Archive for October 2011

Benefits of a Solo 401k

Today I want to talk to you about individual 401ks also known as solo 401k and what are the benefits of this type of plan? And what are the nuts and bolts of this type of plan? Let’s dig into this topic.
An individual 401k is the type of plan that has the ability to invest in anything the law allows, like real estate, private placements or any alternative investment to the stock market. It’s the most tax-advantageous, self employed plan available with very high annual contribution limits. You can set up this plan even if you’re employed at a full-time job. And, you can borrow funds from the account.
An individual 401k plan is available to any individual who is a business owner or who will be establishing a business and does not have, or plan to have, full-time employees. The plan works great for consultants, home based businesses and independent contractors. Another advantage is the owner’s spouse may also contribute to the plan.
The IRS requires any one that is going to have there own individual 401k have a written plan document that establishes the rules of the plan. This plan must be put into place, with rules and guidelines that state how the plan will operate. While the plan itself is lengthy, the Summary Plan Description explains, in plain terms, how the plan works.
Another great benefit from a control perspective is that a trustee must be designated to hold the assets of the retirement plan. In the case of an individual 401(k), you are able to act as your own Trustee and are charged with investing trust assets prudently and productively. You personally cannot benefit from the trust, you as the trustee cannot co-mingle personal funds with the trust and cannot enter into a transaction with the trust.
There are two types of contributions in an individual 401k plan: salary deferrals and a profit sharing contribution. Both contributions are generally tax deductible and they grow tax deferred until withdrawals which may begin penalty-free after age 59 1/2. Withdrawals after age 59 1/2 are taxed as ordinary income. Withdrawals must begin at the age of 70 1/2.
As with any retirement account in order to initially fund the Solo 401(k) you can rollover funds from Traditional IRAs, SEP Plans, previous employer 401(k) plans, Money Purchase plans, Profit Sharing plans, Keogh plans, Defined Benefit plans, 403(b) plans and Rollover IRAs. This is accomplished by setting up an account for the Solo 401(k) and directly transferring the funds from the Custodian to the trust bank account.
Another great benefit with an individual 401k is the amount you can contribute to the account. For tax year 2011 you can contribute the regular 401(k) maximum of $16,500 (with an additional $5,500 if over the age of 50 at year end). And, you can add up to 25% of compensation for the profit-sharing portion. The combined maximum of these contributions can’t exceed $49,000, plus catch-up additions, if applicable. Also, your plan can be designed with a “designated Roth component”, if you desire it.
You want your plan to have a loan provision permitting you to take out a loan. You are able to borrow up to 50% of the total 401(k) value up to a maximum of $50,000, tax free. Repayment of the loan is according to a loan amortization schedule provided when the loan is initiated and must be paid back into the account (including interest). Failure to make the loan payments may cause a loan default causing taxes and IRS penalties.
We are pleased here at Blue Diamond Documents to announce that we are now offering plan documents for a solo 401k plan. We can help you get started with your solo 401k plan at a very competitive price. If you are a self employed person with no employees we can help you start saving for your retirement future. Call us today at 623-628-2072 for more details.

What is a prohibited transaction?

Over the years of working in the Self Directed IRA world the number one question has always been. What is a prohibited transaction?
This is how the code reads:
A prohibited transaction happens under the Employee Retirement Income Security Act of 1974 (ERISA) when the plan engages in a transaction that the fiduciary knows or should know is a direct or indirect:
1. Sale, exchange, or lease of any property by a party of interest;
2. Loan, or extending of credit to a party of interest;
3. Furnishing goods, services, or facilities by a party of interest;
4. Transfer of plan assets to a party in interest or the use of plan assets by or for the benefit of a party
of interest;
Who is a party of interest?
Under ERISA, the following are parties in interest with respect to a plan:
1. Any fiduciary, counsel, or employee of the plan;
2. A person providing services to the plan;
3. Any business owned by a prohibited person 50% or more.
4. A relative that is spouse, ancestor, lineal descendant, or spouse of a lineal descendant and any of
the persons described in 1,2,3.
What this is telling you and me is that your retirement account cannot buy from yourself or your spouse or any of your relatives mentioned. A prohibited transaction is when your retirement account self deals or when you as the account holder benefits personally from the transaction. You cannot take a loan from your IRA and you cannot extent credit to your retirement account. You should not engage in a transaction with someone that is doing a service for your retirement account, like your attorney or CPA. And your retirement account should not engage in a transaction with a business that anyone of those individuals owns 50% or more of.
I have had many discussions with clients that want to invest in companies they own more than 50% or they want to lend money to their son or they want to pay off their mortgage. This is called self dealing and it is prohibited. Your IRA is meant to benefit you when you retire not before. So if you are considering an investment that is going to put money in your pocket today it is probably prohibited.
What penalties may be imposed on a party in interest or disqualified person for engaging in a prohibited transaction?
Under the Code, a penalty tax equal to 5% of the amount involved in the transaction is imposed on the disqualified person (other than a fiduciary acting solely in that capacity) for each year or part thereof that the transaction remains uncorrected. An additional tax equal to 100% of the amount involved is imposed if the prohibited transaction is not timely corrected. Under ERISA, any fiduciary who engages in a prohibited transaction is personally liable for any losses to the plan and must restore to the plan any profit made by the fiduciary through the use of the plan’s assets. Also, the civil penalty imposed by the Department of Labor (DOL) for certain breaches of fiduciary duty applies to prohibited transactions, but the penalty is reduced by any penalty tax imposed under Section 4975.
How is a prohibited transaction corrected?

A prohibited transaction is corrected by undoing the transaction to the extent possible, but in any event placing the plan in a financial position no worse than the position it would have been in had the party in interest acted under the highest fiduciary standards.
Bottom line if you have a prohibited transaction in your retirement account fix it and fix it now.
Remember to continue your education, you won’t have these problems in you know what the rules are and you obey them.
Timothy A Schubert CISP