| The Solo 401(k) Advisor - Newsletter No. 3 • Winter 2011/2012 |
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2011 Year-End FAQ wrap-up
Things you may know, may have forgotten or need to know [first name], I thought I would finish out the year with an assortment of frequently asked questions. Although you may know the answer to many of these, I receive these types of questions often and I thought all my Solo 401k clients would benefit from knowing what kinds of questions others frequently ask. I hope these FAQs help you gain a better understanding of how your 401k plan functions and your role in operating your plan. Enjoy. How many bank or brokerage accounts can my Solo 401k plan have? The short answer is as many as you want. But I think it's a good idea to think of your Solo 401k plan like a company. Most companies, large or small, have multiple bank accounts that they deposit cash in to, but each account is there for a reason. A company may have a short-term cash bank operating account and a longer-term, savings type bank account as well. Your 401k account should be set up to make the accounting/administration for you as easy as possible. So when you're setting up new or repositioning current bank accounts, try to get a good idea on what you're trying to accomplish before you run off an set up too many or the wrong type of bank/brokerage accounts for your Solo 401k plan. Do Prohibited Transactions apply to Solo 401k plans like they do to IRAs? YES!!! To hopefully remove any confusion in this area, all retirement plans (traditional IRAs, SEP-IRAs, Simple IRAs, Roth IRAs, defined benefit plans and Solo 401k plans) are subject to a wonderfully complex area of the Internal Revenue Code, Section 4975. This section discusses (in somewhat vague language) what you can and cannot do with retirement plans. Briefly, you are a separate entity from your retirement plan so according to Section 4975, you (as an individual) cannot "transact" with your retirement plan (Solo 401k plan). Also Section 4975 lists out certain family members (parents, grandparents, children, grandchildren, etc. - "disqualified persons") that your retirement plan cannot transact with as well. In addition, there are certain entities that your Solo 401k plan cannot transact business with (entities you and other disqualified persons own more than 50% of, for example). So...before you engage in anything other than a simple, arms length transaction with unrelated parties, give me a call and we can discuss your particular proposed transaction. What types of existing retirement accounts can I transfer into my Solo 401k plan? The short answer is "most." But there are a few types of accounts that cannot be transferred into your Solo 401k. For example, even though the Solo 401k has the Roth account feature built into the plan, you cannot transfer an existing Roth IRA into the Roth component of your Solo 401k (don't ask me, ask Congress why). Now of course you can transfer the Roth 401k account into a Roth IRA, but not the other way around. Doesn't make much sense, but I don't make the rules. But to help me remember some of the more unique aspects of what types of accounts can be transferred into your Solo 401k, I often refer to a simple IRS table. If you'd like a PDF version of this, please email me and I'll send one your way. Can I get electronic copies of my Solo 401k plan documents? Yes. Your Solo 401k plan documents are in PDF form, so email me if you don't have copies of your documents and I'll email you PDF versions. My CPA would like the "authority" that states my Solo 401k isn't subject to the Unrelated Business Income Tax on my leveraged rental house. The specific reference in the Internal Revenue Code is Section 514(c)(9). Have your CPA or advisor email or call if he/she has any questions about this. Since it's not possible to transfer my existing Roth IRA into the Roth component of my Solo 401k, is it possible to convert my existing Solo 401k plan balance to the Roth 401k component? Yes. This is called an "in-plan Roth conversion." You can "convert" whatever amount you want from prior traditional, tax-deductible contributions (and earnings) and then these amounts will be considered "Roth" funds within your Solo 401k plan. You'll pay federal (and perhaps state) income tax on the amount of conversion and you'll also need to complete the Form 1099-R indicating to the IRS how much you converted. Tax tip: from a time value of money standpoint, it would be more beneficial to convert early in the tax year, as taxes due on the conversion will most likely not be due until 4/15 of the next year. What are the terms for a plan loan? Is the repayment period always 5 years? Can I make a balloon payment at the end of 5 years? The Internal Revenue Code (created by Congress) dictates 401k plan loan provisions. Basically, you can borrow from your 401k plan up to the LESSER of 1) 50% of your plan balance or 2) $50,000. So if your plan had $80,000 of value, you could borrow a maximum of $40,000. If your plan had $210,000, the maximum amount you could borrow would be $50,000. But you can use the plan loan funds for any purpose at all (there are no prohibited transaction issues here, to speak of). The repayment term is usually 5 years with principal and interest payments due at least quarterly. If the plan loan funds are to be used for the purchase of a "principal residence", then the repayment term can be up to 30 years. After expenses, my business only made $20,000 last year. If I'm 52, how much of that can I contribute to my Solo 401k plan? When do I have to make the contribution. Before we begin, because the Solo 401k plan is technically a "defined contribution" plan, you, the business owner, gets to define how often and how much you want to contribute to the plan. With that said, the annual Solo 401k contribution is made up of two pieces: 1) the "employee elective contribution" and 2) the employer profit sharing contribution (The IRS considers you to be both your own employee and employer). We calculate the employee elective piece first and the maximum annual limit on this piece for 2011 is $16,500 or $22,000 if age 50 and over. So since your net income was $20,000 and you're over age 50, your maximum contribution could be $22,000, but in this case it's limited to $20,000 since your earned income is less than the maximum for the employee elective contribution. If you contributed the $20,000 maximum, you wouldn't able to then make more of a contribution via the profit sharing contribution. But if your income was $40,000, you could contribute up to $22,000 in the employee elective piece and then you could make a 20% (we'll assume your business is not incorporated) profit sharing contribution of 20% of $40,000, or $8,000. So the $22,000 employee elective contribution plus the $8,000 profit sharing contribution could allow you to make a $30,000 contribution to your Solo 401k on just $40,000 of net income! As a reminder, any portion of the employee elective contribution can be a Roth contribution, so of the $22,000 maximum employee elective contribution, you could make (for example) a non-tax deductible $12,000 Roth contribution and a $10,000 tax-deductible contribution (or any permutation like that up to the $22,000 employee elective maximum limit). You have until the due date of your tax return to actually make the contribution, which for individuals with an extension would be October 15 of the year following your businesses' year-end. I hope that 2011 was a happy, healthy and profitable year for you and your family. Here's to an even better 2012! [first name], as always, let me know how I can help you or others with retirement planning, structuring and related tax issues. Until next time, here's to a better way of investing!!!
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