401(k) Frequently Asked Questions
- What is a Self-Directed 401(k)?
- What is a TRUE Self-Directed 401(k)?
- What can I invest in if I have a Self-Directed 401(k)?
- What types of retirement accounts can be moved into Self-Directed accounts?
- Is this new?
- Why haven’t I heard of this before?
- Are there downsides?
- Why is there so little information available on Self-Directed 401(k) options?
- How do I get checkbook control of a Self-Directed 401(k)?
- Do I get complete control?
- How do I know that this is legal?
- Can I transfer funds from a 401K, IRA, Sep IRA, Roth IRA, or 403b and direct investments myself?
- Can I invest my Self-Directed 401(k) in Real Estate?
- What does the IRS think of investing your Self-Directed 401(k) in Real Estate?
- Can my Self-Directed 401(k) purchase Real Estate I already own?
- Why does my current broker say I can’t buy Real Estate in my 401(k)?
- What is the easiest way to buy Real Estate using my Self-Directed 401(k)?
- If I buy an income producing rental property, what happens to the rent income?
- I don’t have enough money in my 401(k) to purchase a piece of property outright. Can my Self-Directed 401(k) Plan get a loan and use my 401(k) money as the down payment?
- My 401(k) is small. Can I personally co-invest with my Self-Directed 401(k)?
- Can my Self-Directed 401(k) co-invest with friends?
- Can I be the property manager of the Real Estate?
- May I use my Self-Directed 401(k) funds to make improvements or renovations?
- Can I buy vacation property?
- Can I buy my dream retirement home with my Self-Directed 401(k) and then live in it when I reach the age of retirement?
- What are the advantages of using a Self-Directed 401(k) plan when investing my 401(k) in Real Estate?
- Can my Self-Directed 401(k) Plan get a mortgage on a piece of property?
- Can my Self-Directed 401(k) Plan make loans to other individuals who want to buy Real Estate?
- Can I make a loan to my brother so that he can use the money as a down payment on a home?
- Can my Self-Directed 401(k) Plan make loans to a friend?
- Can my Self-Directed 401(k) Plan make loans to a Real Estate developer?
- Can my Self-Directed 401(k) Plan make loans to businesses or companies?
- Do taxes and penalties apply when I take money out to buy Real Estate?
- Are the gains that my Self-Directed 401(k) Plan makes taxable?
- Are there any special taxes that apply when I use leverage?
- Does it still make sense to use leverage?
- Can I invest outside of my state or outside the country?
- What are Prohibited Transactions?
- What are Prohibited Investments?
- Who is a disqualified person?
- How am I a disqualified person? It doesn’t seem to make sense.
- What would be classified as Self Dealing?
- What are some examples of Prohibited Transactions and / or Self-Dealing Transactions?
- What are Exemptions?
- Can I buy a business with my Self-Directed 401(k) Plan?
- Can I invest in an existing business?
- What about S-Corporations?
- Can I buy Stocks, CDs, Bonds, Options, etc.?
- I have a 401(k) with an old employer. Can I move it into the Self-Directed 401(k) Plan?
- I have a 401(k) with my current employer. Can I move it into the Self-Directed 401(k) Plan?
- I have several IRAs and old 401(K)s. Can I combine them?
- How can I get more information?
- How do I get started?
- Can I use my 401k to buy a house? / Should I finance my house using 401K fund?
- Can I withdraw money from my Roth IRA?
- How much can I borrow from my 401K?
Legally speaking, a self-directed 401(k) is no different than any other 401(k). Having a self-directed 401(k) simply means that you are allowed to direct the investments of the 401(k). Many financial institutions claim that they allow you to self-direct your 401(k) investments but then turn around and restrict what you can invest in. A truly self-directed 401(k) allows you to make the decisions without restriction.
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It is a step further towards putting you in full control of your 401(k). You don’t have to go to your financial institution to get approval of the investment and get a check written. You truly have a self-directed 401(k) because you have checkbook control.
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The investments that you make outside your 401(k) can now be made within it. You the investor have tremendous flexibility to make the investments of your dreams. Wouldn’t you love to be able to invest your 401(k) in:
- Residential Real Estate
- Commercial Real Estate
- Raw Land
- Trust Deeds / Mortgages, and Mortgage Pools
- Private Notes and Loans
- Private Stock Offerings
- Limited Liability Companies (LLCs)
- Limited Partnerships (LPs)
- Tax Certificates
- Receivables
- Stocks, Bonds, Mutual Funds
- Annuities
- Options
- Currency
- Futures
- Commercial Paper
- And MANY other investments!
