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
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. The rules are not that difficult to follow. If you continue to educate yourself a self directed IRA is still the best way to get control of your retirement future. Don’t be afraid of taking control of your IRA, after all nobody cares more about your retirement than you do.
Timothy A Schubert CISP