by Mat Sorensen | Nov 18, 2014 | Prohibited Transactions
The prohibited transaction rules are the most important rules to understand when you self-direct your retirement account. These rules restrict not what investments your retirement plan may acquire but whom your plan may transact with.
How It Happens
A prohibited transaction occurs when a retirement plan (e.g. self directed IRA or 401k) transacts with a disqualified person. IRC § 4975. A transaction is pretty easy to identify and is defined in the code as a sale, lease, exchange, payment, or other transfer of money from a retirement plan. If that transaction is with a disqualified person then the retirement plan has engaged in a prohibited transaction. The consequence of a prohibited transaction for an IRA is distribution of entire IRA while the consequence to a 401(k) or other employer based plan is a 15% excise tax on the amount involved and an additional 100% penalty if the transaction is not corrected. Regardless of the type of retirement account you are self-directing, the consequences are significant. IRC § 4975 (c)(3), IRC § 408 (e)(2)(A). IRC § 4975 (a),(b).
Often times, a disqualified person is generically referred to as a family member. While that definition can be accurate, it really can cause problems when applied as some family members are disqualified (e.g. spouse of plan owner) while others are not (e.g. brother of plan owner). Also, it can be really confusing to determine when a company is disqualified to a retirement plan or when partners are disqualified. Because of the confusion, I’ve created a disqualified person diagram to help sort out the details. If a party is in red, that means they are a disqualified person and that your retirement plan cannot transact with them. If the party is green, that means they are NOT disqualified and your retirement plan may transact with them.
Keep in mind that a self-dealing prohibited transaction can also arise if any disqualified party personally benefits from a retirement plans investments. In summary, you should avoid all transactions with disqualified persons and should seek legal counsel whenever a disqualified person is involved in any retirement plan investment.
by Mat Sorensen | Oct 28, 2014 | News
The IRS recently announced 2015 retirement plan contributions limits. Despite the typical bad news coming from the IRS, this year we see increases in HSA and 401(k) contributions for 2015. Here’s a quick breakdown on the changes.
– IRA contribution limitations (roth and traditional) stayed at $5,500 with an additional $1,000 catch-up amount for those 50 and older.
– HSAs contribution limits increased ($50 indiv/$100 fam) from $3,300 individual and $6,550 family to $3,350 individual and $6,650 family.
– 401(k) contributions also increased on the employee and employer side. Employee contribution limitations increased from $17,500 to $18,000 for 2015. Also, the additional catch-up contribution for those 50 and older increased from $5,500 to $6,000. The annual maximum 401(k) (defined contribution) total contribution amount increased from $52,000 to $53,000 ($59,000 for those 50 and older).
There were additional modest increases to defined benefit plans and to certain income phase-out rules. Please refer to the IRS announcement for more details here.
All of these accounts provide tax advantageous ways for an individual to either save for retirement or to pay for their medical expenses. If you’re looking for tax deductions, you should determine which of these accounts is best for you. Keep in mind there are qualification and phase out rules that apply so make sure you are getting competent advice about which accounts should be set up in your specific situation.
By: Mat Sorensen, Attorney & Author of The Self Directed IRA Handbook
by Mat Sorensen | Oct 14, 2014 | News
As we reach the end of the year it is time to start thinking about how to best maximize your annual retirement plan contributions. One of the most commonly used strategies for our clients is an s-corporation and 401(k). A properly structured s-corporation is utilized best for tax purposes when the business owner adopts and contribute to a 401(k) plan. Whether the business has only one owner/employee (or spouses only) or whether the business has dozens or even hundreds of employees. Simply put, a 401(k) plan can be used as a tool for putting the income of the business owner (and applicable employees) away for retirement with the added benefit of a tax deduction for every dollar that can be contributed. There are so many neat things about 401(k) plans and there are so many options. For example, you can do Roth 401(k) plans, you can self direct a 401(k) plan, and you can even loan money to yourself from your 401(k) account. While books have been written about all of these options and benefits, one of the most misunderstood concepts of 401(k) plans is how s-corporation owners can contribute their income to the plan. That is the focus of this article.
In order to understand how s-corporations income can be contributed to a 401(k) plan, you need to understand the following three basic rules.
1. Only W-2 Salary Income can be Contributed to a 401(k). You cannot make 401(k) contributions from dividend or net profit income that goes on your K-1. See IRS.gov for more details. Since many s-corporation owners seek to minimize their W-2 salary for self-employment tax purposes, you must carefully plan your W-2 and annual salary taking into account your annual planned 401(k) contributions. In other words, if you cut the salary too low you wont be able to contribute the maximum amounts. On the other hand, even with a low W-2 Salary from the s-corporation you’ll still be able to make excellent annual contributions to the 401(k) (up to $17,500 if you have at least that much in annual W-2 salary).
