The operation of a self-directed 401K is much more than just opening an account for the plan. Unfortunately, that is how many people perceive it as the individual 401K plan has much less reporting requirements than its cousin, the multi-participant 401K plan. While certainly not faced with the same type of reporting requirements, the operation of a self-directed 401K plan is still of critical importance.
One aspect related to the operation of a self-directed 401K plan that may help the Trustee understand his/her responsibilities is to understand that the plan has a “life cycle” which is much akin to that of a person. The operation of a self-directed 401K will be much easier to understand if you keep this life cycle in mind.
Similar to a person, the 401K plan life cycle includes its birth, life and termination (we won’t use that ugly word “death”). Let’s look into each of these cycles and how it may impact the operation of a self-directed 401K plan.
401K Plan Birth — The self-directed 401K plan, like any person, has a birth or a creation. It emerges onto the scene ready for the life. When born, the plan is intended to benefit the retirement interests/needs of the participants, but the plan must also be established in compliance with IRS and DOL regulations. As such, plan documents are of critical importance in outlining how the plan will be operated by the Trustee. Further, the plan must have a satisfactory opinion letter on file from the IRS confirming that the plan documents meet the threshold requirements for such plans.
While there are many documents utilized with the operation of a self-directed 401K plan, key documents must include the plan’s Adoption Agreement and Basic Plan Document. These plan documents are written as the road map for the plan to be in operational compliance with IRS and DOL regulations.
Also, part of the birth of the plan is to ensure that plan assets are adequately cared, maintained and accounted for. This can be done, in part, by establishing the correct type of account and sub-accounts for its operation. For example, the plan must have earmarked and designated accounts for various contributory accounts of the plan including pre-tax, Roth, Rollover and Profit Share contributions.
401K Plan Life – The continual, on-going “life” parallels the operation of a self-directed 401K. The operation of a self-directed 401K plan is of critical importance because if it is not administered and operated correctly, the plan can be rendered as disqualified. If disqualified, the plan assets may be determined to be distributed and, as a result, the participant may face excessive taxes and penalties.
The operation of a self-directed 401K includes:
1) Operational compliance with 401K plan documents, and maintaining such including any amendments, updates and re-statements
2) Ensuring that plan transfers and rollovers are executed correctly
3) Verifying that employee and employer contributions are not exceeded and correctly held in stand-alone sub-accounts
4) Maintaining strict compliance with IRS Prohibited Transaction regulations
5) As needed, adequate reporting of plan assets and termination of the plan.
Which leads us to the plan’s….
401K Plan Termination – Unlike an IRA that can seemingly go on forever, this is not necessarily true with any 401K plan, especially a self-directed 401K. Quite bluntly, the plan will terminate. As a business owner, you will not be operating your business forever and the plan will terminate at some point in time. Your responsibility will be to correctly terminate the plan at that time and account for the assets. In many cases, upon termination of the plan, plan assets will most likely be rolled over to an IRA, self-directed or not. At minimum, the plan will need to be terminated through a Form 5500-EZ, which will officially inform the IRS that the plan has been terminated and the disposition of plan assets.
Having responsibilities for the operation of a self-directed 401K, you (the Trustee) have the responsibility to create, operate and maintain, and terminate the plan with IRS and DOL regulations. This is a serious responsibility which, again, is more than opening an account and just making investment choices. If you keep in mind the “life cycle” it may just very well assist you with your responsibilities.
As always, the information provided is intended to be educational in nature. It is not intended, nor should it be interpreted as, any form of tax, legal, financial of investment advice. You must always consult with your respective professional in all such matters.