Transfer SEP IRA to Solo 401k and Non-Recourse Loan Questions

QUESTION 1:

I have both a rollover IRA from a previous employer and a SEP IRA. Can I combine these into a solo 401K?

ANSWER:

Presumably you are self-employed if you are already participating in a SEP IRA, but to clarify, here is how the IRS defines self-employment:

Yes the IRS rollover rules permit the transfer of SEP IRAs and Rollover IRAs to a self-employed 401k such as a solo 401k plan.

To see a full list of retirement account types that may be transferred to a solo 401k plan click here.

QUESTION 2:

Also, is it possible to purchase real estate using a non-recourse loan plus a down payment from the solo 401k?

ANSWER:

Yes a solo 401k may incorporate non-recourse loan financing when investing in real estate, whether for domestic or international real estate.

Some of the rules that apply when using debt financing in conjunction with a self-directed 401k to invest in real estate properties include the following:

  • The non-recourse loan is to the solo 401k, not the solo 401k owner/participant;
  • the lender, whether a bank or an individual, can only look to the property for repayment in the event of non-recourse loan default, not any other asset of the solo 401k; and
  • The non-recourse loan does not show up on the solo 401k trustee’s credit report.

Visit solo 401k non-recourse loan for a full breakdown of the rules, and visit solo 401k real-estate purchase methods to learn about others ways to invest a self-directed solo 401k into real estate.

How to Structure a Promissory Note Investment with 2 Trustees Solo 401k Plan

QUESTION:

I still have a few questions on the logistics of how we will structure the purchase of a single promissory note pool for $100K in our self-directed Solo 401k with funds from our two separate solo 401k checking accounts. Will we need to have the seller split the note pool into separate parts to be purchased under different names and accounts? Please clarify how this process will work.

ANSWER:

Good question. Because both business owners are participating in the self-directed solo 401k plan and both want to invest in notes, the promissory note investment can be structured in any of the following ways.

Option 1: One Note & Title is taken in both trustees name and the solo 401k plan name is listed

List both trustees as the beneficiaries/lenders on the same promissory note, and the deed if the note is secured by real estate.

For example, if Joe and Lucy Byrd are both participating in the Pine Trees Solo 401k Trust and each invest $50,000 of solo 401k funds in the same (one) promissory note, both will be listed on the same note investment and title is taken as follows: Joe Byd & Lucy Ford, Trustees of Pine Trees Solo 401k Trust

As a result, both Joe and Lucy sign the same note and the promissory note payments are divided 50/50 and flow to each of their respective solo 401k sub accounts. The borrower makes out two checks for each note payment—that is, a separate check is made out for each solo 401k sub account (one for Joe and the second for Lucy) and deposited into each respective solo 401k sub account.

Option 2: Tow Notes & Title is taken separately in each trustees name and the solo 401k plan name is listed

On the other hand, they can each process a separate promissory note investment from their respective solo 401k sub accounts, so each note is tilted as follows:

Promissory Note 1: Joe Byrd, Trustee of Pine Trees Solo 401k Trust

Promissory Note 2: Lucy Byrd, Trustee of Pine Trees Solo 401k Trust

Therefore, just like in option 2 above, the borrower writes two checks for each promissory note payment and the checks are deposited to each solo 401k owners respective sub accounts.

Click on solo 401k promissory note investment procedure for more information on making promissory note investments with a self-directed solo 401k.

 

 

Using a 401k to Buy a Business

While the Employee Retirement Income Security Act of 1974 (ERISA) permits the use of 401k retirement funds to buy your own business (commonly referred to as rollover as business start up (ROBS), the following rules should first be understood before using your 401k funds to buy a business:

  • The ROBS 401k/PSP arrangement calls for the purchase of stock shares; therefore, only a C-Corporation structure qualifies.
  • IMPORTANT: Don’t confuse the use of funds borrowed from the 401k (known as a 401k participant loan) with the use of 401k funds to buy a business. To clarify, under a 401k loan, the 401k owner uses the borrowed funds to personally invest in his own business, whereas under the ROBS arrangement the 401k, not the 401k owner, invests directly in the C-corporation. As a result, among other things, all of the 401k funds can be used to buy a business.

