If you’re looking for a tax break this year, there’s still time to open a Solo 401(K). But do your research and seek experts to help you understand the plan, how to manage your account without the need for a custodian which amounts to extra fees, and how to transfer your existing new plan. You’ll find the options for investing and maximizing your contributions are plentiful but the clock’s ticking—you only have until December 31st to open one for 2009.

For the self employed, a fantastic development has occurred over the past few years – the Solo 401(k). One distinct advantage of the Solo 401(k) over an IRA is that it is not subject to paying UBIT on profits from financed real estate. Eliminating UBIT by using a Solo 401(k) eliminates the need to file a return (Form 990-T) as well as the accompanying tax. Sound pretty good so far?

The difficulty in recent times has been obtaining nonrecourse financing. The leader of NR financing in the Self Directed IRA industry for the past few years has been North American Savings Bank. Last year, they took the familiarity of IRA lending and applied it to Solo 401(k). Unfortunately for many Solo(k) investors, this has only been available to plans who choose to name a custodian as trustee of the plan. Qualified plans (which is what all 401k plans are) are different than IRAs in that they are not required by law to name a custodian (bank or trust company) as trustee of the plan assets. Investors who establish Self Directed Solo 401(k) plans that name themselves as trustee for simplicity have not been able to readily obtain mortgage loans for their Solo (k) plan from NASB.

Well, as of this month, NASB has expanded their loan products to include a nonrecourse loan program for self trusteed Solo 401(k) plans. I caught up with Matt Allen to discuss the great news on UNLIMITED RETIREMENT ACCOUNT® Radio. The skinny is that the program is almost identical to the IRA lending program. If you aren’t familiar with their guidelines, check out the URA Radio show podcast as it become available soon.

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Solo 401(k) retirement plans can grant direct checkbook control without the use of an LLC or custodian.

The concept of custodian comes from Internal Revenue Code Section 408(a)(2) and is defined in Section 408(n). This entire IRC section 408 is devoted to Individual Retirement Accounts, or IRAs. The code basically explains that an IRA is normally a trust, and the trustee must be a bank. It then defines bank as a bank, trust company, or any company specifically approved by the IRS. This capacity of trustee to an IRA is known as “custodian”. This trustee role is simply that of investing the plan as directed by the accountholder.

A Solo 401(k) plan is a type of 401(k) that is designed for self employed individuals whose businesses have no full time employees. All 401(k) plans are qualified plans, and qualified plans do not have any special restrictions on who can serve as trustee.

So the significant difference is that with a Solo 401(k), the participant can actually be the trustee and handle the investment transactions themselves. This can serve to simplify operating the plan because no third party is introduced. Such simplification can also serve to minimize third party fees.

Titling of Assets

If you’ve been researching or operating a self directed IRA, you may be familiar with how IRA assets must be titled. If Jeremy Smith had an IRA with Sunwest Trust, his IRA’s assets would be titled as:

Sunwest Trust, Inc. F/B/O Jeremy Smith IRA

“F/B/O” means “for benefit of”. To experience the benefits of checkbook control, some self directed IRA accountholders choose to create a special purpose LLC to be owned by their IRA but managed by them. So the membership units of the LLC would be titled as:

Sunwest Trust, Inc. F/B/O Jeremy Smith IRA

…and Jeremy (as manager of that LLC) would further invest the new LLC funds to purchase assets that would be titled in the name of the LLC.

To own and directly control retirement assets in a Solo 401(k) plan can be much simpler. Jeremy would simply have his plan setup to name himself as trustee. He would then direct the plan to purchase assets to be titled to:

Jeremy Smith Solo 401k Trust

…or whatever Jeremy chooses to name the trust that exists for the sole purpose of managing the assets for his Solo 401(k) plan. In this case, there is absolutely no need to setup an LLC for the purpose of gaining checkbook control.

This convenience is little known because conventionally 401(k) plans have served as an investment vehicle for large corporations with many participants. Solo 401(k) plans are much easier and less expensive to operate. In fact, Jeremy can serve the roles of employer, employee, plan participant, plan administrator, and plan trustee. Serving the role of employer and employee allows him to contribute up to $46,000 per year to his account (or $51,000 if he’s over age 50). If Jeremy’s wife works in his business, she can participate as well and contribute up to another $46k each year.

The Downside of Checkbook Control

You may hear about potential problems of checkbook control, such as recordkeeping and legal compliance. Firstly, the only reporting required for a Solo 401(k) is annual filing of Form 5500-EZ, and it is only required once plan assets exceed $250,000 in value. There are plenty of companies who will prepare this form for about $300.

