Checkbook IRA/ Checkbook 401K: Its is Legal or Illegal

[Stephen E.]

I have known about self direct IRA but not Self Directed 401K and 'Checkbook' IRAs. I wanted to take control of my personal debt and let my IRA benefit from the loan but still maintain tax preference.

• What circustances and conditions would i have to follow for this to be legal?
• What kind of reporting is needed for this to maintain a legal status? 
• If this completely illlegal, what areas would this follow under?

Thanks

[Dmitriy Fomichenko]

@Stephen E.

A Checkbook IRA is a self-directed IRA that uses special purpose, single-member LLC as an investment vehicle. It is perfectly legal and millions have used it.

Just like an IRA, a 401k can be setup in a conventional way, or it can be setup as self-directed, giving you unlimited investment options. The advantage it has over an IRA is that it does not require a use of third party custodian, and you don't need an LLC to gain checkbook control. It has contributions limits that are 10 times higher than an IRA, allows you to invest tax-free using Roth sub-account, allows you to access up to $50,000 via participant loan feature, exempt from UDFI tax on leveraged real estate, and more! However, it is not for everyone, to qualify you must be self-employed or own a business without full time employees.

When you create this vehicle, the plan document provider firm will provide you with IRS Determination letter, this will address your question about the legality and validity of the plan. They will also help you with required reporting, form 5500EZ, which is pretty simply to complete (only two pages). As document sponsor they will report your plan as "active" to the IRS annually. 

You can and should be in control of your debt. However your IRA can't benefit from it, it's quite the opposite. Taking early distribution from an IRA (resulting in steep taxes/penalties) to payoff your debt would be unwise. To begin this process you should evaluate all of your expenses, get rid of all non-essential and start tacking your debt using "snowball" strategy (you can google it, I'm sure you can also find discussion of this strategy on BiggerPockets forum). The bottom line is you need to live below your means, spend less than you make, otherwise you will never reach financial independence.