A Warning About Your Solo 401(k) Plan [EPISODE #250]
The Big Idea
An old IRS Revenue Ruling makes Solo 401k's set up by banks, brokerages and self directed IRA custodians just as risky as IRA's in the event of a prohibited transaction... and it does not need to be that way. Pay close attention for the problem and the solution.
Points To Ponder
- 401(k) plans (including Solo 401k's) can be set up as "Custodial" or "Trust" plans
- "Custodial" plans are usually those set up by financial companies, including Self Directed IRA custodians
- "Trust" plans are usually those where the employer/business owner directly manages the 401k
- IRS Revenue Ruling 71-153, in effect, says that Custodial-type 401k plans are not able to be "fixed" if a prohibited transaction occurs, but that Trust-type plans can be corrected
- This means that Custodial 401k plans are just as susceptible to the horrible risk of prohibited transactions as IRA's... and the risk there is catastrophically significant
- If you have a Solo 401k plan, your action items are:
- Determine whether your plan is Custodial or Trust
- If your plan is a Custodial plan, consider amending it so that it's a Trust-type of 401k plan
- Contact solo 401k attorney Tim Berry here to determine if your plan is a Custodial plan, and to have it amended if necessary
- Revenue Ruling 71-153 is a very old ruling, so an alternative legal opinion is plausible. However, subsequent regulations have been issued which echo the verbiage in this ruling, so there's substantive reason to believe it remains relevant.
This is a warning to anyone who has a Solo 401(k) set up by a Self-Directected IRA custodian or other financial firms… and it’s a warning to the Self-Directed IRA custodians, too. All of you folks – custodians included – are being shafted by a little-known part of the law, and you need to hear about it right now. I’m Bryan Ellis. This is Episode #250 of Self Directed Investor Talk.
Hello, Self Directed Investor Nation! Welcome to the show of record for savvy self-directed investors like you, where each day of the week, you learn to find, understand and profit from the finest ALTERNATIVE investments known to man as you DECLARE INDEPENDENCE FROM WALL STREET more and more each day!
Ok folks, today’s show is going to ruffle some feathers, I’m afraid. But hey… that’s what I do. There’s a lot of information that’s REALLY important that I’ll refer to today, and all of that is available to you on the SDI Insider’s page for Episode #250, which is, of course, SDITalk.com/250.
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Ok, folks, you’re about to learn something that REALLY matters, and that you’ve never heard before.
So here goes: 401k plans – including, of course, the Solo 401(k) plan – can be organized in a couple of different ways: As a “custodial” plan or as a “trust” plan.
The difference APPEARS to be, fundamentally, that a custodial plan involves a bank, brokerage or IRA custodial company whereas a trustee plan is directly controlled and managed by the plan sponsor, such as YOU, if it’s your Solo 401(k). I’m no lawyer, so don’t quote me on that… but chances are – and we all know this by now – chances are pretty good that I’m right <g>
So bottom line: If you opened your Solo 401(k) through any bank brokerage, or through a Self Directed IRA custodial company, chances are quite good that you have a custodial plan. If you opened your Solo 401(k) through a lawyer, CPA or other professional, then chances are good that you have a TRUSTEE plan, though you’d have to check your plan documents to be sure.
Why does this matter? Boy oh boy does it matter.
A bit of context will help: One of the biggest reasons that I believe Solo 401(k)’s are so vastly superior to Self Directed IRA’s is that if you commit a prohibited transaction in an IRA, your account is done for. It’s total Armageddon… a financial nuclear detonation. But if you commit the same prohibited transaction in a 401k, there are STILL ramifications, and there will still be a cost to fix the problem… but fixing the problem is ENTIRELY possible.
So what’s the effect of this Revenue Ruling 71-153?
Bottom line is that if you’re using a “custodial” type of 401k plan, just as a function of that choice alone, your 401k plan is NO LONGER any more secure against prohibited transactions than an IRA. But if you use a “trustee” type of 401k plan, then the plan has all of the protections and safeguards that we know and love about 401k plans.
Don’t take my word for it. Go read the ruling yourself – which is shockingly brief – over at SDITalk.com/250. You’ll see phrases like “may not regain its qualified status” when describing custodial plans, and phrases like “may regain it’s qualified status” when describing trustee-type 401k plans.
What are your action items as a result of this:
First, remember I’m not a lawyer, just an exceptionally well-informed layman, who was informed about this issue by THE GREAT ONE, self-directed IRA/401k attorney Tim Berry out of Phoenix, who is the nation’s leading attorney for self-directed retirement account issues. But hey… we may be wrong, so confirm it for yourself.
Second, look at your plan docs to determine if you’ve got a custodial or a trust-type plan… or maybe have Tim or some other lawyer confirm it for you.
Third, if you do have a custodial type of Solo 401(k), consider amending the plan to be a trust instead. A great resource for doing exactly that is available to you over at SDITalk.com/250.
And hey – a quick shout-out to THE GREAT ONE, attorney Tim Berry, for bringing this to my attention. If you need a great lawyer for self-directed IRA and 401k issues, Tim is the guy – he also sets up Solo 401k’s in the RIGHT way. His info is on today’s SDI Insiders page at SDITalk.com/250.
And hey – for all of you Self Directed IRA custodians who listen to this show on the sly – you know who you are! If I’m you, I’ve got to think about reaching out to my congressmen to request that this law be changed, because it isn’t doing you guys any favors at all.
Now let me be totally clear with you. Today’s content comes from a reading of Revenue Ruling 71-153 and some related background research. But that is an OLD ruling, and so it’s entirely possible that a good legal case can be made to the contrary, and that is precisely why it’s so important that you look into this with your own legal counsel! But the opinion is supported by regulations that have since been issued with the same verbiage, so our confidence is high.
That’s all I’ve got for you today. But here’s some big news: new President Donald Trump has already taken an action that will have profoundly POSITIVE benefits for you and me as self-directed investors… I’m very serious about that. And depending on when you’re hearing this, you can find the link to THAT episode about Trump’s actions on today’s page at SDITalk.com/250.
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My friends, invest wisely today, and live well forever!
Bryan Ellis is host of Self Directed Investor Talk, America's #1 radio show and podcast for affluent self-directed investors. He's also an expert in self-directed IRA's, solo 401k's and turnkey rental property investing... at least, that's what his wife tells him 🙂 He's a contributor to well-respected publications like TheStreet.com, Entrepreneur and ThinkRealty. Bryan lives in metro Atlanta, Georgia with Carole Ellis - his wife, business partner and best friend - and his 4 children ranging in age from 2 to 19.