- Traditional IRAs
- Sep IRAs
- Roth IRAs
- 401(k)s
- 403(b)s
- Coverdell Education Savings (ESA)
- Qualified Annuities
- Profit Sharing Plans
- Money Purchase Plans
- Government Eligible Deferred Compensation Plans
- Keoghs
No. There are two TRILLION dollars held in retirement accounts; however, only about 3% of retirement accounts are self-directed and only about 2% are invested in Real Estate. But what most people don’t know is that the stock market isn’t your only investment choice for your Self-Directed 401(k). You have been able to invest in Real Estate since the day 401(k)s were created. That was about 30 years ago!
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Who would tell you? Your stock broker? They will only let you invest your 401(k) in investments that their firm offers. At a bank you will be limited to CDs. At a brokerage firm you will be limited to stocks and bonds. As a consequence and unfortunately for many investors, it has been a well kept secret that they have other options for their 401(k)s. The traditional investment community has had control of over 97% percent of retirement accounts and they have been making a great living off your accounts. Why would they want to let you know of alternatives that they wouldn’t benefit from?
As investors have become more disillusioned and frustrated with traditional investment choices, they have begun looking for alternatives. After the steep stock market decline, corporate scandals and corruption (e.g. Enron, ImClone, Worldcom) and many investors seeing their retirement accounts cut in half, they are ready to take control of their own investments. They often want more tangible investments such as Real Estate.
However, when they ask their current custodians / brokers, they are typically told that such investments are illegal, too complicated or that it can’t be done. But those are ignorant and self-serving responses. Although those custodians / brokers may not allow it, it can be done. It is just likely you can’t do it through your current custodian so they financially suffer if you make a move. They aren’t going to tell you about it.
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The only downside is that some people don’t want to be in charge of their own retirement investments. They are happy having someone else make all the decisions. A self-directed 401(k) is not right for them.
For the rest of us who want to be involved in our retirement investments and make decisions that will affect our retirement, there are no downsides. Just be aware of the prohibited transactions / restrictions (no self-dealing). We firmly believe that you are the best steward for your money. Nobody cares as much about your retirement as you do.
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The traditional investment community has control and is making money of over 97% of the retirement accounts. Why would they want you to know that you had other options, and risk losing the commissions on your retirement accounts?
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Many people and advisors equate a Self-Directed IRA and a Self-Directed 401(k) as being the same. They are not — they have similarities but are quite different. One major difference is: Self-Directed IRAs require a custodian, while Self-Directed 401(k)s DO NOT. The trustee of the Self-Directed 401(k) plan calls all the shots. For example, in the Self-Directed 401(k) plan for John Smith known as the “John Smith 401(k) PSP,” Mr. Smith is the trustee, and he is in complete control of the plan.
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Yes, as stated in the answer for #9, the Plan Trustee writes the checks and controls the investments. There isn’t a need for an LLC (as with Self-Directed IRAs) to obtain checkbook control.
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This is a question that is frequently asked by investors who have never heard that they could invest in anything other than stocks and bonds. They have no idea that they can invest in Real Estate and many other investments. However, Real Estate has been an allowed investment since the day 401(k)s were created.
Find out for yourself by going to the Internal Revenue Service’s website at www.IRS.gov. Request Publication 590. On pages 40-41 you will see what investments are not allowed (see below – collectibles, life insurance, s-corporation stock, etc.). Real Estate is NOT mentioned as a disallowed investment just like stocks, bonds, mutual funds are not mentioned as a disallowed investment.
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Yes. You can self direct all of these types of accounts. They can all be invested into the Self-Directed 401(k) for truly self-directed investing.
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Absolutely. Although less than 3% of retirement accounts are invested in non-traditional investments (anything other than Dow & Nasdaq stocks, bonds, CDs, etc), and less than 2% are invested in Real Estate, that is changing. More and more individuals are becoming more and more frustrated with the options offered by their current custodians. Individuals are exploring investments that they can see and touch and that have some tangible value such as Real Estate. They have seen the outstanding returns that investors have historically received in Real Estate and want to move all or part of their retirement money into various Real Estate investments.
