Leveraging funds in 401k how to get up to speed?

Question

When it comes to tax and financial planning I am dumb as a stump!

I always find out about tax consequences too late.

By way of an example, a few years ago I had a substantial amount of fully vested company granted, fully vested stock options due to expire. I ignored it until the last minute, like a week prior to expiration date, which happens to be late December. I end up exercising all of it, paid the grant price, and it being a private company, and I didn't need money at the time, I didn't even think about it until I got a W2 a few weeks later, yes, its a non-qualified stock option, so even though I have not gained a penny from exercising, I paid dearly that year to Uncle Sam. The added "wages" even kicked me up another tax bracket, and I paid an EXTRA 80k in federal taxes that year. Big ouch.

So anyways, I have some funds parked in a 401k plan. Fully vested. I am no longer with that employer, but the funds are still managed by the company's designated retirement funds manager, which is JP Morgan. I don't do much with it, other than diverted some of it to a stock account by Schwab, where I do some stock trading with it.

I have never heard of solo 401k, I did joke with a friend some years ago that it would be nice to use 401k money to buy real estates. I even researched it at the time but didn't find anything.

Now this is the first time since joining BP I stumbled into this subforum. So...it is possible.

I read a whole bunch of threads in the last 24 hours, and I must confess, I am more confused then ever, LOL. I don't think I am qualified yet to ask specific questions yet.

So my first question is where is a good place to start reading, in a more general fundamental level, about sdira, solo 401k, ROBS, their respective tax consequences etc...

A good book? A series of web sites? Hire a tax consultant?

Also, from my preliminary reading, is it true all you can leverage out of these are 50k max? What if your 401k has substantially more? You can't touch a penny over 50k?

Sorry I am pretty sure this is a topic re-iterated 1000 times, I have a lot to catch up on. Thanks in advance for any advice.

David Beard · Answer

@Sam Leon - it seems from reading this that you may be confusing a couple of different types of self directed 401k's. 1) Solo 401k -- around $500 to set up and $150-200/year 2) Rollover as Business Startup (ROBS) - $3,000 to $5,000 to set up and $500-$1,000/year You would use (1) if you are going to invest in rentals, notes, and making non-profit sharing loans (e.g. just interest and points), or if investing in other traditional asset classes such as stocks, bonds, funds, ETFs, etc. You would use (2) if you want to invest actively in rehabs, wholesaling, new home construction, property management business (or in a profit-sharing arrangement on rehabs and construction, even if your role is passive), or any other type of active business such as a Subway franchise. You can take a salary in a ROBS setup, provide a personal guaranty so that the business can get financing, and hire disqualified parties as employees. You do not want to invest actively in (1), or even make a passive investment in an operating business, or you will hit the UBIT tax (steeply progressive, uses trust tax tables, and hits 39.6% at less than $12k of annual income) Here is a paper on ROBS, though I assume you are just wanting to invest passively (rentals, notes, loans) and a Solo 401k is probably sufficient. I'm looking to potentially set up a ROBS for an active business, so have been researching it lately. http://www.frankseldenlaw.com/uploads/ROBS_Paper.pdf

Matt Devincenzo · Answer

Old Cars, Baseball Cards, and Real Estate? Here's a very timely BP blog post from today that discusses some of the retirement plan stuff.

Matt Devincenzo · Answer

I'll take a stab at a couple of the "easier" to answer questions. I don't have a i401K(solo 401K) but do plan to start one, and I have had a SDIRA (ROTH) for about 9 years now and have only ever used it for RE. I'm not exactly sure what you were specifically asking as far as leverage so I'll address 3 points that I thought you could have been asking about. So let's take an example of you having a 150K balance in your account. If you wanted to take a personal loan from your account you can take up to 50% or 50K whichever is less, so in that sense yes you could only take a 50K loan. Next example you want to buy a rental property. It is a 150K property and you want to use leverage to purchase it. For loans to a retirement plan they must be non-recourse, so usually you will find loan products in a 50% LTV lets say. So you could purchase this property for 75K down and a loan of 75K resulting in your 50% LTV. This is fine. Now in other plans (IRA, ROTH IRA ect) if you were to use leverage you would be subject to Unrelated Debt Financed Income (UDFI), sometimes confused with Unrelated Business Taxable Income (UBTI or UBIT). This is basically the governments way of making sure that since your plan doesn't pay taxes, that the playing field is level with other businesses so you aren't able to undercut the market. As I understand it an i401K is actually exempt from UDFI, which gives you an advantage in using leverage compared to an IRA which would have to pay the UDFI if it was to use leverage. Now as far as "you can't touch a penny more". Yes you can use as much of your balance to purchase investments as you would like. The 50K limits are just in place for your taking a personal loan against the account and paying it back over time.

Gautam Venkatesan · Answer

It is the lesser of 50K or 50% of the amount in your 401K.

Dmitriy Fomichenko · Answer

@Sam Leon thanks for clarifying. In this case you would rollover portion now and then when you are able to liquidate company stocks, you would rollover the balance. Assuming the employer would allow this (typically most 401k with past employers would not allow partial rollover). However, in your case they should allow you to do that under described circumstances.

Jean Bolger · Answer

I've just been reading up on these too. It's super confusing! Be sure to read Jeff Brown's recent blog post on Roth solo 401ks: http://www.biggerpockets.com/renewsblog/2014/01/24/capital-growth-cash-flow-taxes/ it really opened my eyes to some things to consider going forward

Dmitriy Fomichenko · Answer

@Sam Leon To answer your questions: 1. Yes, you will not be able invest in real estate using Schwab, etc. You will need a self-directed account. 2. No, with self directed account you can invest in stocks, etc. The only limitation are "prohibited transactions" 3. Different providers charge different fees, but the numbers you quoted there are high. 4. You only need one account. 5. You can rollover multiple accounts into Solo 401k, there is no extra charge for that. 6. Not sure if I fully understand your question, but if your former employer only allows you to rollover part of the account, then you will rollover part and the rest will stay with former employer 401k. 7. Just owning a rental is a passive activity, however, if you are actively managing it, that changes things. Hope this helps.

Dawn Anastasi · Answer

You asked this question at the same time. SD-IRAs and Solo 401(k) are complex topics that it's helpful to read more about.

Sam Leon · Answer

Thanks everyone. Matt, thanks for the examples and the article, that's very helpful. Dmitriy, great info. There seems to be a lot of variables. I have a lot to digest. Hopefully, later that I can begin to ask qualified questions.

Dmitriy Fomichenko · Answer

@Gautam Venkatesan and @Matt Devincenzo good comments! One of the major benefits of the Solo 401k plan is that it allows you to take what's called a "Participant Loan". It is a personal loan feature that allows you to access your retirement funds at any time tax free and penalty free! This is not available with self directed IRA. And not all Solo 401k providers offer this feature either, so be sure to check on that before you make a decision who you wish to use. Now regarding buying investment property in your self-directed IRA or 401k. Matt explained it very well using good example. Sam Leon , if you wish you can pay all cash for a property, or you can use "non-recourse" loan and buy it with financing. Here is a list of lender who will do this kind of loans: http://www.sensefinancial.com/non-recourse-lenders/. The down-payment is typically 30-50%. And again, Matt is correct, property financed in Solo 401k is not subject to UDFI tax (unlike with self directed IRA).