Self-Directed 401K Plans — Don’t Trip

It’s a nice day, you are taking a nice casual walk and almost like someone playing a joke on you, you stumble while you are walking and almost fall flat on your face.  You look back, firmly believing that someone left something out to purposely make you look foolish, and what do you see?  Yes, that small crack in the sidewalk that most people wouldn’t trip up on unless they were dragging their feet.  You wonder how you could get tripped up on something so small.

Well, the same can be true with a self-directed 401(k) plans and IRS Prohibited Transactions.  In and of themselves, they are not difficult to navigate, but it sure does seem like a lot of people fall over them….just like the crack in the sidewalk.  But, just like falling over that crack, some of us almost fall and then realize to our own embarassment that we almost entered into an IRS prohibited transaction without even intending to do so.

So, what are some of these “cracks”?  Well, for this blog post, we are going to address a key point that is NOT a Prohibited Transaction.  In the next blog post we will address the PTs….so what is this one non-PT that can drastically affect the establishment of a 401(k)?!

Qualifying for a 401K — Many people are enamored with the benefits associated with a 401(k) vs. its lesser counterpart, the IRA. I mean, who wouldn’t like a plan where you can contribute more, take out loans, possibly have no annual fees, not get stung by UDFI taxation and, if you make an error in your plan, you wont necessarily get killed by early distribution penalties and taxes.

BUT, there is a key point.  You must qualify for the plan.

Yes!  Go figure, huh.   The IRS does not prohibit you from participating in more than one 401(k) plan, but it DOES limit your contributions to annual contribution limits.  And, you must qualify for the plan.  For a breakdown on qualifying for a 401(k) plan, keep in mind that the first condition is that you ACTUALLY have a business or side business (if a W-2 employee) that can sponsor the plan and is a justifiable business.   This isn’t rocket science, but it is one that people may try to take advantage of.

Let’s delve in this a bit further…..while each case is viewed on its own merits, let’s discuss the next concern.  The intent of establishing a 401(k) plan is to plan and contribute for your retirement…not just necessarily rolling over funds from other plans just so you can “get your hands on those funds”, when you have no interest in “working” your business or making future contributions to the plan.

(and, if you don’t think that the IRS would not look at this issue if your plan was audited, don’t bet the farm on it).

So, explore the wonderful opportunity afforded to you by self-direction and establishing your own 401(k) plan.  Just remember that you must qualify for the plan.

As always, the information provided is not intended, nor should it be interpreted as, any form of tax, legal, financial or investment advice.  You must always consult your respective professional.