Still Employed

  • If your only source of retirement funds is a current employer 401k and you are under age 59 1/2, you may not be able to access these funds. Reason being, the current employer has the authority to restrict your access to those funds until you leave the employer.

The Benefits of Buying Your Own Business with Retirement Funds:

  • Neither taxes nor early distribution penalties apply under the Rollover Business Startup (ROBS) transaction because the funds that were transferred from your former employer plan and/or IRAs are directly rolled over into the new ROBS 401k/PS which are then invested in your own C-corporation.
  • Because the use of 401k funds to buy a business is not considered a 401k participant loan but rather a stock purchase, you do not have to contend with paying back a loan, which can be challenging during the initial years of the business.
  • Securing funding for your business purchase usually takes 14 to 21 days.

List of Self-Directed IRA Providers

Following is a list of self-directed IRA providers for opening a self-directed IRA for investing in alternative investments such as real estate, precious metals, promissory notes and private company shares, to name a few.

Those looking to use the IRA LLC (also known as a checkbook IRA) to invest in alternative investments such as real estate, promissory notes, private shares, tax liens, and precious metals, to name a few, the following self-directed IRA LLC providers provide this service.

My Solo401k Financial http://www.mysolo401k.net/Self-Directed-IRA-LLC.html

Accuplan: http://www.accuplan.net/

Checkbook IRA: http://www.checkbookira.com

Nabers Financial: http://www.nabers.com/

Those looking to invest in alternative investments such as real estate, promissory notes, private shares, tax liens, and precious metals, to name a few, the following  self-directed IRA providers provide this service.

IRA Services Trust Company: https://www.iraservices.com/

Pensco Trust Company: https://www.pensco.com

Millenium Trust Company: http://www.mtrustcompany.com/

Equity Trust Company: https://www.trustetc.com

ROBS 401k Providers List – 401k Business Financing

List of Rollover as Business Startup (ROBS) Providers

It will be important to consider the below in selecting a company to help you use your retirement funds to start your own business.For your convenience, below is a list of Rollover as Business Startup (ROBS) 401k plan providers:

Are you considering using your retirement funds to finance your own business via rollover as business startup or ROBS 401k? Perhaps you want to buy a business or start a franchise using money in your 401k or IRA?

If so, you should know that there are very important requirements that must be followed both initially when you fund your business as well as in the future as you run your business. Moreover, the specific requirements that will apply to you will depend on your particular circumstance. As a result, it is important to select a provider that has experience and expertise as well as provides ongoing support that is specific to your business.

Technical Steps

In order to reap the benefits of a ROBS transaction (including tax and penalty-free access to your retirement funds), certain technical steps must be followed.

  • At a minimum, these include setting up a C-corporation to operate your business as well as establishing a qualified 401k plan that allows for investing your retirement funds in your business.
  • Additional considerations include whether an initial business valuation is necessary, whether the nature of your business qualifies, whether your retirement funds are eligible to be transferred, etc.
  • Of course, no two transactions are identical and the issues that apply to your particular scenario will depend.For this reason, it is best to speak to an expert professional (rather than a salesperson) as quickly as possible to confirm that you qualify and identify the specific requirements that will apply to you.

Ongoing Support & Requirements

For businesses funded via a ROBS transaction, there will be additional ongoing requirements.At a minimum, these will include:

  • An annual filing requirement (i.e., Form 5500) as well as making amendments to the 401k plan to keep pace with changes in the law and preserve the plan’s qualified status.
  • Additional considerations include whether the 401k plan needs to be offered to other employees of the business, whether 401k contributions needs to be made for employees, whether an ERISA Fidelity bond is needed, etc.

As with the initial requirements described above, it is best to work with a company that can provide you with ongoing support by an expert professional who is familiar with your business – rather than a provider who may simply assign a support person who may lack the requisite expertise or experience with your particular plan.

Process of Investing IRA Funds in a Franchise or Start-Up Business

This blog post discusses the two methods to invest IRA funds in a franchise or business start-up. Both methods fall within the the IRS guidelines; however, each method has a separate set of rules. Thus, it is important to fully understand and analyze both before investing IRA retirement funds in a franchise or business start-up.

Brief Differences

  • Method one entails passively investing IRA funds in a franchise or business start-up.
  • Method two involves actively investing IRA funds in the franchise or business start-up (whether an existing or a new franchise ) by transferring the IRA proceeds to a roll over as business start-up 401k profit sharing plan (ROBS 401k).