The issue of checkbook control legal compliance is quite simple. All self directed accountholders and participants must avoid prohibited transactions. This requirement and responsibility rests solely on you as accountholder/participant regardless of whether you have checkbook control and regardless of whether you are using and IRA or Solo 401(k). See an elaborate explanation here.

The facts are that when using a self directed, self administered, self trusteed Solo 401(k):

• meeting the reporting requirements is simple, and it’s inexpensive to have Form 5500-EZ prepared for you
• there is no special or unique risk of legal noncompliance that would otherwise be eliminated by using a custodian

Conclusion

In my opinion, a Solo 401(k) where the same person serves all roles involved is the simplest, most effective and direct way for that person to self direct their retirement plan investments. It opens doors to the most flexible options possible. This allows for investment into foreign assets, investment clubs, tax liens, precious metals, and many other investments that some custodians optionally refuse.

So if you’re self employed (through your own Corporation, LLC, or even Sole Proprietorship) and you have no full time employees, the rules are bent in your favor with a Solo 401(k) – arranging and utilizing checkbook control is easier.

What is a participant loan?

A Solo 401(k) participant can borrow up to either $50,000 or 50% of their account value with the following terms:

• To be repaid over an amortization schedule of 5 years or less
• Regular payments no less frequently than quarterly
• At a reasonable rate of interest… generally interpreted as prime rate + 1%

Such a loan may only be made in accordance with the Solo 401(k) plan documents. While most plan documents disallow this type of loan, the Unlimited® 401k offered by my company does allow it.

Under what conditions is this allowed?

Any. As long as the plan documents allow for it & the proper loan documents are prepared and executed, a participant loan can be made for any reason.

When is this useful?

This can be useful when someone is thinking about distributing money out of their Solo 401k plan for some reason. I recently talked to a man who was going to distribute his 100k IRA to pay for finishing the repairs of 2 fixer upper houses. After we spoke, his strategy was amended to instead:

• Setup a Solo 401k plan (adopted by his business) and transfer IRA funds into it
• Take a participant loan of $50k
• Use the loan proceeds to finish rehabbing Property #1 (which was owned personally free & clear)
• Do a cash out refinance on Property #1 once rehab is complete
• Use refi proceeds to finish rehabbing Property #2 & pay back the Solo 401(k) participant loan

In his situation, it made sense to pull some equity out of Property #1 to pay for the completion of Property #2 (and the early repayment of the participant loan) because the rental income (upon completion) of Property #1 covered about 350% of its new loan payments.

The result of the new strategy

• Avoided IRA distribution
• Avoided $35,000 in distribution taxes
• Paid participant loan back within a few months
• The rental income of Property #1 will payoff its mortgage within 6 years (with maximum principal reduction payments)
• Left $100k in his retirement account for maximum tax deferred growth

There are many other common uses for a Solo 401(k) participant loan. If a person wants to make a <$50k investment that would otherwise be a prohibited transaction, they can just borrow the money and do the investment as an individual.

What other uses can you think of?

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If you talk to the average CPA, he’ll tell you that UBIT is the boogeyman and is to be avoided… always. Discussing this topic with an above average CPA (such as Eric Wikstrom of Integrated Wealth Strategies) yields different advice.

The Two Types of UBIT

1. Triggered from a trade or business – if a tax exempt entity (such as an IRA or 401k) owns a trade or business, the income of that business is taxed at trust rates (i.e. very high tax rates). Both IRA & Solo 401k accounts are subject to this type of UBIT.
2. Triggered from ownership of leveraged real estate – if a tax exempt entity (including IRA) owns real estate leveraged with a mortgage loan, the portion of that income attributable to the mortgage loan is taxed at trust rates. This type of UBIT is specifically referred to as UDFI – Unrelated Debt Financed Income. Solo 401k accounts & other qualified plans are exempt from UDFI.

Trust tax rates are very high, so it might make sense to avoid Type 1 UBIT at all costs. On the other hand, a close examination of UDFI tends to revoke its “boogeyman” status.

The reason UDFI isn’t a detrimental cost is that non-recourse mortgage loans (the only type an IRA/401k can legally obtain) are typically only offered at a 65% loan-to-value maximum. So this means that the UDFI tax is only payable on up to 65% of the property’s net income. (That’s right – net income. You do get to deduct depreciation and other expenses before paying UDFI tax).

Let’s examine a simple comparison of the taxes payable on net real estate income with 50% leverage:

Example A

Example B

The gap between the dollar amount of taxes paid widens as the income increases:

Let’s go back and look at Example B. Take the difference in taxes and examine the long term effects of 25 years of investing and compounding returns. These charts assume a 15% annualized ROI:

Example B1

This uses an effective tax rate of 16.23% for UDFI

Example B2

This uses an individual tax rate of 28%

The result? The IRA has a balance of $631,385.87 more than the individual does.

