SDIRA vs Solo401k - IRS have any issue with Checkbook control?

Question

I've been looking into SDIRA vs. Solo 401k options for a while and read many posts related to that. Based on my reading and understanding, it seems that that Solo401K is a much better option than SDIRA-LLC and one can do it even if I am on W2/full time employed, just by setting up some micro business.

Actually, I am a licensed RE Agent and already have set up S-Corp for the same. I and My wife have some money in 401Ks with our previous employers and I was wondering if Solo401K is a better, feasible and viable option for us. In fact, I was very close to make a decision and talked to couple of facilitators/custodians including Equity Trust. I was told (misleaded???) by Equity Trust that I still need a custodian (not HAVE TO but SHOULD) to avoid any issues/possible audits from IRS. They also mentioned the same with regard to Checkbook control saying..IRS don't like that idea and you are more likely to get on IRS radar...They also tried to convenience me that many facilitator who advocates Checkbool Solo401k are doing so because they are NOT custodians and it is not the right thing to do.

I don't want to get stuck into Analysis Paralysis  but want to make sure I get it right since it is not easy to fix once it is set up.

Would appreciate views and inputs from experienced BP members...

thanks!

Mark Nolan · Answer

@Kumar Paj

Having worked for a self-directed IRA company  that got bought out by Equity Trust, I can tell you that regardless of the type of account that you open, whether an account with a custodian or a facilitator, that the IRS does not audit solely based on the types and who you open the retirement account with.

Brian Eastman · Answer

@Kumar Paj

Let me star by noting that you need to consider the source when it comes to information in this field.  Equity Trust has a long track record of opposition to the idea of checkbook control, not because of the risk they infer, but because it deprives them of fee revenue.

The Checkbook IRA LLC is widely accepted by a number of registered IRA custodians who are members of RITA (retirement industry trust association) and regulated by the Fed and IRS.  The IRA LLC model has been around for more than 20 years and has been tested in the courts.  There is no issue with the structure, but you absolutely need to be aware of the rules and use the structure in accordance with the IRS guidelines.  When you work with a quality facilitator, you should have access to ongoing education in this regard, backed by a licensed tax attorney and/or CPA.  Of course, having your own counsel is always a good practice with any type of self directed plan.

The Solo 401k is somewhat more robust from a legal perspective when it comes to self direction.  All 401k plans are by design controlled by the principal of the business (or appointed representative) who serves as trustee.  There is no tax code requirement that a 401k trust have a custodian or 3rd party administrator, but that has always been the dominant paradigm in the Wall Street world of investing where trades are institutionally processed.  As the trustee of the plan, you can self direct the plan into alternative assets such as real estate and lending, and do so out of a simple trust account held in the name of the plan.

None of this is new, or inherently risky at the structural level.  The risk you take is in ensuring that you use the tool correctly.  Increased responsibility is the trade-off for increased flexibility and control.

I would also point out that while many custodians of self directed IRA and 401k plans market as if "they have your back", they have no obligation whatsoever when it comes to ensuring your intended plan activities are within the IRS guidelines, and will defer to your counsel when it comes to ensuring compliance.  Sure, they will refuse to issue a check made out to you or something else that would be clearly obvious as a prohibited transaction, but they will not perform any substantive review of your entire transaction.  In that respect, you actually have better resources for help with compliance when you work with a quality plan facilitator that provides access to guidance.

Doreen Chaisson · Answer

There are many different companies to choose from when deciding which IRA provider will help you invest your retirement funds into real estate. What often gets overlooked is the type of company you are choosing. IRA /Solo(k) providers can be put into three separate categories: Custodians, Administrators, and Facilitators.

Custodians are the first type of company, and are usually the most common. They’re either a bank, credit union, or non-bank custodian approved by the IRS (usually a broker dealer who obtains IRA approval). Custodians are permitted to custody assets held in an IRA under IRC Section 408. They’re also subject to strict regulatory oversight at a State or Federal level.  Custodians tend to take a more conservative approach when reviewing alternative assets for investment, as they want to avoid the custody of any assets that may be involved in prohibited transactions.  Alternative Asset custodians cannot give any tax, legal or investment advice, cannot assist with the structure of an investment, and cannot endorse, promote or align with specific investment sponsors.

Administrators are the next type of company. Essentially anyone can be an administrator, and their main function is to perform administrative functions only. Because of this, they also need to have an identified custodian for the self-directed IRA named in the account disclosure documents. Administrators are only subject to regulation if required due to profession (CPA or attorney), not for role as administrator. This allows administrators to be much more liberal in accepting assets and allows the ability to align with investment sponsors.  Review fee schedules carefully – there may be separate charges for whatever 3rd party custodian they are using.

The third company type is a Facilitator. They educate investors on the process of self-directed investing or assist in setting up single-member LLCs for either “check-book control” or to purchase a franchise or ROBS (Roll-Over Business Startup).  They may also provide administrative services for the LLC. Like Administrators, Facilitators must have an identified custodian for the self-directed IRA, but are only subject to oversight on a professional level and are not regulated. As a result, they are much more liberal in accepting assets and can align with investment sponsors, something normally avoided by regulated custodians and administrators. Because they answer to no regulatory body, facilitators may not be as aware or adept at alerting clients about prohibited transactions.  Again, review fee schedules carefully – there may be separate charges for whatever 3rd party custodian and/or administrator they are using.

So when you’re looking for someone who offers a self-directed IRA, make sure you know the type of company you’re dealing with. This will help when determining which company best fits your investment scenario

Justin Windham · Answer

Excellent responses above. I will add that many concerned with compliance and IRS scrutiny are comforted by the fact that the Solo 401k often comes with an IRS determination letter addressing the structure's legitimacy.

Steven Hamilton II · Answer

There are different components, you will have an administrator, that is the person who is charge of the account, making sure there is no prohibited transaction (can be you who does this job; however, you must know the regulations).

There are a lot of factors to consider.

I love Solo 401ks, they are definitely superior to the SDIRA.  But you must handle things the correct way.

Doreen Chaisson · Answer

Best bet would be to meet with a knowledgeable CPA or attorney, familiar with IRS laws as they pertain to Solo(k) assets.  My company is an administrator and custodian for both Solo(k)s and Self-Directed IRAs.  We work closely with our clients over the lifetime of their investment to ensure the accounts maintain their tax-deferred status.  Your Solo(k) will still need an administrator, and they may have certain requirements regarding whether a custodian is needed or not.

Gautam Venkatesan · Answer

@Dmitriy Fomichenko should be able to help you out setting up Solo 401K

Doreen Chaisson · Answer

A few issues here:  First, a micro business may qualify you to set up a Solo(k), but keep in mind salary deferrals into it must come from that micro business, and not from your W-2 salaries at your other jobs.  They are good if you have funds in other retirement plans you can roll over into them, or if your micro business generates considerable income for you to contribute to the plan.  Otherwise your funds to bulk it up may be limited.

As far as checkbook control, these generally involve a single-member LLC to facilitate. Some IRA custodians will not accept Single Member LLC due to increased regulatory scrutiny that started back in 2009.  Other custodians will accept them, provided you appoint a special advisor - a licensed attorney or CPA - who will review all transactions of the LLC to make sure it's not running afoul of prohibited transaction rules.

SDIRA vs Solo401k - IRS have any issue with Checkbook control?

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