Complete breakdown of both Methods–IRA franchise and business start-up financing

Method 1: The process of a actively investing IRA funds in an active franchise or business start-up.

  • A new C-corporation is established.
  • Corporation sponsors a new 401k/PSP.
  • The IRA funds are transferred to a new brokerage account opened for the 401k/PSP.
  • The new franchise corporation issues stock shares to the 401k/PSP for the benefit of the franchisee.
  • The franchisee must be an employee of the franchise business and he or she may take a reasonable salary.
  • The franchisee’s family members may be employees of the franchise business and receive reasonable compensation for their services.
  • To the extent that the corporation generates profits and elects to distribute those profits to the owners of the business, the percentage of the profits associated with the shares held in the 401k/PSP will flow back to the 401k/PSP brokerage account.

 

Method 2: Passively investing IRA funds in a new franchise or business start-up:

  • Here is what transpires when passively investing IRA funds in a franchise or business star-up.
  • The IRA owner/participant may not personally benefit from his or her IRA’s investment in the franchise business; as such, the IRA owner is prohibited from taking a salary.
  • The IRA owner is prohibited from working for the franchise or business start-up.
  • It is prohibited for IRA owner to serve as a director, officer or in any position having powers or responsibilities similar to those of officers or directors.
  • Most family members are prohibited from working for IRA funded franchise or business start-up. For example, the following family members are restricted from working or providing services to the business (whether for enumeration or not).
  1. The IRA owner’s parents
  2. The IRA owner’s grandparents
  3. The IRA owner’s children
  4. The IRA owner’s spouse
  • Passively investing IRA funds in a franchise or business start-up entails taking title either in the name of the IRA custodian f/b/o the IRA, or a single member IRA LLC is setup (after the IRA has been transferred to a self-directed IRA custodian such as IRA Services Trust Company); the IRA LLC is then funded with self-directed IRA funds, and the IRA LLC purchases stock shares in the case of C-Corporation, or units in the case of an LLC in the franchise business.
  • Compliance Note 1: The S-Corporation rules restrict an IRA or any type of retirement account from owning stock shares in an S-Corporation.

After the IRA or IRA LLC buys stock or units in the franchise business, the franchise business issues a stock certificate in the name of the IRA, or in the name of the IRA LLC.
Profits resulting from the IRA’s ownership percentage in the franchise flow back to the IRA or IRA LLC.

Compliance Note 2. When an IRA or an IRA LLC invests passively in an operating business, gains in excess of $1,000 will be subject to unrelated business income tax and must file Form 990-T.

 

IRS View on Using Retirement Funds (ROBS 401k) to Finance Your Own Business

 ROBS or Rollover as Business Start-Up is the coined term by the IRS to refer to the use of one’s retirement funds (e.g., IRA, 401k, 401a, 403b, TSP, 457, PSP, DBP, etc.) to finance a new or an existing business that the retirement account holder will operate.

Here is a review of the IRS’s published statements with respect to ROBS (Rollover as Business Startup) transactions:

October 2008 Memorandum: Brief Summary

  • This is the first official publication where the IRS formally addressed the use of retirement funds to finance one’s business;
  • IRS affirmed that the use of retirement funds to finance one’s own business is not considered noncompliant and stating its view that these transactions may be not challenged as “non-compliant per se”;
  • IRS explains the steps involved in the ROBS transaction; and
  • IRS identified compliance holes–for example, the non-filing of the annual retirement plan form 5500 tax return, non-filing of the corporation’s tax return, the nonattainment of an annual valuation of the plan’s assets including the investment in the corporation stock.

2009 – ROBS Project

  • In 2009, the IRS initiated a “ROBS project” to define traits of compliant ROBS plans and in doing so acknowledged that the use of one’s retirement funds in a ROBS transaction can be conducted in a compliant manner.

2010 – IRS Telephone Forum

  • In a 2010 telephone forum conducted by the IRS, the IRS’s Director of Employee Plans Examinations Office and the Area Plan Manager stated that ROBS transactions are not “abusive per se” and that “you can have a textbook ROBS that is pretty much problem-free.”

