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Rollover A Solo 401(k) to a Checkbook IRA

A self-directed Solo 401(k) is a great retirement plan.  With high contribution limits and the ability to invest in anything the IRS rules allow for like real estate and private equity, the Solo 401(k) is one of the best ways to take control of your retirement savings.

The one drawback of a Solo 401(k) is the required linkage to active self-employment in an owner-only business.  If your business grows to hire employees or you decide to shut your self-employment activity down, you may no longer qualify to have a Solo 401(k).

Fortunately, there is a good option if your Solo 401(k) reaches this end-of-use moment.

Solo 401(k) Qualification

A Solo 401(k) is an employer sponsored retirement plan.  That means the plan is linked to one or more business entities that establish the plan as an employee benefit.

Any kind of active business can sponsor a Solo 401(k), including sole proprietorships, LLCs, corporations, and partnerships.  The business just needs to produce active, earned income.  Passive activities like rental property or other investment holding vehicles cannot sponsor a retirement plan.

The simplicity of a Solo 401(k) stems from the fact that there are no non-owner employees covered by the plan.  The sponsoring employer, or any other business controlled by the business owner, cannot have any full-time employees working more than 1,000 hours per year.  Long-term, part-time employees working 500 or more hours per year in two consecutive years will also qualify for retirement benefits and disqualify a business from having a Solo 401(k).

Events that End Qualification

When you decide to establish a Solo 401(k) for your business, you need to ensure that your business continues to qualify to sponsor the plan into the future.  Some events can put you in a situation where you no longer qualify for the Solo 401(k).  These include:

  • Closing your business and not maintaining any other form of self-employment.
  • Hiring full-time or long-term, part-time employees in the business that sponsors the plan.
  • Being a controlling owner of a separate business that has full-time or long-term, part-time employees.

So, what do you do if you have a Solo 401(k) holding non-traditional assets like real estate or notes and you need to close the plan?

The Checkbook IRA Option

For investors who want to continue to be fully diversified and in control of their retirement investments, a checkbook control IRA provides a great back-up option for the Solo 401(k).

Like the Solo 401(k), a checkbook self-directed IRA has the ability to invest in anything the IRS rules allow for.  If you are used to being able to execute contracts and deploy plan funds at a moment’s notice without 3rd party processing, you will appreciate the same benefits from the self-directed IRA.

While based on the IRA retirement plan format with a different structural design, a self-directed IRA functions very much like a Solo 401(k) as an investment vehicle.

One key difference between the Solo 401(k) and IRA is that the IRA requires a 3rd party custodian to be the record keeper and intermediary for IRA layer transactions like contributions, rollovers, or distributions.

The way to obtain checkbook control in an IRA environment is to have the custodian-held IRA invest into a specially crafted LLC.  The IRA owns the LLC.  You can be the manger of the LLC and direct the affairs of the LLC.

The end result is much like your Solo 401(k).  Plan capital is held in a legal entity for which you have the authority to act on behalf of the plan.

The Rollover Process

Because we want to have an LLC that holds plan investments on the IRA side, it is easier to form that LLC within the current Solo 401(k) first.

Once a new LLC is formed under the umbrella of the Solo 401(k), all the current investments of the Solo 401(k) are transferred into the LLC.  This event is a transfer-to-self since the 401(k) owns the assets that are then placed into the 401(k)-owned LLC.  There is no special reporting or taxable event associated with the transaction.

Once all 401(k) assets have been placed in the LLC, the LLC itself is then rolled over in-kind to a new self-directed IRA custodian.

Voila!  The Solo 401(k) has been closed and rolled over to an IRA.  The investments of the Solo 401(k) remain in place and there is no tax on the rollover.

Solo 401(k) Plans with Multiple Accounts

The process can be a bit more complex if your Solo 401(k) holds a mix of tax-deferred and Roth funds.  While a Solo 401(k) can separately hold both types of retirement money, an IRA is either Traditional or Roth.

In this scenario, you will need to create separate IRAs.  The Solo 401(k) will then need to create a tax-deferred LLC and a Roth LLC for rollover to the separate IRA accounts, respectively.

Similarly, if your Solo 401(k) has more than one participant, such as a spouse or business partner, the plan assets will need to be allocated accordingly.

A One-Year Window

In most cases, you will have at least one year to make a graceful exit from your Solo 401(k).  Depending on your specific Solo 401(k) plan document, qualified employees may not be granted benefits until they have a year of eligibility.

The key thing to keep in mind is that a Solo 401(k) is not a set-it-and-forget-it program.  You should regularly check on your plan status to make sure you are still eligible to sponsor the plan.  If you find you no longer qualify, reach out to your plan provider to plan a graceful exit.

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