“Mistakes are portals of discoveries.” ~ James Joyce
Mistakes are undoubtedly true precursors to great discoveries, and mistakes indicate that you are trying to improve your life. However, some mistakes are more expensive than others. For example, releasing a product that has not received the required traction increases your training, but a financial mistake that can impose severe penalties and destroy your financial resources is expensive.
One such costly mistake in the financial life of Solo 401k retirement plan owners is to engage in prohibited transactions. With a core clientele involving small business owners and self-employed professionals, we hold events, discuss the responsibilities of plan owners and the latest rules to follow. Our team decided to take a look at some of the most common mistakes Solo 401k retirement plan owners make.
What are the prohibited transactions in the Solo 401k retirement plan?
In the case of the Solo 401k pension plan, none of the regulations, including the Pension Income Security Act (ERISA) or the Internal Income Code (IRC), defines eligible transactions for the plan. Instead, they discuss who or what is prohibited from investing, and these transactions in the Solo 401k plan are called prohibited.
One of the common features of a prohibited transaction is the participation of a disqualified person. Simply put, a disqualified person is either the owner, or service provider, or beneficiary of the Solo 401k plan, or certain family members of those parties. The main reason for describing prohibited transactions is to ensure that this retirement tool is not used for the personal benefit of the plan owner.
Sale, lease or exchange of property for a disqualified person
4975 (c) (1) (A): Direct or indirect sale, trade or lease of property between a Solo 401k plan and a “disqualified person”.
The tax office allows you to invest in real estate, but it is important that these transactions are carried out at arm’s length, which means that the owner of the plan or another disqualified person should not receive personal benefits from the plan. Let’s look at a few examples of prohibited transactions.
Nathan uses his Solo 401k fund to buy property owned by his father.
Amanda is selling the property she owns, according to the Solo 401k plan.
Mark rents his son property belonging to his Solo 401k plan.
Joe uses his personal funds to pay for the closing costs associated with his Solo 401k real estate investment plan.
In each of these examples, a disqualified person is present, including the owner of the plan, or their descendants or ancestors. The IRS prohibits any such transactions that directly or indirectly involve a disqualified person.
Loan money or credit to a disqualified person
4975 (c) (1) (B): Direct or indirect borrowing of money or other loan extension between a Solo 401k plan and a “disqualified person”.
Under the rules of the Tax Code, a Solo 401k plan that lends money or any other form of credit to a disqualified person is considered a prohibited transaction. Some examples of such operations are given below.
Judy offers a personal mortgage guarantee to purchase a residential property in her Solo 401k plan.
Martha lends her husband $ 30,000 from the Solo 401k plan.
Mitchell acquires a credit card for his Solo 401k bank account.
Jason borrows a loan from a company that is controlled and owned by his father.
Exchange of goods, services or facilities with a disqualified person
4975 (c) (1) (C): The direct or indirect provision of goods, services or facilities between a Solo 401k plan and a “disqualified person”.
Current IRC guidelines prohibit Solo 401k plans from receiving any services from a disqualified person. It can be something simple, like painting a house, to address basic design issues. Some examples of such prohibited transactions are mentioned below.
Ron acquires the property using his Solo 401k, and fixes it himself.
Sally hires her father to manage the property belonging to her Solo 401k plan.
Tiffany prepares an investment plan for her Solo 401k and receives compensation for it.
Doug acts as a real estate agent for the property acquired by his Solo 401k.
Transfer of income or property to a disqualified person
4975 (c) (1) (D): Direct or indirect transfer to a “disqualified person” of income or assets of the Solo 401 (k) plan.
Assets or profits earned by investing in the Solo 401k plan should not benefit disqualified individuals directly or indirectly. Some examples of such prohibited transactions are discussed below.
Merisa uses $ 10,000 from solo 401,000 bucks to pay off personal debt.
Harry lives in a house owned by his Solo 401k plan.
Steve contributes the proceeds from the lease of the Solo 401k property to his personal bank account.
Rob borrows money from his Solo 401k company he runs.
The Solo 401k plan can accelerate retirement savings and help you quickly build a significant nest; however as a sponsor / trustee of the plan you are required to ensure compliance of the plan with the law. Never hesitate to seek professional help, especially when it comes to something as important as retirement planning.