something I set up independently under the solo 401K trust? I am not sure how I would do that since it sounds like I need to establish separate accounts for traditional and Roth contributions — would they be set up under the same EIN for the new solo 401K trust?
In the bigger picture, is there a downside to preparing for the real estate investment option but it doesn’t come to fruition in the future? I live in Northern CA where the real estate is very expensive. While it is my intention to rollover my existing 401K funds to the newly established solo 401K account and hopefully use these funds for local real estate investment, this depends on the recovery of my current 401K from the recession and the local housing market.

ANSWERS:

1) This confirms that there needs to be two separate accounts.

2) These two accounts can simply be at Fidelity. While you can have a bank account and a brokerage account, it is not necessary.  Please note that Fidelity Investments offers a free checkbook with the account.

3) Each account will be under the same EIN of the Solo 401k.

4) We will certainly prepare the paperwork and assist with opening the accounts (bank and/or brokerage).

5) You can certainly invest the solo 401k in real estate but you don’t have to and there is no deadline to invest.

Solo 401k

Solo 401k Promissory Note Investment Default

June 3, 2020 | By Mark Nolan

Background:

When a solo 401k invests in a promissory note, the note can be structured as secured or unsecured. If secured, the solo 401k promissory note investment is generally secured by some form of physical real estate such as vacant land, vacant lot or physical property.

By investing in a secured promissory note, the solo 401k can take over the property securing the note investment in the event of default.

QUESTION:

I invested my solo 401k in a promissory note secured by a vacant lot and the borrower defaulted on the loan, resulting in my solo 401k plan now owning the vacant lot. The land has entitlements to be developed into 16 units. Can I sell the solo 401k owned land to an unrelated developer, and the solo 401k plan receive the proceeds from the sale of the units?

ANSWER:

When the now solo 401k owned land is sold to an unrelated party (in this case a developer), the proceeds from the sell flow back to the solo 401k plan and continue to grow under the tax sheltered umbrella.

On the other hand, if the solo 40k trustee decides to have the solo 401k owned land developed, the following solo 401k rules apply:

A Solo 401k cannot run a business out of the 401k such as a real estate development company.

Running a business could be challenged as a prohibited transaction or the income your Solo 401k receives could be subject to Unrelated Business Income Tax (typically 40% tax rate)

If the Solo 401k were to partner with a developer in the form of an LLC, the following would apply:

 The Solo 401k would contribute the land, which is owned free and clear to the LLC for units.

The Solo 401k would need to a minority owner of the LLC (own less than 50% of the LLC).

The Solo 401k cannot be a General Partner; Any other partner/investor must be an unrelated person (e.g. cannot be the solo 401k participant personally). 

The Solo 401k would need to be strictly a passive investor only and you could not work on the development.

Any construction loan or debt would need to be obtained by the developer and there could be no recourse to the solo 401k or the solo 401k participant personally.

The solo 401k participant cannot personally guarantee any loans to the LLC.   

Another is to Sell the Property to a developer and the Solo 401k maintaining a portion of the equity. The solo 401k owned property can be sold to a developer for both cash and equity in the development. The 401k would retain the equity and any additional returns from the sale of the development would-be deposited to the Solo 401k. However, it would be prohibited fro the solo 401k participant to acquire any equity ownership personally.  

Solo 401k

Solo 401k Real Estate LLC – Should I set up a separate LLC for each property? 3 Factors to Consider

May 30, 2020 | By George Blower

QUESTION:

I am looking to invest about half of my Solo 401k in equities via my Solo 401k brokerage account at Fidelity and the rest in real estate investment properties.  For the real estate investments, I will invest my Solo 401k funds in an LLC.  Should I set up a separate LLC for each property?

ANSWER:

Investing in real estate is one of the most popular investments for our customers.  While many of our customers choose to invest their Solo 401k funds directly in real estate (i.e. the title to the property is held in the name of the Solo 401k), some also choose to invest via single-member LLC where the member is their Solo 401k.  For this latter group, some choose to hold all real estate investments ina single LLC while other clients elect to hold each investment property in a separate LLC owned by their Solo 401k.  Below are 3 factors to consider in deciding whether to hold all investments in  a single LLC or multiple entities:

Solo 401k LLC – Liability Protection

  • Holding each property in a separate LLC will provide a degree of liability protection for each property
  • Holding multiple investment properties in a single LLC could expose all the properties to liability that arises on one property

Solo 401k LLC – Financing

  • If the LLC obtains financing to acquire real estate (non-recourse loan), the lender may require that LLC only holds a single property.