2. Easy Elective Salary Deferral Limit of $17,500 or 100% of Your W-2, whichever is less. If you have at least $17,500 of salary income from the s-corporation, you can contribute $17,500 to your 401(k) account. Every employee under the plan is allowed to make this same contribution amount. As a result, many spouses are added to the s-corporation’s payroll (where permissible) to make an additional $17,500 contribution for the spouse’s account. If you are 50 or older, you can make an additional $5,500 annual contribution. Follow this link for the details from the IRS on the elective salary deferral limits. The elective salary deferral can be traditional dollars or Roth dollars.
3. Non-Elective Deferral of 25% of Income Up to a $52,000 total Annual 401(k) Contribution. In addition to the $17,500 annual elective salary contribution, an s-corporation owner can contribute 25% of their salary compensation to their 401(k) account up to a maximum of a $52,000 total annual contribution. This non-elective deferral is always made with traditional dollars and cannot be Roth dollars. So, for example, if you have an annual W-2 of $100,000, you’ll be able to contribute a maximum of $25,000 as a non-elective salary deferral to your 401(k) account. If you have employees who participate in the plan besides you (the business owner) and your spouse, then the non-elective deferral calculation gets much more complicated. But for now, let’s assume there are no other employees and run through the examples.
Lets run through two examples. The first is an s-corporation business owner looking to contribute around $30,000 per year. The second is a business owner looking to contribute the maximum of $52,000 a year.
Example 1, Seeking a $30,000 Annual Contribution.
S-Corporation Owner W-2 Salary = $50,000
Elective Salary Deferral = $17,500
25% of Salary Non-Elective Deferral = $12,500 (25% of $50,00)
Total Possible 401(k) Contribution = $30,000
Example 2. Seeking Maximum $52,000 Annual Contribution
S-Corporation Owner W-2 Salary = $138,000
Elective Salary Deferral = $17,500
25% of Salary Non-Elective Deferral = $34,500 (25% of $138,000)
Total Possible 401(k) Contribution (maximum) = $52,000
As a result of the calculations above, in order to contribute the maximum of $52,000, you need a W-2 salary from the s-corporation of $138,000. Keep in mind that if you have other employees in your business (other than owner and spouse) that you are required to do comparable matching on the 25% non-elective deferral and as a result such maximization is often difficult to accomplish in 401(k)s with employees other than the owner and their spouse. Consequently, the additional 25% non-elective salary deferral is best used in owner only 401(k) plans.
by Mat Sorensen | Aug 4, 2014 | News
Do you need access to your retirement account funds to start a business, to pay for non-traditional education expenses, to make a personal investment, or to pay off high interest debt? Rather than taking a taxable distribution from your 401(k), you can access a portion of the funds in your 401(k) via a loan from the 401(k) to yourself without paying any taxes or penalties to access the funds. The loan must be paid back to the 401(k) but can be used for any purpose by the account owner. Many people are familiar with this loan option but are confused at how the rules work. Here is a summary of the items to know. For more details, check out the IRS Manual on the subject here.
FAQs on Loans from Your 401(k)
- How much can I loan myself from my 401(k)? 50% of the vested account balance (FMV of the account) of the 401(k) not to exceed $50,000. So if you have a $200,000 401(k) account value you can loan yourself $50,000. If you have $80,000, you can loan yourself $40,000.
- What can I use the funds for? By law, the loan can be used for anything you want. The funds can be used to start a business, for personal investment, for education expenses, to pay bills, to buy a home, or for any personal purpose you want. Some employer plans restrict the purpose of the loan to certain pre-approved purposes.
- How do I pay back the loan to my own 401(k)? The loan must be paid back in substantially level payments, at least quarterly, with-in 5 years. A lump sum payment at the end of the loan is not acceptable. For loans where the funds were used to purchase a home, the loan term can be up to 30 years.
- What interest rate do I pay my 401(k)? The interest rate to be charged is a commercially reasonable rate. This has been interpreted by the industry and the IRS/DOL to be prime plus 2% (currently that would be 5.75%). If the loan was for the purchase of a home for the account owner then the rate is the federal home loan mortgage corporate rate for conventional fixed mortgages. Keep in mind that even though you are paying interest, you are paying that interest to your own 401(k) as opposed to paying a bank or credit card company.
- How many loans can I take? By law, you can take as many loans as you want provided that they do not collectively exceed 50% of the account balance or $50,000. However, if you are taking a loan from a current company plan, you may be restricted to one loan per 12 month period.
- What happens if I don’t pay the loan back? Any amount not re-paid under the note will be considered a distribution and any applicable taxes and penalties will be due by the account owner.
- Can I take a loan from my IRA? No. The loan option is not available to IRA owners. However, if you are self-employed or are starting a new business you can set up a solo or owner only 401(k) (provided you have no other employees than the business owners and spouses) and you can roll your IRA or prior employer 401(k) funds to your new 401(k) and can take a loan from your new solo 401(k) account.
