Solo 401k questions: qualification, Roth contribution, and adoption deadline

  

Good morning,

BACKGROUND: I have been considering starting an account before the end of the year.
 

My situation may be slightly different than what you're used to seeing.
I've been looking at the traditional self-directed IRA options (truly
self-directed) using custodians, etc.  My direction was to open a
standard SD IRA and a Roth.  Fund the standard IRA fully once per year
and convert it to the Roth.  (I can't contribute to a Roth due to
income.)  I planned to "invest" in a trust with all of the assets of the
Roth, and make investments through the trust, thus achieve checkbook
control over the entire account.  I've known about solo 401k options for
a while, but didn't think they would work for me.  I'm rethinking that
now that I've come across your website.  So, I have a few questions that
I hope you won't mind answering for me.

Here's my situation.
 

I do own a business, but almost none of my income is earned income.
It's all interest and investment income.  But I can convert all or part
of it to earned income at any time to create income that is eligible for
a solo 401k.
 

I do not have any employees in my business.
 

My wife's earned income is over $200,000 per year.
 

My wife has 401k options available at her work, but does not utilize
them in an way.  We have no other IRA accounts of any kind.
If possible, I prefer to get my money into a Roth, ultimately.

Given these facts, my questions are:

QUESTION 1) If I convert some of my business income to earned income, am I
eligible to open a solo-401k?

ANSWER: As long as you are doing actual work yes. However, if you are not doing work for the business it is not a good idea to just simply treat some of the passive income as earned income as it may be construed by the IRS as trying to circumvent the solo 401k self-employed qualification rules. This may be hard to track by the IRS but it may come up in the event of a routine audit.

QUESTION 2) If I were to hire part time employees, would I still be eligible for
solo-401k?

ANSWER: Yes as part-time employees (those working less than 1,000 hours per year) may be excluded from the solo 401k plan.

QUESTION 3) Do my wife and/or kids count as employees?

ANSWER: Spouses count as owner only employees. Children may not participate in the solo 401k plan.

QUESTION 4) Can I open a solo-401k Roth and convert what's in the solo-401k each
year into the Roth account each year, like described above?

ANSWER: Yes the solo 401k allows for what the IRS calls Roth Designated contributions, meaning that the employee contribution ($17,500 for 2013)   may be applied as a Roth 401k contribution. Yes the pre-tax solo 401k contributions may be converted to a Roth solo 401k.

QUESTION 5) If I can't do 2, can I sweep the solo-401k into a standard custodial
self-directed Roth IRA?

ANSWER: Yes the Roth solo 401k amounts may be transferred to a Roth IRA; however, the transfer would need to be reported on Form 1099-R as non-taxable.

QUESTION 6) My wife received half of the unearned income from the business.  If I
convert some of it to earned income, as in #1 above, is she eligible for
any of this even though she's also employed otherwise?

ANSWER: Yes as long as she has true earned income from self-employment activity. Yes the rules allow for contributions to multiple retirement plans (e.g., full-time employer plan and part-time self-employed plan).  

QUESTION 7) Aside from contribution limits, are the rules and regulations on
management of the solo accounts the same as they are for the standard
self-directed accounts?

ANSWER: Yes for the most part. But variances exist. For example, unlike an IRA, the business owner may borrow form his or her solo 401k. This is known as a solo 401k loan. Also, UBIT does not apply to most solo 401k investments in real estate, but it does to an IRA.

 
QUESTION 8) If it looks like I can make this work, can we get it done by the end
of the year so that I can fund the account fully for 2013?

ANSWER: Yes as we can generally draft the solo 401k documents in 24 hours after you fill out the information on our solo 401k sign up page. Note that the solo 401k needs to be adopted (i.e., the solo 401k documents must be signed) by 12/31 in order to make the annual solo 401k contribution by next year’s business tax return due date plus extensions.

I know it's a lot of questions.  I apologize for inundating with so
many.  Hopefully, you'll be able to help me with them and we can get
started on this.

Thank you!

David in Arizona

Why a Self-Directed IRA LLC

This blog posting covers the IRA LLC process and rules.