Conclusion

It might make sense to avoid Type 1 UBIT, while Type 2 UBIT (UDFI tax) results in less taxation than the alternative of investing with individual funds. For those eligible for the Solo 401k, Type 2 UBIT (UDFI tax) generally does not apply.

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1. Be eligible for a Solo 401k in the first place. This means that you have to have self employment activity (such as Schedule C income on your 1040 or own a business), and you have to have no employees at any businesses in which you or your spouse have significant ownership. (An “employee” is somebody who works over 1000 hours per year for your business and receives a W-2).
2. Add me on Facebook. Go to my Facebook profile to add me to your friends. If you don’t have a Facebook account, just create one. It’s very simple and easy, and it will help you stay connected for updates, news, events, etc.
3. Write a brief explanation of the most powerful business or investment opportunities in our current recession. Explain the “how” and the “why” as much as you can, but be direct and to the point at the same time. Submit it in a comment on this blog post (the one you’re currently reading) OR post it to the “wall” at the bottom of the Facebook Solo 401k Contest page. I’ll review all entries, and the person with the best idea will get a Solo 401k setup for them by Nabers Group with the entire establishment fee waived.

Submission Deadline: March 15, 2009

Value: $210,585

The math: Over the past 10 years, most stock indexes have produced a return of approximately 0%. With a Self-Directed Solo 401(k) plan, the accountholder can buy real estate, gold, stock in private companies, and loan money to individuals or corporations. Surveys have shown us that over 80% of our Solo 401(k) clients have a target return of investment of 12% per year or more. An investor with $100,000 of existing funds who earns 12% per year for 10 years will generate a profit of $210,585.

We’ve never done this before, and I don’t know if we will ever do this again. Now’s your chance – start working on your entry today!

* The value is based on the potential profit you could earn and will vary based on your investment decisions. With a Self-Directed Solo 401(k), it’s up to you to find and choose investments, and only you will decide how profitable and valuable this investment vehicle will be.

We’ve never done this before, and I don’t know if we will ever do this again. Now’s your chance – start working on your entry today!

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This is quite a simple concept so this post will be very brief.

• Our weak economy has brought very high inflation: as high as 13% over the past year.
• Future dollars are worth much less than dollars today.
• With a Solo 401k you can make tax-deductible contributions to your retirement plan in today’s dollars and pay taxes later in less valuable dollars.
• Successful entrepreneurs and self employed individuals can contribute $49,000 per year or more to their Solo 401k in 2009.

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In this segment we briefly discuss the Solo 401k and how it differs from a Self Directed IRA.

The following clip observes the benefits of unrestricted investment choices.

[Additional clips from this discussion to come]

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While there are many people finding themselves more fearful than ever, there are others who are more excited than ever. Here’s why…

1. The rules of safety and courage have changed. Since the industrial revolution, employee-ism has surged. During this time, getting a job to work for somebody else was the safe thing to do. On the other side of the coin the risky, courageous act of working for oneself is what brings riches. As a result, each person has been faced with a choice to pursue either safety or riches. Part of what made employee-ism the safe bet for an individual is the stability of companies as well as what has become the largest store of non-real estate wealth in our country: holdings in the stock market. This year we have seen the rules of the game permanently changed. Our financial system is crashing, and trustworthiness has evaporated from corporate America and the financial services industry. Now working for yourself is no longer the courageous thing to do; it’s the safe thing to do.
2. Technology has brought immense power to everybody. Personal computers and the internet are now available to just about everyone. This has made some very expensive things become cheap or free. This has made it possible to do things that were previously impossible. There is no longer a need for every transaction to take place in a physical location. Needs and desires are able to be fulfilled online. In many circumstances, the large corporation cannot compete with the one-man shop. Today a person can start and run several businesses for little or no money. Taking something and creating or increasing its value has never been more accessible.
3. Arbitrage has never been easier to find and profit from. Arbitrage is the process of equalizing values. When two similar or identical assets can be bought at different prices in different markets, arbitrageurs show up to buy the assets in the lower priced market and sell them in the higher priced market. This act itself will usually bring the prices together in both markets. People have been “arbing” since the beginning of time. A farmer grows corn, and there is a town close by where he sells his corn. He discovers that in an other town further down the road, his corn will sell for more. He takes it there and enjoys increased profits for a period of time. In the book The 4 Hour Work Week, Tim Ferriss discusses geo-arbitrage. He describes this as the act of spending time in foreign locations that have a lower cost of living without reducing your standard of living – in fact he offers case studies in which people have largely upgraded their standard of living while maintaining or lowering their expenses. Anyone who can run their business over the internet will have the opportunity to enjoy geo-arbitrage. More change brings more arbitrage. We find ourselves in a time when change has never been more rapid or significant. Arbitrage has also never been more abundant.

