Self-administering a Solo 401(k) isn’t necessarily rocket science, but it does require strict compliance with both IRS and DOL regulations. Failure to comply can result in the IRS considering your retirement fund disbursed, penalizing you, and then taxing the disbursements. In other words, the penalties can be high when you don’t adhere to the strict guidelines.
Nonetheless, self-administration offers 401(k) holders unmeasured flexibility in the types of investments they can hold in their retirement account.
Today, we’re going to focus on one aspect of self-administering a Solo 401(k): the segregation of funds.
Segregating Funds within a Self-Directed Solo 401(k)
Segregating funds within the plan serves a specific purpose. They can be invested or even distributed in different ways. It also helps keep your books more transparent.
For instance, 401(k)s are funded in various ways. There are funds that have been rolled over into the current plan, contributions made by you, and returns on investments, for instance. Suffice it to say, when all these funds are kept as one lump sum, it becomes difficult to show compliance with certain IRS restrictions.
As an example, there may be some instances in which you can hold life insurance in a 401(k). If all the funds are mixed, however, it’s that much more difficult to prove to the IRS that you are in compliance with their regulations. Now you have the IRA hovering over your retirement fund with the threat of penalties and disbursement looming on the horizon.
You also want to segregate pre-tax contributions from other funds within the account because it’s easier to show the IRS where this money went when you claim it at the end of the year. Roth funds, on the other hand, must be specifically designated as such.
Segregating Funds is Simply Good Practice
It may sound like a lot of work, especially when you’re your own trustee, but it works to your benefit and protects you from a possible audit. Being able to account for all funds in your retirement account will keep you in the clear with the IRS and allow you to easily show where all of the money in the account came from.
A self-directed Solo 401(k) plan is a great investment vehicle and very versatile in terms of your investment options. But as the trustee, you’re responsible for anything that goes awry with the plan. With the proper planning and bookkeeping, you can ensure that you comply with all IRS regulations.