This is a timely post due to a conversation I had late last week regarding self-directed 401Ks. It seems that an individual’s CPA had told his clients that they could not serve as Trustees of their own retirement plan (401K). Now, to set the stage, the husband and wife own their own C-Corp business and are the ONLY employees of the company. They want to have the ability to have a greater say in what their retirement funds invest into and are seriously contemplating self-directing their retirement assets by establishing a self-directed 401K.
Well, they had been provided information about self-directed 401Ks and were interested in their ability to have a greater say with how their funds are invested when….low and behold….their CPA put a momentary stop to the process.
Why, you may ask?
In fact, for those of you who read my posts here and on www.pgiselfdirected.com, you would be correct that, as a general rule, the circumstances surrounding the structure of their business (e.g., no employees) would permit them to establish a self-directed 401K and have checkbook control of their retirement account assets….right?!
For this post, I am going to touch this issue more from a layman’s perspective vs. IRS language…..trust me, if I didn’t we would both be asleep by the time I am done. Heck, you may be sleeping now for all I know! So, while this could go “deep” I will keep it as close to the surface as possible. So . . .
What needs to be considered in determining if the CPA is correct in their assessment that the couple in question cannot self-direct their 401K assets?
1) What assets does the IRS permit within a qualified retirement plan?
2) What 401K documents are in place for the plan and, more importantly, have the documents been approved by the Department of Treasury?
3) What is a Trustee? What is a Participant? And, why does it matter?
IRS Permitted Assets in Qualified Plans — As a general rule, the IRS permits any Trust (or qualified plan) the ability to invest into assets that the Trustee believes are in the best interest of the plan and its participants as long as the assets are not life insurance contracts (even though such an investment may be structured as a permissible investment) or collectibles (as defined under IRC). There are other prohibitions on certain assets (e.g, physical gold) and certainly Prohibited Transactions. Further, the plan documents must permit such investments as far as assets are concerned. However, if permitted, the ability to invest in “real” or “other” property is quite expansive. As a very brief example of what a Trust/Trustee can invest in based on approved 401K documents with a Letter of Determination directly from the Department of the Treasury consider this:
“The Trustee may invest the Trust Fund or any portion thereof to acquire or hold Qualifying Employer Securities or Real Property, provided that the portion so invested shall not exceed the amount allowed as an investment under the Act. There shall be no limit on the acquisition of Qualifying Employer Securities in an individual account balance plan in which Participants may direct the Trustee to buy Qualifying Employer Securities on their behalf.”
What 401K Documents are in Place for the Plan?
Each 401K plan must have a required written document(s) in place for the operation of the plan. These documents must meet all DOL and IRS regulations and must be updated and amended (i.e., kept current). It is imperative that whether a company or an individual are establishing a 401K plan, they work with a company that will assume the responsibility of maintaining and keeping current these documents for the company (or individual) sponsoring the 401K plan. As part of this, all documents must be approved in writing by the Department of the Treasury and a Letter of Determination has been issued by the Department of the Treasury confirming that the written documents for the plan are accepted as permissible for such plans (e.g., 401K).
What is a Trustee? What is a Participant? And, why does it matter?
In simple terms, think of the Trustee as the individual/entity that is responsible for the plan’s operation and growth of assets to benefit all participants of the plan. The Trustee’s role is an important and vital role for the plan. Specifically and legally, all assets held by the Trustee, whether in a Trust Fund or Segregated Funds, shall be owned exclusively by the Trustee, and no Participant or Beneficiary shall have any individual ownership thereof. Participants and their Beneficiaries shall share in the assets of the Trust, its net earnings, profits and losses, only as provided by the Plan.
Sounds kinda important, huh?! Well, yes, and the Trustee has a tremendous responsibility to always act in accordance with the highest fiduciary standards as they, in effect, are the caretakers of the plan and its assets. So, how does the IRS define a Trustee? Well, let’s take it directly from them:
“Acting solely in the interest of the participants and their beneficiaries; Acting for the exclusive purpose of providing benefits to workers participating in the plan and their beneficiaries, and defraying reasonable expenses of the plan; Carrying out duties with the care, skill, prudence, and diligence of a prudent person familiar with such matters; Following the plan documents; and Diversifying plan investments.”