Fall of 2010 Retirement News for Employers: Brief Summary

  • The IRS confirms that the ROBS transaction is not considered an abusive tax avoidance transaction;
  • The IRS does not protect business owners (also known as the plan sponsor) from incorrectly administering the retirement plan;
  • The IRS confirms that if the rules are not followed the retirement plan will be subjected to adverse tax consequences

February 2013 Employee Plans Compliance Unit ROBS Project: Brief Summary

  • Last report published by the IRS regarding rollovers as business start-ups (ROBS);
  • Much of the same information contained in the October 2088 Memorandum was published in this summary; and
  • The IRS again confirmed that ROBS is not considered abusive transaction.

In sum, the IRS has clearly taken the position regarding the ROBS arrangement as clearly supported in the above IRS published communications.

The IRS essentially agrees that it is an allowable transaction if properly carried out and maintained. As such, it is essential to work with competent professionals such as compliance personnel and attorneys.

Thus, it is clear that per these statements the IRS’s position is that a ROBS transaction can be conducted in a compliant manner. Rather than whether a ROBS transaction is authorized, the focus of the IRS’s compliance-related concerns has been on the ongoing operation of the plan – such as not filing the Form 5500, not communicating the plan to new employees, etc. (note: while the IRS is also concerned that individuals may be putting their retirement savings at risk the IRS clearly acknowledges that this risk is not a compliance issue but rather a financial risk).

For anyone considering a ROBS transaction, the IRS’s concerns highlight the importance of understanding the ongoing compliance requirements and working with an experienced professional that can provide ongoing compliance support.

Thus, while entrepreneurs should certainly understand the compliance requirements and work with qualified professionals, a ROBS transaction remains a viable financing strategy with manageable compliance risk.

EBRI Report Points to Need for Emergency Fund Within 401k Plans

The Employee Benefit Research Institute (EBRI) released a report in August 2019  based on data they examined from the Federal Reserve that points for the need of a rainy day fund paired with 401k plans to help cover unexpected emergency expenses including a job loss. The emergency fund would also help reduce distributions from 401k plans for emergency reasons, which is not always the best option(for some it is the only option) since taxes and early distribution penalties apply.

Following is data  from the EBRI report with some drawn from the Federal Reserve Data:

  • Only half of workers say they have a rainy day fund that could cover three months of expenses in case of sickness, job loss, economic downturn, or other emergencies.
  • Families whose heads were DC plan (note that the solo 401k plan falls under this umbrella) participants were found to be more likely to have sufficient liquid savings to cover three months of expenses.
  • The need for an emergency savings fund is not limited to just families with low incomes or with younger heads.

Emergency Fund Could Potentially Increase 401k Balances

The EBRI report also sates that addressing short-term financial issues could lead to even better long-term results through a reduced need for early withdrawals (and tax penalties) and potentially higher contributions to a DC plan after an account for short-term financial issues is funded.

However, EBRI understands that the current rules applicable to DC plans (e.g., 401ks and PSPs) would need to be amended in order to implement an emergency fund in within the 401k umbrella, but the infrastructure to provide it appears to already be available.

Closing Comments

Here at My Solo 41k Financial, we have seen a steady uptick over the last 10 (ten) years in solo 401k owners taking distributions to cover unexpected expenses  ranging from a car repair to a more financially challenging event such as a spouse’s job loss. Therefore,  we can certainly understand how an emergency fund within a solo 401k plan, for example, could both benefit the plan as well as the participant. The AARP also did a study in 2018 on the need for a rainy day fund and found that 71% of employees would be in favor of a payroll-deduction rainy-day savings program.

 

 

IRA and Solo 401k Plan Assets Not Always Exempt from Bankruptcy

In Daniels v. Agin bankruptcy court case involving debtor’s IRAs and profit sharing plan, the court basically ruled that the debtor’s IRAs, which were originally funded via rollover from his 401k profit sharing plan, were not exempt from creditors bankruptcy estate because the IRA participant had engaged in prohibited transactions with his 401k profit sharing plan pursuant to IRC 4975.

It is important to point out that had the debtor’s IRAs or 401k profit sharing plan not been deemed to have engaged in prohibited transactions, “the debtor’s retirement plan assets would have been exempt from creditors under Bankruptcy Code Sec. 522(b)(4)(B) if the fund is in substantial compliance with the applicable requirements of the internal revenue code, or if not in substantial compliance, the debtor is not materially responsible for the failure.

