Can a self-directed 401k accept a non-recourse loan with the purpose or using the money to fund a loan the 401k will give to a rehabber?

QUESTION: Can a self-directed 401k accept a non-recourse loan with the purpose or using the money to fund a loan the 401k will give to a rehabber? 

ANSWER: It is our understanding that non-recourse loan funds may only be incorporated in conjunction with the planned self-directed 401k owned property—that is, the debt financing proceeds must be used to purchase the property not for rehabbing the property. Of course, the non-used self-directed 401k funds may be utilized to improve or develop the property.

QUESTION CONTINUED: As an example, non-disqualified lender makes 5% non-recourse loan to my 401K. My 401K loans money to rehabber at 12% (rehabber is also a non-disqualified individual). Rehabber pays 12% interest and principle back to 401K. 401K pays back lender at 5%. 

In a sense my 401K earns 7% interest on the deal with none of its own money invested. 

ANSWER CONTINUED:  Our understanding is that the self-directed 401k cannot obtain a loan for the purpose of reinvesting the borrowed funds in a promissory note (e.g., the 401k loans the borrowed funds to a rehabber and charges an interest rate of return).  The only circumstance where funds maybe loan to a solo 401k other than for the purpose of investing in real estate directly (non-recourse loan) is if the 401k runs into liquidity problems.  Click on ProhibitedTransaction Exemption 80-26 (PTE 80-26) to read our blog surrounding this topic.

Regards,

Christine in Florida

Solo 401k Retirement Account Planning question

BACKGROUND & QUESTION: Please address my particular situation retirement account planning situation.  My wife is a realtor that we currently report via schedule C.  We want to establish an LLC for her that we both own 50/50 and a related 401k for investments and real estate related earnings.  I am a W-2 employee with a traditional IRA held at Fidelity investing in stocks that I would like to transfer to the 401k.  How can we optimize this structure?  If we do it right we should be able to max out the yearly contribution tothe Solo 401k.

ANSWER: Because a solo 401k is for spouses who are self-employed, as long as you are both performing self-employment activity whether through an LLC or a sole proprietor entity type, you can both participate  the plan—meaning, that you can each transfer retirement accounts from former employers or your Fidelity Traditional IRA to the new solo 401k and then invest the solo 401k funds in alternative investments such as real estate, tax liens, trust deeds, precious metals, in addition to equities.  Again, if you both want to open a solo 401k and both plan to participate in the solo 401k plan, you both must be self-employed (this means performing services that are intended to lead to earned income, as passive income(gains from investments) does not qualify). See IRS publication 560 for more information on qualifying for a solo 401k as well the definition between earned income and passive income.

Lastly, note that the earnings generated from the solo 401k investments (e.g., real estate rentals) must flow back to the solo 401k account and not your personal account or business account. Reason being, solo 401k assets may not be commingled with the solo 401k owners personal assets and the solo 401k distribution rules come into play when distributing funds from the solo 401k.

Thanks,

Sam in Dallas Texas  

When does it make more sense to participate in a solo 401k over a SEP IRA?

 QUESTIONS: If my goal is to contribute a maximum of 25% of my income up to $44k a year and only invest in equities then a SEP IRA is the way to go. However, if my goal is to contribute 25% of my income up to $44k, as well as an additional solo contribution and have the flexibility to invest in equities and/or private investments then solo 401k is a better option. For example, on $144k salary I am limited to 25% or $36k with a SEP IRA. However, with a solo 401k, I could contribute the $36k SEP portion, as well as $15k solo 401k portion.

To get this started, we could set up a solo 401k through same financial institution (LPL) as my SEP IRA and continue to have the equities portion managed by my financial adviser moving forward.  Based on $144k income, I would continue to put $36k into it each year. Additionally, i would contribute $15k (based on $144k salary) to my new solo 401k and would have this money available for private investments.  

Is this correct?

ANSWER: You are correct with respect to the above except that LPL would not setup the solo 401k, but rather manage the funds. As the solo 401k provider, we would take care of the solo 401k compliance requirements in conjunction with you, such as filing the annual Form 5500-EZ, providing the solo 401k plan document updates, 1099-R reporting and solo 401k loan document preparation.  

Thanks, 

Rick in San Diego CA