Within the broad category or Real Estate there are many options for investment:
- Residential Rentals
- Commercial Properties
- Condominiums
- Mobile Homes
- Raw Land
- Real Estate in Foreign Countries
- Trust Deeds / Mortgages, and Mortgage Pools
The IRS rules do not prohibit Self-Directed 401(k)s from investing in real estate.
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No. This would be considered a prohibited transaction (see IRC 4975). You many not purchase property which is currently owned by you or any other disqualified person (see below). You would need to find another piece of Real Estate that you don’t already own to purchase.
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Likely because your current broker won’t let you invest in real estate through their custodian. Just because that isn’t something they offer doesn’t mean that you can’t do it; It just means that you can’t do it through them. It is a limitation that your broker is placing on your 401(k) NOT one that the IRS is placing on your 401(k). Or your current broker may just be ignorant. Either way, you can invest in Real Estate.
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A truly Self-Directed 401(k) plan easily allows you invest in real estate. Because your plan has a checking account, you simply write a check to the title company, etc., and title the real estate in the name of the plan.
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The income goes back into the Self-Directed 401(k) plan, and you retain the tax deferred or tax free status of the investment.
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Yes you can use your 401(k) money as the down payment and then have your Self-Directed 401(k) plan get a loan for the balance. However, you will not be able to personally guarantee the loan. It must be a non-recourse type of loan which means that if your 401(k) fails to make payments, the only recourse the lender has is against the property itself. Further, there will be tax ramifications to doing so; UDFI (unrelated debt financed income) tax applies when a loan is obtained so you would want to confer with your tax professional about what forms would be necessary.
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It would be a prohibited transaction to co-invest your personal funds with funds of the plan.
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Yes. Self-Directed 401(k)s may purchase an undivided (and proportionate) interest in Real Estate.
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As trustee of your self directed 401(k) plan, you have complete checkbook control of all investments the plan makes. For example, if you decide to purchase real estate, you (as trustee) can locate the property, purchase the property and manage the property. Managing can include collecting the rents, and paying expenses such as insurance and handyman services. You personally cannot go in and “change the light bulb.” That could be construed as “sweat equity,” and is not allowed. Remember, you are a disqualified person to the plan and must pay non disqualified persons to effect repairs, etc. Managing your investment property yourself can save the expense of management firms and help to increase your rate of return.
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Yes. In fact, you must use Self-Directed 401(k) funds to make the improvements and pay all expenses associated with the property. All expenses of the property are paid with Self-Directed 401(k) funds, and all profits made on the property are returned to the Self-Directed 401(k). This makes sense because it is an investment of the Self-Directed 401(k).
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Yes. Doing so would not constitute a prohibited transaction. However, you cannot vacation there.
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Yes. Your Self-Directed 401(k) would be the original owner. You would use your Self-Directed 401(k) money to make the purchase and maintain the property. Any rents generated would be returned to the Self-Directed 401(k). However, upon reaching retirement age, the property could be distributed out to you. Of course, you would have to pay taxes at that point but without penalty.
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Real estate deals can be time sensitive. With a true Self-Directed 401(k), you can act immediately to secure the down payment, etc. If you see something you like, write the check.
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Yes. The mortgage would need to be a non-recourse type of loan, meaning that if your Self-Directed 401(k) fails to make the payments, the only recourse the lending institution has is the property itself. Also, be aware that if your Self-Directed 401(k) obtains a loan, unrelated debt financing income tax will apply.
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Absolutely. And this is done frequently, and it is a great investment for your Self-Directed 401(k) because the loan can be secured by the property.
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Yes. According to IRC 4975, siblings are not included in the definition of disqualified persons. Thus, a loan to your brother would not be a prohibited transaction. Although some suggest that it was an error on the part of the IRS to omit siblings from the definition, they, nonetheless, were omitted and to the best of our knowledge, there has never been an IRS ruling to the contrary.
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Absolutely. Friends are not disqualified persons under the Code, and therefore, your Self-Directed 401(k) can make a loan to them for any purpose whatsoever (boat, airplane, hot tub, home improvements, etc.). Of course, you want to make sure that there are proper formalities and reasonable terms to the loan.