Solo 401k LLC – Investing in different states

  • If your Solo 401k will invest in real estate located in different states, the LLC may need to be registered in each state.
  • Rather than registering a single LLC in different states (e.g. as a foreign LLC in states other than its home state), some clients prefer to register a separate LLC in each state where they hold property.
401k Business Financing

SBA Business Loan Quick Start Guide – 3 Questions to Ask Yourself

May 30, 2020 | By George Blower

  

Many of our clients obtain a business loan backed by the Small Business Administration, including by using their retirement funds as a down payment via a ROBS 401K business financing plan.

For many entrepreneurs looking to start, buy or expand a business, an SBA loan can offer attractive terms.

As you consider an SBA loan to fund your business, ask yourself these 3 questions:

Do you qualify for an SBA loan?

  • If your credit score is too low (e.g. sub-600) or if you have had recent bankruptcies, it will be difficult for you to qualify for an SBA loan. 
  • You will need to put a certain amount down in order to obtain an SBA loan (min 10% but up to 25-30%).  Note: You may be able to use your retirement funds without paying taxes or penalties as a down payment for an SBA Loan.
  • Most lenders will require collateral (e.g. equity in your home since you will need to personally guarantee the loan).

Is an SBA loan a good fit for your business plan?

  • If you will need the funds quickly, an SBA business loan may not be the best option.  While an ideal candidate may be able to close on an SBA loan in a month, the process typically takes at least 60 days.
  • Once you take an SBA business loan, your business will need to service the debt so you should consider whether your cash flow will support a monthly loan payment

What happens if your business fails?

  • In order to qualify for an SBA business loan, you will be required to personally guarantee the loan.
  • If your business fails and defaults on the loan, you will be personally obligated to pay back the loan including putting your personal home and other assets at risk if you are unable to personally pay back the loan.  This means that you could lose not just your business.
Regulations
Solo 401k

Solo 401k Rules: Am I required to make “substantial and recurring” contributions to my self-directed Solo 401k?

May 28, 2020 | By George Blower

QUESTION:

I attended a small business conference which included a presentation on 401k plans.  The presenter stated that in order to keep a 401k plan in compliance “substantial and recurring” contributions must be made to the plan.  How does this requirement apply to my Solo 401k? Am I required to contribute to the plan every year?

ANSWER: 

First, the IRS clearly states that the employer does not need to contribute to a 401k plan every year. 

For certain employers, if contributions are not made for several years it can create a presumption that the plan has been discontinued.  For example, if a business offers a 401k plan in which non-owner employees participate and are not 100% vested, this issue is one of several different factors that the IRS considers in determining whether a plan is discontinued (e.g. if the employer has been profitable but has not made any profit-sharing contributions in 3 of the last 5 years).   

With regards to Solo 401k plans:

  • The IRS’s own Internal Revenue Manual states that this is not an issue if plan participants are fully vested at all times.
  • Since all participants in your 401k are 100% fully vested (i.e. you), this is not an issue per the IRS guidance.
IRA LLC

Self-Directed IRA TIC Investment Question

May 26, 2020 | By Mark Nolan

QUESTION:

I came across your web site and blog which has a few questions and answers similar to my situation but I couldn’t quite find an answer, I wonder if you can help me.

My two brothers and I own a small investment property with equal ownership 1/3 each, directly in each of our names i.e. taxable, no IRA’s.  The mortgage is down to about $130k and we are considering just paying off the mortgage and owning the property outright, we’d each pay 1/3 of the remaining mortgage balance. We manage the property ourselves, never have any personal use, and split all income and expenses 3 ways.

I would prefer to own this in an IRA if possible.  I know that selling real estate from myself to my IRA would be a prohibited transaction, but I wonder if that applies if I am just a 1/3 owner.  I wonder if we can sell the property such that the new owner is 1/3 each of my two brothers and 1/3 my IRA. I am not sure if they’d be interested in owning the property in their iRA or 401k, if not, then the new ownership may be a mix of IRA and non-IRA accounts.  I see in your tenants in common section you describe some ownership combinations like this but I don’t see this one.

ANSWER:

Whether an individual owns part or all of an investment property, the IRA prohibited transaction rules do not allow for the sell or exchange of personally owned (directly or indirectly) property to his or her own IRA.

Your proposed transaction would specifically run afoul with the the following IRA prohibited transaction rule:

Selling, exchanging, or leasing property

Click Here to read more about the IRA prohibited transaction rules.


A tenancy in common (TIC) transaction is a very specific transaction. For one, the purchase of the investment property would need to be from a third-party (not the IRA account holder).