I believe we’re moving into a time when self employment will replace much of the employee-ism of our recent history. Self employment today is quite different than just working a job for your own company. Owning a business in our rapidly changing, technology-armed environment allows you to disconnect your compensation from your time. Once your business can function independent of your personal time, you can develop additional streams of income and find ways to improve your businesses.

Every person, every government, and every company in the world is feeling the pressing of tremendous forces. Some of them include rising gas prices, rising food prices, rising real estate prices, falling real estate prices, unemployment, competition, etc. All of these problems create a demand for solutions. In some scenarios, large businesses with thousands of employees are too cumbersome to make changes as effectively as small businesses. As long as we continue to see change, there will be growing opportunity for small businesses to make the world a better place and profit in the course of doing so.

I believe self employment, responsibility, and self directed wealth management will become more common than the unnatural dependence of our recent years. There will be little opportunity for fraud and corruption once we have moved our wealth and power into our own hands.

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We have seen some unbelievable things over the past few years… especially the past few months. The only thing certain is that there is a lot of uncertainty ahead. If you haven’t already done so, right now I strongly suggest you watch the 30 minute condensed version of the film I.O.U.S.A. This film features David Walker, the former U.S. Comptroller General… aka the chief accountant of the government. He tried to fix the government’s financial problems, but Dick Cheney and others told him he needed to stop because they didn’t need solving. So he stepped down from his position and decided to prove to the world just how bad of shape our government really is in.

Today some people, including congressmen, are promoting some very extreme ideas. Some of these ideas involve the government “nationalizing” (or “confiscating” for those of us who speak directly) the assets of the people. Some plans even call for confiscation of retirement account assets specifically. In one scheme called the “Guaranteed Retirement Account” all retirement assets would be liquidated and handed over the Social Security Administration for investment management in a program that would provide a guaranteed return of 3% per year. This kind of silliness doesn’t need to be gratified by anything more than a brief response:

1. We’ve already seen how well the Social Security Administration manages money. It simply doesn’t. There is no money. There is no account. It just hands its income straight over to the general spending account of the government, and (not surprisingly) it gets spent!
2. Liquidating $16 trillion is impossible. It would crash the securities market entirely, and $16 trillion would not be withdrawn. If you started liquidating people’s retirement accounts alphabetically by name, those with names that start with letters n through z would receive little to nothing because of the price free fall created by the first half of the mass sell off.
3. The real world cost of living increases do not jive with published CPI figures, and there is often a discrepancy of much more than a few percent. A 3% return on investment would likely be a steady loss of principal when accurately indexing for inflation.

While we may not see that particular scheme enacted into law, it can’t be ignored that this type of solution is being considered. This government theft approach isn’t unheard of. In fact, Argentina just did it! Don’t forget that our government “confiscated” personal gold holdings in 1933… at least sort of. It was really more of a “government request” than a confiscation. An executive order was announced that requested that citizens show up to a Federal Reserve Branch within a month to sell their gold for $20 per ounce. The notable fact here is that not all the gold was turned in. According to author John Rubino, only 22% of the gold in circulation was actually turned in. Shortly thereafter, the gold price was set to $35 per ounce, thus devaluing the dollar by 41%.

It is not beyond possibility for our government to aim to take our wealth to pay for its financial problems. The difference between the gold confiscation of the 1930s and the threat of retirement account confiscation today is this: In the 1930s it was effectively voluntary to surrender your gold, while today over 99.9% of retirement assets are in the hands of custodians who are regulated by the federal government. While the 1933 confiscation was only 22% effective, a confiscation today would be 99.9% effective because of our unfounded trust in the financial services industry.

If a wealth “nationalization” plan were pursued, the outlook is grim for the overall population, but you can protect your wealth by simply taking direct possession of it. With an IRA LLC or a self-directed, self-trustee Solo 401k plan, you can legally hold your retirement account assets yourself directly. If an order were placed for you to surrender your retirement account assets, you could simply distribute them to yourself before the order deadline. In such a case you might have to give up 40% or more of your assets to taxation, but that is much better than losing 100%.

Again, I don’t like to come off as spreading “gloom and doom”, but unbelievable economic events are occurring left and right. The acts of the Fed (in concert with Fannie Mae and Freddie Mac) may have already devastated your first pillar of wealth – home equity. Don’t let further acts of foolishness destroy your retirement account.

Spend your time looking at the lighter side of things – investments that perform well; investments that you can understand and have predictable results. Just make sure that you are protected from losing your assets due to lack of optimal structuring. Whether you use a Self Directed IRA or Solo 401k to invest in a variety of alternative assets, make sure you set yourself up for direct possession of your assets.

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