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Yes. Your Self-Directed 401(k) can loan money to a Real Estate developer to finance the purchase of property or the development of property. Developers often look for private financing so it is a great way to get your Self-Directed 401(k) involved in Real Estate development. And because developers often pay an above market interest rate, the loan can be a great investment for your Self-Directed 401(k).
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Sure. Your Self-Directed 401(k) can make a loan to any type of business. However, be aware that there are some restrictions on loan money to any business that you or any other disqualified person has an ownership interest in.
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No. You DO NOT take money out to purchase Real Estate or anything else you want to buy. It is just a purchase of your Self-Directed 401(k). There are no taxes or penalties. Instead of buying 1000 shares of Microsoft or any other typical stock, your Self-Directed 401(k) is just making a different type of investment. The method of doing so is different but the tax ramifications are the same.
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Not in most cases. If a Self-Directed 401(k) buys a piece of property and then sells it at a profit, the gains stay within the Self-Directed 401(k). If you have a traditional 401(k), the gains are tax-deferred. If you have a Roth 401(k), the gains are tax free. Note, you alter that result if you use leverage.
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Unrelated debt financing for real estate purchases DOES NOT apply. It does with a self-directed IRA, so this is a huge advantage.
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Absolutely, because of your increased buying power when you use leverage.
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Yes! Your Self-Directed 401(k) can invest outside of the U.S. States. There are many great investment opportunities in other countries.
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Understanding what constitutes a prohibited transaction is very important when it comes to making investments within your Self-Directed 401(k). The IRS defines a prohibited transaction as follows:
“Generally a prohibited transaction is any improper use of your 401(k) account or annuity by you, your beneficiary or any disqualified person. Disqualified persons include your fiduciary and members or your family (spouse, ancestor, linear descendant, and any spouse of linear descendant).” IRS Publication 590
IRC 4975 is the section that lays out the rules on prohibited transactions. Prohibited transactions generally involve one of the following: (1) doing business with a disqualified person; (2) benefiting someone other than the 401(k); (3) loaning money to a disqualified person; or (4) investing in a prohibited investment.
In plain English, prohibited transactions are those transactions that violate the basic intent of the 401(k). Your Self-Directed 401(k) must benefit rather than benefiting you personally. In other words, there can be no “self dealing” transactions. However, there are many ways in which you can invest your Self-Directed 401(k) and not be in violation of the prohibited transaction law. And when your Self-Directed 401(k) benefits, you benefit because it is for your retirement.
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The Internal Revenue Code does not specifically authorize investments within a 401(k); rather, the code outlines what types of investments are not allowed. The Prohibited Investments include:
- Artwork
- Rugs
- Antiques
- Metals
- Gems
- Stamps
- Collectible Coins
- Beverages
- Stock in a S-Corporation
- And certain other tangible personal property
- the 401(k) holder and his or her spouse;
- the 401(k) holder’s ancestors, lineal descendants and their spouses;
- investment advisors and managers
- any corporation, partnership, trust or estate in which the 401(k) holder has a 50% or greater interest; and
- anyone providing services to the 401(k) such as a trustee or custodian.
There is a clear distinction between your 401(k) and you individually. You and your 401(k) are not the same. Your 401(k) is a separate Trust for your benefit when you retire.
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Self dealing is using your Self-Directed 401(k) in transactions that in some way benefit you (or other disqualified persons) individually. The purpose of your 401(k) is to provide for your retirement. It is not intended to benefit you prior to retirement and distribution of the funds.
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- Self dealing with a family member (having your Self-Directed 401(k) purchase a home from your father).
- Self dealing with yourself (having your Self-Directed 401(k) purchase a home from yourself).
- Personal use of Self-Directed 401(k) property (buying a rental vacation home with Self-Directed 401(k) money and then staying in the home when on vacation).
- Receiving personal benefit from your Self-Directed 401(k) (paying yourself for work that you do on the property such as repairing the roof).
Exemptions are permission to invest in something or in some way that is technically a prohibited transaction. For example, it is a prohibited transaction to rent property owned by your Self-Directed 401(k) to your child. An exemption would allow you to do so.
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Yes you can buy a business with your Self-Directed 401(k) money. Please contact us for details.
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Yes. This can be done as the purchase of stock as a loan to the business.
