401k
401k Information

401k Loans Rules

The most notable difference between endeavors down the path of using a self directed IRA versus traditional investing is the unique rules that apply to the former. The extremely simple rule is that an IRA (specifically) cannot buy life insurance or collectibles (such as rugs, works of art, alcohol, bullion).

The more involved rule is known as ano self dealinga and is described in Internal Revenue Code section 4975. This rule basically says that for each retirement plan/account, there is a list of adisqualified personsa with whom that plan cannot do business. These DQPs include:

1. The accountholder/participant and any other fiduciary (person who makes investment decisions for the plan)
2. Companies who provide services
3. A member of the family of #1 or #2 above (family defined as spouse [husband/wife], ancestor [parents, grandparents, etc], lineal descendants [children, grandchildren, etc], and spouses of lineal descents)
4. A corporation (or other entity) that is 50% or more owned (directly or indirectly) by #1, #2, or #3 above
5. An officer, director, 10% or more owner, or highly compensated employee of #4 above.
6. A 10% or more (in capital of profits) partner or joint venturer of #4 above

Every self directed IRA/401(k) investor should make this DQP list before making any investments.

Too many people seem to think of the list as only athe accountholder and his familya. As you can see it is a bit more involved than that. This doesn’t require calculus, but you should actually write out the list step by step to ensure that it is complete. This list can actually get quite extensive if you, your family member, or anyone who provides services to your plan has ownership in several companies.

So, what is a prohibited transaction?

In a nutshell, when a DQP transacts with a plan it is a prohibited transaction (abbr aPTa). The trick here is what is considered to be a atransactiona. This is generally defined in IRC 4975 as when one of the following happens between a plan and DQP directly or indirectly:

* sale, exchange or lease of property
* lending of money or extension of credit
* furnishing of goods, services, or facilities

So I consider that to be the general rule. There are a couple of special rules and they consider a PT to also include:

* When plan assets are transferred to, used by or creating benefit to a DQP
* When the accountholder/participant directs his plan in his own interests (to benefit him now instead of through a proper distribution)
* When the accountholder/participant receives compensation from anybody in connection with plan income or assets

The reason I call these last three items aspecial rulesa is because they transcend the 50% rule in determining when corporations are DQPs. In other words, if XYZ Corp is owned 49% by the accountholder’s mother then XYZ Corp isn’t techinically a DQP. Buuuuuut, if the plan then transacts with XYZ Corp it is obvious that the transaction might violate one of these special rules simply because you can’t ignore that the mother’s position in XYZ Corp was probably considered in the decision to direct the plan into that transaction.

All in all, a little common sense goes a long way. The intent of IRC 4975 is to obviously keep the plan out of transactions connected to people that the #1 & #2 DQPs might be able to control or use as a strawperson. So, clever concoctions that aim to evade prohibited transactions rules by a technicality often times still violate the last 3 special rules. It all comes down to intent, and this is something that DOL (the Department of Labor – the government agency that solely bears the responsibility and authority to interpret prohibited transaction expemtions) concludes based on assembling a fact pattern.

So the adirectly or indirectlya part of the rule allows them to let some common sense override the technical rules. It also means that if a plan invests into an entity (Corp, LLC, etc) and that entity invests with disqualified person, it may still be a PT. More on that (plan asset rule) in a later post.

In summary, every self directed IRA/401(k) investor should make a disqualified person list before doing any transactions that involve the plan. Overlooking this is on par with a teenager not making and reviewing a budget because he thinks he can learn from and apply the concepts without actually doing the budget. Once this list is made, prohibited transactions can easily be avoided as long as the plan is never involved in any deals connected to anyone on the DQP list.

Frequently Asked Questions

  1. QUESTION:
    What is the rule for loan paid back to your 401K?
    My husband had a balance of about ,000 on his 401k loan. He was paying himself back when he left his job. He withdrew his 401K but the money he owed himself was withheld from his check, If it was his money to begin with where did the ,000 go when he left his job?

    • ANSWER:
      He already got the money when he took out the loan. He didn’t have to pay tax on it when it borrowed it. Now that he can’t repay it, he will have to pay tax.

      He ate his dessert early. Now it’s spinach time.