Instead, the court discovered that the debtor had subjected the plan’s assets to many prohibited transactions such as loaning the plan’s funds to the debtor’s son and involving the plan in real estate transactions with the debtor’s family members.  The debtor was ultimately responsible for the plan’s assets because the debtor was managing them.

Similar to a self-directed 401k where the self-employed business owner manages the assets of the self-directed 401k, this case should serve as a good reminder that knowing and following the 401k prohibited transaction rules is of utmost importance.

It is also worth noting that even if the IRA assets been invested under a single member self-directed IRA LLC arrangement, had the LLC assets been subjected to prohibited transactions, the court would have most likely ruled against the debtor. While the use of an IRA LLC to gain checkbook control over your IRA funds and for liability protection is not prohibited, the use of an LLC IRA to circumvent the  IRA prohibited transactions rules is not afforded creditor protection.

401k Business Funding Facts

The funding of your own business through the purchase of employer stock (equity investment) using retirement funds is most commonly known as 401k business funding because a 401k/PSP is adopted by the new business that is structured as a C-Corporation (because only stock can purchased not units an LLC  does not qualify for the ROBS 401k/PSP business funding structure).

The following facts breakdown the 401k business funding arrangement:

Fact 1:  The IRS refers to the use of a 401k for business funding as Rollovers as Business Startups (ROBS)

Fact 2: Retirement funds from the following types of retirement accounts may be used 401k business funding.

SEP IRA; SIMPLE IRA; Traditional IRA; 401k ; PSP; TSP; 457b; 403b; MPP; and DBP.

Fact 3: Roth funds may not be used in the 401k business funding arrangement.

Fact 4:  ERISA 408(e), and ERISA Reg. 2550.408 list information regarding the use of 401k funds to invest in employer stock of the employer’s corporation.

Fact 5: Facilitation fees in connection with the setup of the ROBS (401k business funding) arrangement must be paid with outside funds, not retirement account funds (directly or indirectly), in order not to run afoul with IRC 4975(c)(1)(E).

Fact 6: The IRS formally commented on the use of 401k business funds on Oct 1, 2008 by issuing IRS memo commenting that the use of retirement funds is not disallowed but continue to be reviewed by the IRS.

Fact 7: The use of retirement funds for business funding entails the 401k purchasing stock shares in a C-Corporation.

Fact 8:  The 401k adopted by the C-Corporation must be offered to all full-time employees during and after the adoption of the 401k plan; therefore, the 401k plan must be communicated to all full-time employees pursuant to Treas. Reg. 1.401-1(a)(2)

Fact 9: A fair market valuation (annual appraisal) must be performed annually on the assets, including the C-Corporation shares, of the c-corporation sponsored 401k.

Fact 10: While additional purchase of stock in the C-Corporation stock is permitted, employees participating in the plan must also be given the option to invest in stock of the employer (the C-Corporation).

Fact 11: Annual non-discrimination testing must be performed on the C-Corporation sponsored 401k.

Fact 12: The 401k adopted by the C-Corporation must be adopted with the intent of being a permanent set-up. Permanency is a qualification requirement for all retirement plans including those used for 401k business funding.

Fact 13: An annual Form 5500 must be filed for the 401k.

Fact 14: Th annual corporation tax return Form 1120 must be filed.

Fact 15: You cannot draw a salary from the 4o1k funded business until income is generated. What is needed is income not necessarily profit (i.e. the C-corporation can be “breaking even”).  You should wait to receive w-2 compensation (e.g., salary, bonuses, etc.) until the C-corporation is generating income to justify your salary and then your salary should not be unreasonably high (i.e., no more than what the company would have to pay someone else to do all of the things that you do).  Any compensation that you receive should be paid to you as W-2 wages (i.e. not as 1099 income).  As such, it will be prudent to coordinate with your business tax adviser.

  • About MySolo401k

    We help our clients take control of their retirement money. Our products and services provide our clients the freedom to invest their retirement savings in their own business as well as alternative investments such as real estate, private companies, promissory notes, precious metals, tax liens and equities.
    Learn more

    Connect with us

  • We’re here to help.

    Call: 800-489-7571

    Monday-Saturday

    7:00 am - 5:00 pm PT

    Why us?
MENU