Rollover IRA used to open Self Employed 401 (k) no employees, no income,

Submitted by Mike Kresloff on Thu, 2016-10-06 19:41

I am considering moving IRA rollover money into a new self directed 401 (k).
I have a Dba that is not earning revenue,and it could take a year before I am generating income. No employees, no revenue.
Am I at risk moving rollover money into this new account and would it be considered a distribution?
Thank you.



Submitted by Alan - IRA critic on Thu, 2016-10-06 20:08

You may be entering a gray area if you open the 401k before you are even generating revenue, much less a net profit after expenses. You cannot make solo K contributions under those circumstances. I am not aware of specific guidelines on starting a business in relation to opening a solo K, but when business activities cease, you must terminate the plan within a few months. If you happen to never get the business up and running, and the only activity in the plan is an IRA rollover, especially if you are doing this to execute a back door Roth, it is possible that the direct rollover would be voided and then you would have a distribution. No way to determine the amount of risk you would be taking, but if the direct rollover amount is sizeable, you might want to wait awhile. Of course, for the initial rollover you would receive a G coded 1099R, so it would take well over a year and probably longer to receive any IRS contact should they want further information.



Submitted by Mike Kresloff on Thu, 2016-10-06 21:17

So f I am not contributing, merely opening a new qualified plan connected to a new business, and rolling existing qualified funds into it, are you saying  this may be considered a distribution And not a rollover?  I get it that if the business fails I may need to move the funds but if I would rollover back to a qualified plan there would be no funds distributed. 



Submitted by Alan - IRA critic on Thu, 2016-10-06 21:36

  • If you actually start the business even though you cannot contribute business income to it, you probably will not have a problem other than having to terminate the solo K and roll the former IRA money out of the plan.
  • But if you never make a legitimate attempt to establish the business, it is possible that the IRS could take the position that the solo K was not valid and was intended only as a plan to transfer IRA money into. Most plans are not established until fairly close to the time when contributions from the business would take place. Another possibility would be some kind of fine, but the rollover into the solo K would not be questioned and you would be allowed to just roll it back out.
  • Therefore, if you decide early on to abandon the business, I would terminate the solo K and roll the IRA money back out to an IRA or to your employer plan if you have another job and the plan would accept a direct rollover from the solo K.
  • Is the prime reason for the IRA rollover to the solo K to enable a back door Roth IRA?


Submitted by William Tuttle on Thu, 2016-10-06 22:49

A Self-Employed Individual is defined as someone who has earned income with respect to a a taxable year or if no earned income in that taxable year, had earned income in a previous taxable year. My interpretation is that If your business has had no earned income, You are not a Self-Employed Individual as defined by section 401. I see no way to open an Individual Participant 401k and roll over an IRA until a taxable year with earned income.



Submitted by David Mertz on Thu, 2016-10-06 23:25

For the definition of a self-employed individual, see 401(c)(1)(B), which appears to indicate that anyone who files Schedule C, Schedule F, or receives a Schedule K-1 (Form 1065) showing self-employment earnings or loss is self-employed within the context of section 401, whether or not there is a net profit.  Also, once self-employed, forever self-employed: https://www.law.cornell.edu/uscode/text/26/401#c_1_B



Submitted by William Tuttle on Fri, 2016-10-07 03:13

If you will note, I was also referring to 401(c)(1)(b). Note: It is (b)(i) and (b)(II). So yes, you are considered to be an Self-Employed Individual even if you have no profit in a given year, but if and only if you have earned income in any previous year.



Submitted by David Mertz on Fri, 2016-10-07 13:13

I would agree with your interpretation if 401(c)(1)(b)(ii) did not include the words “an individual.”  However, with the words “an individual” present in (ii), it indicates a requirement independent of (i), i.e., two separate classes of individuals.



Submitted by William Tuttle on Fri, 2016-10-07 20:57

What are you talking about? (B) proper refers to an individual “an individual who has earned income”, just like (i) and (ii) refer to an indiviudal. We will just have to agree to disagree. The tax code doesn’t get any plainer than this.



Submitted by Mike Kresloff on Fri, 2016-10-07 02:48

The advisor I am considering transferring my IRA rollover to has a planning model that converts the IRA to a self directed 401 (k).  He includes a choice of two or three investment buckets of 2nd trust notes paying 7-18% with a commitment of 12-18 months with residential developers, funded by an investment bucket of structured settlements paying 2-4%.  This feeds a universal life policy that has cash value year one and year 3 policy loans begin to fund additional real estate notes when previous ones mature. Compounding interest shows nice growth over 10 and 20 yrs (I’m 60’and don’t feel love for the equity markets). Why would he be pressing to open a 401 (k) rather than keeping it in an IRA rollover except maybe you can’t buy life insurance in an IRA.  I may be uninsurable so he says I can buy a policy on one of my kids to utilize compounding interest and policy loans. Or add real estate trust notes. He charges 1.5% annual management fee but If he advises me wrong and the IRS says I took a distribution and  to pay income tax then that would be a home wrecker and no skin of his is in the game.  Maybe he knows something others don’t know? 



Submitted by Mike Kresloff on Fri, 2016-10-07 02:50

We never discussed that but sounds compelling if I can move money tax free



Submitted by Alan - IRA critic on Fri, 2016-10-07 04:45

If I was you I would avoid this advisor. You will end up with an extremely complex plan that you will never understand that contains several unintended pitfalls. He probably wants to use the 401k because that avoids the oversight of an IRA custodian. Also, IRA custodians are now required to report the nature of all alternative IRA investments such as real estate on Form 5498 so the IRS knows what investments are in the IRA. A 401k does not have that requirement, so it is more difficult for the IRS to discover prohibited transactions and other violations. Finally, once you got locked into this complex arrangement it may be very costly to get out, so you would become a captive client. Not worth the risk in my opinion.



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