Open Self-Directed 401k | Self-Employment vs. Passive Income

BACKGROUND: I called last month to make an initial inquiry about your self-directed 401k services. Today, I have spent a little more time reading your website to learn about the process, and I have come up with a couple of questions that I’d like to ask before moving forward. 

My circumstance right now is that I am a salaried state worker in Oregon with a handful of small state pension accounts, and one very small IRA account. The state pensions cannot be rolled over until I quit my job. I am aiming to go freelance this spring, which will give me the opportunity to roll these pensions into a solo 401K, and hopefully focus my income generation more intensively toward retirement savings growth. I’m 54 years old.

 So, my questions are as follows:

QUESTION 1:      Can I establish the self-directed 401k now, even though I am not going freelance until later this spring? I could roll the small IRA into it for now.

ANSWER: I recommend waiting until you are truly self-employed. Further, you might want to read IRS Pub 560 as it deals with the IRS Solo 401k regulations, the publication dealing with self-employed retirement plans, as it talks about the difference between passive income and earned income, as the former does not qualify for solo 401k purposes. Passive income includes gains from investments whereas earned income stems from personal your personal self-employment services. See page 14 of 29 section titled: “Self-Employed Individual” of IRS Pub 560.

QUESTION 2: May the fee paid to your firm to establish the Solo 401k be paid out of existing pension funds? (I have in mind the IRA mentioned above.

ANSWER: We require payment up front and via credit card. I don’t recommend depleting your tax-deferred funds on admin fees since they can be paid with personal or funds from your self-employed business. Please visit paying Solo 401k expenses to find out the difference between admin and investment expense fees and which type must be paid with personal funds vs. solo 401k funds.

QUESTION 3:  Related to question A, do I need to have an existing business in order to establish the Solo 401K?

ANSWER: Yes to open a solo 401k you need to have a true business that is not considered a passive investment generating company but instead one that you are actively performing services/work for and filing the appropriate tax return to report the earned income.

Please feel free to reply at your convenience. Your advice will be greatly appreciated.

Sincerely,

 MC in Oregon