Start with a self-directed IRA, later move to Solo-401k?

Question

Hello,

I have been reading up on self-directed IRA's and solo 401k's.

I feel like I am starting to understand some of the details now, and have a tentative plan.  I'm looking for any feedback/issues with it.  Hopefully this post isn't too long...

My situation:

* I am interested in investing in real-estate partnerships in my retirement accounts.

* To complicate things, I currently have a traditional IRA (which I have rolled over previous 401k's into). I also managed to include some after-tax contributions in this IRA in 2005/2006, so it has a small amount of after-tax contributions in it.

* My employer allows after-tax payroll contributions into my 401k, which can then be rolled over (in-service) into a Roth-401k (or an external Roth-IRA). This seems like a very good way to boost my Roth savings, as the contribution amount can be pretty large.

* If it doesn't complicate things too much, I would also like to make a yearly (after-tax) Traditional IRA contribution, and roll that into a Roth IRA.

* Right now my wife and I don't have self-employment income (since passive income from rentals and investments don't count). The rentals we have are not local, so we aren't managing them directly.

Here is my thinking:

Overall, the solo-401k plan looks better to me than a self-directed IRA, due to all the reasons mentioned in other threads (UDFI not an issue for any future real estate purchases, no custodian requirements, possibility of a loan, plus it allows me to make a Traditional IRA contribution yearly and roll it over to a Roth IRA, without having pre-tax IRA funds complicating things).

But, without self-employment income (yet), maybe a 2-step approach makes sense...

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Short Term:

* Start a self-directed IRA, using my traditional IRA account. Is there any benefit to separate out the pre/after tax portions into two separate IRA accounts now? i.e. will that make it easier to roll over the pre-tax portion into a solo-401k later on?

* Make annual "after-tax" traditional IRA contributions (my IRA already has after-tax contributions, so I'm assuming it isn't any more complicated if I make more after-tax contributions now).

* Start doing after-tax payroll deductions into my employer's 401k, then roll them into a Roth 401k (in-plan).  When a solo-401k account is setup, then do an in-service rollover into a solo-401k Roth sub-account (where they can then be invested in real-estate).

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Longer Term:

* Work towards generating self-employment income.

One possibility is if we sell our current house, and buy a place where we can rent out part of the property (4-plex?). Then we should be able to pay ourselves for the property management work. We have been thinking of doing this anyways, and this might be another reason to do so.

* Then, start a Solo-401k plan.

Roll over (pre-tax) funds from my IRA. As I understand it, this will separate out my pre/after tax contributions, so the after-tax portion can be converted to a Roth IRA. I think this will require calculating the gains on the pre/after tax contributions separately, likely with a CPA's assistance, but I don't understand all the details of this yet.

Question: Is it common for a solo-401k plan to accept "in-kind" rollovers of real-estate partnerships, etc. from a self-directed IRA? I wouldn't want to have to liquidate these partnerships to do the rollover.

Thanks for any feedback...

John Woodrich · Answer

If he is paying himself a wage on a property owned outside of his IRA/401(k) this would be an OK transaction however he would have potential SE tax implications which would have otherwise been avoided. There are also the annual 401(k) contribution limits so it would just seem easiest to max out his work plan instead of playing games trying to generate SE earnings through rental income.

I would also double check that your employer plan allows you to roll your funds into an outside investment while you are still employed. Most plans do not allow a rollover even if a person is fully vested.

I would also double check that your employer plan allows you to roll your funds into an outside investment while you are still employed.  Most plans do not allow a rollover even if a person is fully vested.

Eric Lee · Answer

@John Woodrich

No, I was thinking of buying a house + rental unit with after tax funds, and paying myself for the work to manage the rental.

That would be a business (generating self-employment income), which could be used to fund a Solo 401k.

No transactions have taken place, I am learning about the options at this point.

Justin Windham · Answer

@John Woodrich I believe Eric is talking about paying himself from his rentals that he does (or would) own outside of the retirement account and using this as his SE activity to adopt a Solo 401k plan.

@Eric Lee What you are saying makes sense to me. Establishing the earned income from SE is a pre-requisite for the Solo 401k, but you're on the right track.

Eric Lee · Answer

Account Closed

Thanks for the comment.  I hadn't known about that.  Fortunately (I guess) our Roth IRA will be fairly small, so I'll probably end up in a stock fund.  This would be another reason to go that direction with the Roth IRA.  If they ever do allow Roth IRA -> Roth 401k rollovers that would be nice, though.

Would there be any issue with investing in the same real estate partnership with both self-directed IRA and after-tax funds?  Or both my self-directed IRA and my wife's self-directed IRA?

I had been thinking of doing that.

Account Closed · Answer

@Eric Lee, some of my clients have run into logistics issues with wanting to combine funds from a traditional IRA and a ROTH IRA into the same investment. Prohibited transactions can be created if not managed and reported correctly through the custodian. In addition to @Dmitriy Fomichenko's caution about the SoloK setup, you also need to look at the IRA account setup to see whether they allow an in-kind transfer out. Not all of them do.

Mark Nolan · Answer

@Eric Lee

Your plan sounds like a good one. It is always good to write it down.

John Woodrich · Answer

You couldn't pay yourself to manage the properties, that is a prohibited transaction.

John Woodrich · Answer

I got lost reading the above.  If you have a wage at an employer, you have self-employment income.

It sounded like you were considering purchasing an investment (in a tax deferred account) and paying yourself?  The only way you can pay yourself out of a tax deferred account would be for services you are providing to the IRA such as annual reporting requirements, Unrelated Business Income Tax returns, etc.  You can't pay yourself for working for the properties and you surely can't live in a property owned in your tax deferred account!  These are the definitions of prohibited transactions.

There may have been a comment about not getting a loan on for properties in a self-directed IRA, you can but it must be non-recourse.

I am concerned that you are piecing this information together by talking to investors and other non-professionals.  I am also concerned that you may have already triggered a prohibited transaction...  I would highly recommend you talk to a self-directed IRA or Solo 401(k) expert.  These transactions are very touchy and there are many losing court cases with big dollars out there.

Eric Lee · Answer

@Nathan Click

Thanks for the comment.  Using the IRA to purchase properties would be further down the road for us, I am looking at more passive partnerships now.

Eric Lee · Answer

>Paying yourself to manage part of your residence while technically possible practically may or may not work. You can only pay yourself so much for the property management work and would be converting passive income into income that would be subject to self-employment tax...

Dmitriy,

Thanks for the info, I had not thought about self-employment taxes.

As a rough estimate, if there was a separate 2 bed/2 bath unit that might rent for $3k per month (we are in a high cost area).  So, if we paid ourselves 8% of the rent (similar to what we pay for out-of-state management now) it might be an additional SE tax cost of (3000*12*0.08*0.153) = $440?

I like the idea of a local rental, as we did this several years ago, so I'm confident we do it (I did most of the repairs, we were able to find good tenants, etc.).  But if it won't work, I'll have to keep thinking about other side businesses.

@Dmitriy Fomichenko

Start with a self-directed IRA, later move to Solo-401k?

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