Further, the IRS states:
“These are the responsibilities that fiduciaries need to keep in mind as they carry out their duties. The responsibility to be prudent covers a wide range of functions needed to operate a plan. And, since all these functions must be carried out in the same manner as a prudent person would, it may be in your best interest to consult experts in various fields, such as investments and accounting.
In addition, for some functions, there are specific rules that help guide the fiduciary. For example, the deductions from employees’ paychecks for contribution to the plan must be deposited with the plan as soon as reasonably possible, but no later than the 15th business day of the month following the payday. If you can reasonably make the deposits in a shorter time frame, you need to make the deposits at that time.
For all contributions, employee and employer (if any), the plan must designate a fiduciary, typically the trustee, to make sure that contributions due to the plan are transmitted. If the plan and other documents are silent or ambiguous, the trustee generally has this responsibility. As part of following the plan documents in operating your plan, the plan document will need to be updated from time to time for changes in the law.”
Now, one quick thing to point out…the IRS does NOT say who or what entity the Trustee must be. As it relates to a self-directed or self-administered 401K plan, can the Trustee be the business owner (and, in effect, Participant)…YES. Again, provided they meet all DOL and IRS regulations.
Further, the next question then would be if the Trustee can select the investments (complying with DOL and IRS regulations), and the Trustee can only invest in assets permitted by the plan…where does it state that our husband/wife couple who own their own C-Corp cannot also serve as Trustees of their plan? You are right if you are thinking…there is no exclusion or prohibition.
A Participant is strictly that. They (e.g., employees) participate in the plan through contributions to the plan. They and their beneficiaries are the recipients to their “share” of the Trust’s plan assets. A participant, typically, will not have ANY say in how the investments made by the Trust are chosen or executed. All responsibility falls onto the Trustee. One noticeable exception to this is that the Plan can allow Participants to self-direct their retirement assets. When this occurs, the Trustee is NOT responsible for the Participant’s gains or losses within their Segregated account (more on that later).
Why does it matter? Due to the fact that by the very nature of how they are defined, most people believe that a Trustee AND a Participant MUST be different people, etc. This is not a requirement. For example, with a company 401K plan (e.g., with employees), the Trustee MAY be the owner of the company and the Trustee will not be a Participant. Or, the company can assign a different individual/entity to serve as the Trustee of the plan. With a self-directed 401K (with no employees other than, potentially, a spouse of the business owner), the Participant and Trustee CAN potentially be the same person(s). Or, the owner can select some other individual/entity to serve as the Trustee of the Plan. The important thing to note, however, is that there is nothing illegal with the self-employed individual serving in both a Participant or Trustee role….as long as they adhere to the legal requirements of serving as the Trustee, accept that role, have written documents in place for the plan and operate the plan in compliance with all DOL and IRS regulations.
Finally….remember, we are not trying to go “deep”, what does a typical 401K plan document state regarding Participants “self-directing” their own retirement assets ane the permissibility of doing so. Again, let’s briefly review a sample document that has received a Letter of Determination from the Department of the Treasury. It states:
“If the Employer elects in the Adoption Agreement to permit Participants to direct the investment of their Accounts…they can do so by “appropriate direction to the Trustee.”
“….the Trustee shall not have any investment responsibility with respect to the Participant’s Controlled Account. In the event that a Participant elects to have any such funds transferred to a Controlled Account and invested in particular securities or assets pursuant to this Section, the Trustee shall not be liable for any loss or damage resulting from the Investment decision of the Participant.”
Bottom line, hopefully we got across that alot of rules must be adhered to but as a general rule, a business owner can serve as the Trustee of their own 401K plan provided:
1) They operate the plan in full compliance with DOL and IRS regulations;
2) The plan is established with legal, compliant and approved written documents in place that fully explain how the plan operates. These plan documents must be approved by the Department of the Treasury and a Letter of Determination must be issued;
3) The Trustee of the Plan can only invest into assets that are approved by the DOL and IRS but also of the Plan itself.
There is not a restriction on our couple serving as Trustees of their own plan. Provided the plan is established correctly and they dutifully serve the role as Trustee of their plan, they CAN control their retirement assets and invest as they see fit.
As always, this post is not intended to provide, nor does it provide tax or legal advice…and it cannot be construed as such. It is merely educational information intended to assist those with questions pertaining to this subject matter. All of us should consult our tax and legal professionals to determine what is best for us in making these kinds of decisions.