Provided certain rules are followed, under a TIC transaction, the IRA account holder may be able to invest along sided his or her IRA in the same property. If so, here are some of the main items to consider:

  • Only cash can be used to make the investment (no debt);
  • The ownership percentages must be based on on amount invested by each party;
  • Title to the property must list all parties who invests funds; and
  • The income and expenses would need to be split in accordance with the ownership percentages.

401k Business Financing

Compare ROBS 401k vs SBA loan for Business Financing: 7 Key Differences

May 25, 2020 | By George Blower

Many entrepreneurs that we speak to are considering different options to finance the startup or purchase of their business including comparing a ROBS 401k (Rollover as Business Startup) and a loan backed by the Small Business Administration (SBA Loans).

There are some important differences between ROBS 401k Business Financing and an SBA loan.   Depending on your business plan, this may make one option more attractive than another.  Of course, many business owners choose to use both options – effectively using a ROBS 401k to fund the down payment on an SBA Loan.

Can my business afford to make the loan payments?

When you use a ROBS 401k plan to invest invest your retirement funds in your own business, this investment is not a loan from your 401k.  This means that there is no requirement for you or your business to make loan payments.  On the other hand, your business will be obligated to make loan payments on an SBA loan.  As a result, it will be important consider whether your business can afford to make loan payments.

How quickly do I need the money?

With a ROBS 401k plan, you will typically have access to your funds in 3-4 weeks.  While an idea candidate may be able to obtain an SBA loan in a month, you should plan on taking a least a few months to close on an SBA loan.

What happens if I sell the business?

Since a ROBS 401k plan is structured as a stock purchase (rather than a loan), you will own a significant amount of your business through your 401k plan.  If you fund your business via an SBA loan, you will not give up an ownership in your business to obtain the loan which means that you may own 100% of your business in your own name.

Practically, this difference can have a big impact of what happens if you decide to sell your business in the future:

  • If you own a significant portion of your business via your 401k, then a large percentage of the sale proceeds (after paying expenses, creditors, etc.) will flow back to your 401k account.
  • If you own 100% of your business in your own (e.g. because you financed it via an SBA loan), you will receive 100% of the sale proceeds.

What happens if my business fails?

In order to qualify for an SBA loan, you will need to personally guarantee the loan.  This means that if the business fails and is unable to pay back the loan, you will be personally obligated to pay back the loan including putting your personal home and other assets at risk if you are unable to personally satisfy the loan.  In contrast, if you funded your business via a ROBS 401k, there is no personal guarantee requirement such that while you might deplete your retirement savings you won’t put your home at risk by virtue of funding your business via a ROBS 401k.

ROBS 401k vs SBA loan – Key Differences

 ROBS 401kSBA Loan
Credit CheckNoYes
Personal GuaranteeNoYes
Down PaymentNoYes
Timing3-4 weeksMonths
Loan PaymentsNoYes
TermNo10 years
Interest RateNOPrime + 2.25-2.75%
IRA LLC

Self-Directed IRA First-Time Home Buyer Exception

May 23, 2020 | By Mark Nolan

Generally, the 10% early distribution penalty applies to distributions taken from a self-directed IRA prior to the account holder reaching age 59 1/2, and this penalty tax is in addition to federal taxes and possibly state taxes. Fortunately, the 10% early distribution tax penalty is waived if the funds are used for the purchase of the IRA account holders primary residence (the first time home buyer exception). See IRC Sec. 72(t)(2)(F).

First Time Homebuyer Exception -The Required Tests

The following tests must be satisfied in order for the self-directed IRA distribution to fall under the “first-time home buyer exception.”

The distributed funds must be used within 120 days of the date the distribution was received;

Must be a principal residence;

Mus be a first-time home buyer;

Qualifying costs include buying, building, or reconstructing a home;

The home is being purchased for the self-directed IRA owner or her relatives (i.e., her spouse, child, grandchildren, or ancestors of the IRA owner or her spouse; and

The lifetime limit is $10,000 and is aggregated across all the IRA owners IRAs, so not per IRA (see IRC Sec. 72(t)(2)(F).

What is the Definition of a First-Time Homebuyer?

A first-time homebuyer is an individual (and, if married, the individual’s spouse) that had no present ownership interest in a principal residence during the two-year period ending on the date of acquisition of the principal residence (IRC Sec. 72(t)(8)(D)(i)(I)). The date of acquisition means the date on which an individual enters into a binding contract to acquire the principal residence or on which construction or reconstruction of such a principal residence commences.

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