The Exclusive Benefit Rule

The exclusive benefit rule applies to all tax-sheltered retirement plans and is stated in IRC section 401(a) for employer plans and section 408(a) for IRA plans. This rule stipulates that all activities of the plan must be for the exclusive benefit of the plan beneficiaries.

This rule needs to be viewed in two ways:

  • The investments of the plan must be in the best interest of growing the plan savings and meeting the retirement benefit needs of the plan participant(s).
  • The investments of the plan may not provide a benefit to plan beneficiaries or other disqualified persons other than growing the savings value of the plan.

With respect to the first principal of being in the best interest of the plan, the IRS recommends the following criteria to determine if a plan’s policies are for the exclusive benefit of the plan participants:

  • The cost of an investment must not exceed its fair market value (FMV) at the time of its purchase.
  • A fair return commensurate with the prevailing rate must be provided.
  • The investment must be sufficiently liquid to permit distributions per the plan terms.
  • The safeguards and diversity that a prudent investor would adhere to must be present.

When a plan acts or is used in a way that provides a benefit to the participant or a disqualified person, then a prohibited transaction occurs.

When you choose to self-direct your retirement plan, you must therefore act in accordance with these guidelines and follow best practices to invest wisely.

One of the areas where we commonly see risk based on violations of the Exclusive Benefit Rule is when dealing with allowable family members, but in a way that is somehow overly favorable to the counterparty.

While a sibling is not considered a disqualified party to your plan, and may therefore be issued a loan by the plan, if that loan is well below market rates then it is not really in the best interest of the plan.

Similarly, if a cousin were renting a property from your IRA, you would need to evict them for failure to pay rent, just as you would any tenant. Failure to do so would be contrary to the exclusive benefit of the plan.

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