The self-directed IRA LLC process entails the following:

Step 1: Transferring IRA or 401k funds to a self-directed IRA custodian: First transfer your current IRA or former employer 401k plan or other type of qualified plans such as a 403(b), 457 or Defined benefit to a self-directed IRA custodian that allows for investing in private companies, as an LLC falls under the private company or private placement category.

Step 2:  Working with RA LLC Facilitator: Choose a self-directed IRA LLC facilitator company that will register the LLC with the applicable state, obtaining the employer identification number (EIN) for the LLLC and preparing the IRA LLC operating agreement containing the specific IRA language. Note that an off-the-shelf LLC operating agreement from Legal Zoom is not recommended as it won’t contain the required IRA language.

Step 3.  Open the LLC bank account at your local bank. Before the LLC IRA can be funded, you must open a checking account at your local bank in the name of the LLC.

Step 4.  Fund the IRA LLC: After the self-directed IRA has been setup, your former IRA or qualified plan transferred to the new self-directed IRA custodian, and the LLC operating agreement and related forms (LLC EIN, LLC articles of organization, and investment forms) submitted to the self-directed IRA custodian, the new self-directed IRA custodian will wire the funds to the new LLC bank account.

Step 5. Begin placing IRA LLC investments. As the manager of the IRA LLC, place investments in alternative investments such as real estate, promissory notes, tax liens, private placements and precious metals, to name a few.

IRA LLC is a self-controlled investment vehicle in which the Self Directed IRA becomes the member in the newly formed LLC by purchasing units of the LLC.  In the IRA LLC structure the Self Directed can be a full or partial owner of the newly formed LLC. The IRA LLC’s management is vested in the manager(s) where the IRA holder may act as the manager of the IRA LLC.  A key feature of the IRA LLC is the checkbook control. This allows you as the manager of the IRA LLC to direct investments by simply writing a check. IRA LLC offers you a repertoire of investment possibilities that are unlimited, which include real estate, gold, private loans and much more.

Why a Self-Directed IRA LLC

·         IRA LLC allows for holding of alternative investments in the name of the LLC instead of using a self-directed IRA custodian, resulting in far less custodian involvement and thus removing limitations placed by the IRA custodian.

·         IRA LLC allows for multiple investment holdings at no cost whereas the self-directed RA custodian charges transaction fees and holding fees per investment, both at the front and back end.

• IRA LLC arrangement results in processing timely investments because as the manager, you process purchases by writing checks or having the funds wired.
• IRA LLC provides a multi-layer protection against liabilities because investments are made in the name of the LLC not the IRA.
• IRA LLC allows partnering with other investors.
• IRA LLC allows for non-recourse loan/debt financing when investing in real estate.

Self-Directed IRA LLC Rules 

• The same IRA prohibited transaction rules that apply to an IRA apply to an LLC only having and IRA or multiple IRAs as the members.

• An IRA may be a member of an LLC through the purchase of LLC units.

• When an IRA is the sole member of an LLC, the LLC is deemed a single member LLC and thus classified as a disregarded entity.  As such, an LLC where the single-member is an IRA, the LLC does not file a business-tax return.  

• IRA can own a 100% of a newly formed LLC. Important: It is imperative that the LLC is newly registered and units issued for the first time in order for an IRA to own 50% or more of the LLC member units. If not, the transaction will be deemed a prohibited transaction.

• The manager of the IRA LLC may not be compensated if the manager is the IRA owner or a disqualified party (e.g., the IRA owner’s spouse, kids, parents and financial professionals).

• IRA LLC investments must be titled in the name of the LLC not your name or in the name of the IRA.

• IRA LLC bank account may not to be co-mingled with your personal funds.

• Investment gains and expenses must flow through the IRA LLC bank account. Therefore, if the LLC invested in a fixer-upper, you may not pay for such repair expenses with personal funds butrather use IRA LLC funds.

• IRA owner is prohibited from personally guaranteeing debt on behalf of the IRA LLC.

• When an LLC obtains a non-recourse loan from a third-party, usually for investing in real estate, the LLC must secure the loan and thus LLC funds must be used make the loan payments.

• Annual IRA contributions and IRA/401k transfers must flow to the self-directed IRA not the IRA LLC.

 For more information click here.