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S-Corporations do not allow Self-Directed 401(k)s as investors; they only allow individuals as investors. Therefore, it isn’t so much that 401(k)s are prohibited from investing in S-Corporations rather that S-Corporations don’t permit having a 401(k) as a shareholder. It is likely that the investment of the 401(k) would revoke the sub-s status of the corporation.
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Yes. You can invest in any 401(k) permitted investment. That includes publicly traded stocks, CDs, mutual funds, annuities, bonds, stock options, futures, etc. In fact, if you are an active swing trader or day trader, you will be able to trade your Self-Directed 401(k) in a manner that your current broker does not allow you to trade using the Self-Directed 401(k) Plan. For example, you probably have asked your broker if you can buy or sell Options (Calls and Puts). Or maybe you would like to write Covered Calls or do Spreads and have been told no. The Self-Directed 401(k) Plan allows you to trade your way.
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Yes. You can move these 401(k) funds into the Self-Directed 401(k) Plan. You can start controlling this money yourself rather than letting your old employer control your future.
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The 401(k) plan documents will specify what you can do but most of the time you cannot move money from a 401(k) plan if you are currently working for the company. Ask your company plan administrator if “in service transfers” are allowed. If the answer is “yes,” then you can transfer to your Self-Directed 401(k).
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Yes. They can all be combined and then invested into your Self Directed Retirement Plans LLC so that your buying power is maximized. The only restriction is on 401(k)s; is that you generally must no longer work for the employer. You can usually combine multiple retirement accounts into one account. Or in the event that they can’t be combined, such as the case of a traditional IRA and a Roth IRA, they can still be invested into the same Self Directed Retirement Plans LLC so that you still have maximum buying power.
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Email rick@sdretirementplans.com.
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Email rick@sdretirementplans.com. We will get you on the path to optimizing your IRA or 401(k).
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Yes, you can use 401K fund to buy a new house or property. But if you are going to touch that pension fund, think about financial stability and strength during retirement. Utilize this fund in case of acute emergency else explore other financial support schemes. It is best to leave 401K untouched.
Still, if you have made up your mind on using Self Directed 401K, then there are two ways of using this facility to fund the house. The first option is of 401k loans and the second one is 401k hardship withdrawals.
Getting a 401K loan is easy and less costly irrespective of the requirement. The benefit is, that interest paid on this loan is diverted to the 401K fund. On the flip side, be ready to shell out loan fees and miss out on tax benefits. If you end up as a defaulter, you will end up paying tax and 10 % penalty for early withdrawal.
Hardship withdrawal is an expensive risk you take, by touching the 401k fund. By using this alternative, be ready to pay higher taxes, penalty and forget getting additional income from this savings fund.
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You can withdraw money from Roth IRA provided you are aged 59.5 years. Another important thing to consider is whether your Roth IRA account has crossed the five-year threshold and that the fund is qualified for distribution. If you meet these two criteria then all withdrawals will be tax-free income minus penalties.
However, if you don’t fit into the above two listed criteria and want to retrieve your Roth IRA fund, then you will be taxed. Along with the tax as per rules, you will have to pay additional 10 % as penalty towards early distribution.
If you aren’t 59.5 years, but need to make an early withdrawal due to disability, buying a home for first time, or death; there’s an exception to the rule. In these situations the beneficiaries are not burdened with taxes and penalties. The amount is processed as tax-free income.
If you are withdrawing an amount lesser than that you have deposited over the years, then you are not taxed on this withdrawal. But, the most important factor to consider before withdrawing money from your Roth IRA account is that, your account should have the funds you wish to take out.
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Taking money out from your retirement fund requires due consideration. 401K is the fund that ensures you financial help post retirement. But, in case of an emergency, such as, paying college fees for your kid or buying a home urgently; then 401K could be considered.
As a rule, the account holder cannot borrow more than $50,000 or one-half of the benefits accruing on the plan. Whichever amount is lesser will be approved for withdrawal.
It is expected that the amount borrowed from 401K is repaid within five years from the date of withdrawal. You will have to pay interest on the principal amount on a quarterly basis. In the case of using the fund to buy a house, the repayment period is extended.
If you repay the amount on time then there are no taxes to be paid. However, in instances when you fails to make repayment, the amount borrowed is considered as taxed distribution. And, if have not crossed the 59.5 age limit, then you will be required to pay 10 % federal penalty tax on the Self Directed 401K borrowings.
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