A couple of weeks ago, a client forwarded an email with a link to a webinar made by a self-directed IRA and 401(k) promoter. The webinar was your typical webinar that spent a significant amount of time talking about the superiority of the company in establishing self-directed plans and guiding their clients to great wealth through proper planning of their investments with their self-directed plans.
What was of concern during the webinar were several comments made which, at best, were misleading. The focal points that were misleading were:
1) The representation was that the company had somehow discovered a “special” IRA that was “different” than all other IRAs. An inference was made that this type of IRA provided greater protection to the client of their IRA assets against perceived Federal take-over of IRA retirement plans. The promoter went as far as saying that while IRAs fall under the governance of Section 408 of the tax code (which is true), this special IRA falls under Section 401(a) of the tax code.
What is the problem? Well, first, there are no special IRAs that no one else knows about. There are no IRAs that provide any additional asset protection over any other IRA. Second, all IRAs fall under Section 408 of the Code and no IRAs fall under Section 401(a) of the Code. Internal Revenue Code Section 401(a) pertains to qualified retirement plans….which, by the way, includes 401(k) plans. Was the promoter trying to promote a simple 401(k) plan as a “special” type of IRA? Yes….but how is this known?
From the promoters themselves. You see, while they monopolized every webinar attendee’s time by spending about an hour preaching about the wonders of this special IRA, they later mention…and very few times no less….that they are speaking about a 401(k) plan. The promoters went out of their way still referring to it as a special IRA when it is not an IRA at all…it is a 401(k).
2) So, let’s overlook issue #1 and pretend that instead of talking about this special IRA they had actually referred to this self-directed plan as what it actually was….a 401(k) plan. While I would agree with the promoters that, generally speaking, the 401(k) is a much better retirement plan tool one should consider over any IRA, there is a key point to establishing a 401(k) plan….self-directed or not. You MUST qualify for the 401(k) by having a sponsoring business entity (e.g., sole proprietorship, LLC, S-Corp, C-Corp) for the plan. You must have self-employment activities for a legitimate business that is attempting to generate profits and, eventually, make contributions to a 401(k) plan.
The promoters, then, suggested that one could qualify for self-employment activities (if they were not already self-employed on either a full or part-time basis) by linking other potentially-interested, self-directed candidates to the website of the promoter. Questionnable? Many would say so. Miselading? Probably. Some might think that this type of “self employment” may be nothing more than a hobby vs. self-employment. This leads to an obvious question. If one wants to establish a full or part-time business to better themselves financially and, possibly, establish a 401(k) plan for that business, how would the IRS define what constitutes self-employment activities?
The IRS states:
“Generally, you are self-employed if any of the following apply to you.
– You carry on a trade or business as a sole proprietorship or an independent contractor.
– You are a member or a partnership that carries on a trade or business.
– You are otherwise in business for yourself (including a part-time business).”
Let’s delve a little further in determining how the IRS defines “a trade or business” as that term seems pretty prevalent in their definition of self-employment activities. According to the IRS:
“A trade or business is generally an activity carried on for a livelihood or in good faith to make a profit. The facts and circumstances of each case determine whether or not an activity is a trade or business. The regularity of activities and transactions and the production of income are important elements. You do not need to actually make a profit to be in a trade or business as long as you have a profit motive. You do need, however, to make ongoing efforts to further the interests of your business.”
Obviously, while there are many key references within the definition, one important statement is that the “facts and circumstances” of each case will be used to determine whether or not an activity is a trade or business. One might want to ask themselves….Do I want to face an IRS agent and justify that my their “business” or “self-employment” is truly an active business? Does a simple act of “linking” other individuals to a third-party company’s website meet the standard? Each person has to answer that for themselves….but, I would rather not.
Finally, it is true that one can establish a 401(k) plan for their side business even if they participate in a separate 401(k) plan with their full time employment as a W-2 employee. But, how does the IRS define self-employment? According to the IRS:
“You do not have to carry on regular full-time business activities to be self-employed. Having a part-time business in addition to your regular job or business also may be self-employment. Example: You are employed full time as an engineer at the local plant. You fix televisions and radios during the weekends. You have your own shop, equipment, and tools. You get your customers from advertising and word-of-mouth. You are self-employed as the owner of a part-time repair shop.”
3) Representing that there is a special type of IRA when there is not. I mean all IRAs may be “special”, but there is not a special type of IRA that one company knows about and no others. Further, the promoter insinuated that they were limiting the number of people who could sign up for this special self-directed plan (at a special fee of course) as they didn’t want too many people signing up for something that the IRS would then try to shut down. On all fronts, all it appeared is that the promoters sold the event as a special educational event that no one else was providing…..when, at the end, all they were doing was misrepresenting a 401(k) plan as an IRA, a plan that was “special” when, quite honestly, it is available to anyone who qualifies for the plan.
Is self-direction right for you? Who knows…only you can make that decision. But when educating yourself about self-directed plans, do your due diligence and question references to “special” plans.
As always, the information provided is not intended, nor should it be interpreted as, any form of tax, legal, financial or investment advice. Always consult with your tax or legal professional in all such matters.