- Can I take a loan from a previous employer 401(k) and use it to start a new business? Many large employer 401(k) plans restrict loans to current employees. As a result, you probably won’t be able to take a loan from the prior 401(k). You may, however, be able to establish your own solo or owner only 401(k) in your new business. You would then roll over your old 401(k) plan to your new solo/owner only 401(k) plan.
- Can I take a loan from my Roth 401(k) account? Yes, so long as your 401(k) plan doesn’t restrict loans from the Roth account.
- What if I have a 401(k) loan and change employers? Many employer plans require you to pay off any outstanding loans within 60 days of your last date of employment. If your new employer offers a 401(k) with a loan option or if you establish a solo/owner only 401(k), you can roll over your prior employer loan/note to your new 401(k).
The 401(k) loan option is a relatively easy and efficient way to use your retirement account funds to start a small business, to pay for non-traditional education expenses, or to consolidate debt to a better rate of interest. If you have more questions about accessing your 401(k) funds, please contact us at the law firm at 602-761-9798.
by Mat Sorensen | Feb 18, 2014 | Investing
A properly structured s-corporation is utilized best when business owners adopt and contribute to a 401(k) plan. Whether the business has only one owner/employee (or spouses only) or whether the business has dozens or even hundreds of employees. Simply put, a 401(k) plan can be used as a tool for putting the income of the business owner (any applicable employees) away for retirement with the added benefit of a tax deduction for every dollar that can be contributed. There are so many neat things about 401(k) plans and there are so many options. For example, you can do Roth 401(k) plans, you can self direct a 401(k) plan, and you can even loan money to yourself from your 401(k) account. While books have been written about all of these options and benefits, one of the most misunderstood concepts of 401(k) plans is how s-corporation owners can contribute their income to the plan. That is the focus of this article.
Rules for 401(k) Contribution
In order to understand how s-corporations income can be contributed to a 401(k) plan, you need to understand the following three basic rules:
- Only W-2 Salary Income can be Contributed to a 401(k). You cannot make 401(k) contributions from dividend or net profit income that goes on your K-1. See IRS.gov for more details. Since many s-corporation owners seek to minimize their W-2 salary for self-employment tax purposes, you must carefully plan your W-2 and annual salary taking into account your annual planned 401(k) contributions. In other words, if you cut the salary too low you wont be able to contribute the maximum amounts. On the other hand, even with a low W-2 Salary from the s-corporation you’ll still be able to make excellent annual contributions to the 401(k) (up to $17,500 if you have at least that much in annual W-2 salary).
- Easy Elective Salary Deferral Limit of $17,500 or 100% of Your W-2, whichever is less. If you have at least $17,500 of salary income from the s-corporation, you can contribute $17,500 to your 401(k) account. Every employee under the plan is allowed to make this same contribution amount. As a result, many spouses are added to the s-corporation’s payroll (where permissible) to make an additional $17,500 contribution for the spouse’s account. If you are 50 or older, you can make an additional $5,500 annual contribution. Follow this link for the details from the IRS on the elective salary deferral limits. The elective salary deferral can be traditional dollars or Roth dollars.
- Non-Elective Deferral of 25% of Income Up to a $52,000 total Annual 401(k) Contribution. In addition to the $17,500 annual elective salary contribution, an s-corporation owner can contribute 25% of their salary compensation to their 401(k) account up to a maximum of a $52,000 total annual contribution. This non-elective deferral is always made with traditional dollars and cannot be Roth dollars. So, for example, if you have an annual W-2 of $100,000, you’ll be able to contribute a maximum of $25,000 as a non-elective salary deferral to your 401(k) account. If you have employees who participate in the plan besides you (the business owner) and your spouse, then the non-elective deferral calculation gets much more complicated. But for now, let’s assume there are no other employees and run through the examples.
Examples
Lets run through two examples. The first is an s-corporation business owner looking to contribute around $30,000 per year. The second is a business owner looking to contribute the maximum of $52,000 a year.
Example 1: Seeking a $30,000 Annual Contribution.
- S-Corporation Owner W-2 Salary = $50,00
- Elective Salary Deferral = $17,500
- 25% of Salary Non-Elective Deferral = $12,500 (25% of $50,00)
- Total Possible 401(k) Contribution = $30,000
Example 2: Seeking Maximum $52,000 Annual Contribution
- S-Corporation Owner W-2 Salary = $138,000
- Elective Salary Deferral = $17,500
- 25% of Salary Non-Elective Deferral = $34,500 (25% of $138,000)
- Total Possible 401(k) Contribution (maximum) = $52,000
As a result of the calculations above, in order to contribute the maximum of $52,000, you need a W-2 salary from the s-corporation of $138,000. Keep in mind that if you have other employees in your business (other than owner and spouse) that you are required to do comparable matching on the 25% non-elective deferral and as a result such maximization is often difficult to accomplish in 401(k)s with employees other than the owner and their spouse. Consequently, the additional 25% non-elective salary deferral is best used in owner only 401(k) plans.