  2. QUESTION:
    rules on paying back your 401k loan?

    • ANSWER:
      Additionally, if you do not pay it back, it will be regarded as a withdrawal and you will have to pay taxes etc. on the amount. Also, if you leave the company, the loan is due in full immediately.

  3. QUESTION:
    I am needing some information on 401K rules by Prudential.?
    I want to withdraw $ from my prudential 401k fund.I dont have enough cash to get a loan,if I draw out the money,I dont want it to disrupt my normal routine…Basically I want to make sure I dont mess up my 401K program.Could someone in the know,let me know in normal language??

    • ANSWER:
      First, you will need to check with your benefits administrator to see if can take out a loan from your 401k and what the terms of the loan will be.

      You will need to pay back the loan within 5 years. You will be charged interest on the loan, which goes into your 401k as well – so you are paying interest to yourself.

      Payments will come out of your paychecks to pay back the loan according to the loan repayment schedule you agree to.

      If you quit, or lose your job before the loan is paid off, you will be subject to some heavy penalties. Any outstanding balance will be considered an early withdrawal. They will hold 20% of the outstanding balance for income taxes and an additional 10% for an early withdrawal penalty.

      I hope this helps.

      Good Luck!

  4. QUESTION:
    401K Hardship Rules and Penalties?
    I just had to quit my job unexpectedly. I want to cash my 401K in so I can pay my rent! This acct is from a previous job I had a few years ago. It has about 00 in it. I am not sure what the penalties and guidelines are for a hardship loan/withdrawl? I need the $ quickly.

    • ANSWER:
      First, you have to prove and document your hardship and provide evidence that it can’t be cured through other financial means. You will be taxed at ordinary income for all of your withdrawls and also face an additional 10% penalty tax.

      Generally, hardship distributions from a 401(k) plan are limited to the amount of the employee’s elective deferrals only, and do not include any income earned on the deferred amounts. Hardship distributions are not treated as eligible rollover distributions.

      A distribution may be deemed to be immediate and heavy financial need, if the distribution is for payments necessary to prevent the eviction of the employee from the employee’s principal residence or foreclosure on the mortgage on that residence.

      You can only withdraw as much as can cover the immediate financial need (no more) and only if you have no other assets, either owned by you, your spouse or minor children accessible to you.

      Also, a hardship withdrawl is subject to income taxes withheld against those contributions and a 10% penalty tax. This means it may not be worth it to take your hardship withdrawl.

      You can contact your old plan sponsor about taking a loan from your 401k, which is tax-free as long as you are able to pay it back. Repayment should be outlined in your plan documentation, but is a 5year term, so the repayments may be very high.

  5. QUESTION:
    401K hardship withdraw loopholes?
    I’m trying to take a loan out of my 401K but there are rules about only being able to so for foreclosure, medical bills, home purchase, school or funeral costs. Are there any loopholes so that I can get the money out without having to pay the big penalties for a withdraw?

    • ANSWER:

  6. QUESTION:
    Can I use my IRA to pay off a ,000 second mortgage on an investment condo? Would a 401K loan be better?
    I know IRA money can be used for investments other than stocks or bonds, but I want to make sure the money is transferred and used within legal rules for IRAs.

    The 401K option is okay but, even though interest would be paid back to my own account, I dislike taking out ,000 after the market has already tanked (and while I’m still contributing and getting matching funds).

    Either way, I would reduce my negative cash flow while I continue to attempt to sell the Las Vegas condo or rent it out.
    Perhaps borrowing money from a parent at 3% or less interest (to keep up with inflation) is the best option: the ,000 second mortgage at 9.124% interest can be paid off and my tax refund in the next month can pay off about ,000 back to the parent (all without touching my 401K or IRA).

    • ANSWER:
      You can invest IRA funds in real estate utilizing a self-directed IRA. Check out Equity Trust Co. at www.trustetc.com
      You can not self deal which means you can not purchase property with IRA funds that you currently own.
      Therefore, your only option here is to use the 401k borrowing provisions. I do not suggest doing that just to cover a current mortgage.
      I do teach how to utilize this strategy in circumstances that benefit you and not hinder your 401k.
      Contact me for more info if you like.

  7. QUESTION:
    Should I contribute more to a PRE-TAX invest. acct like 401K or into a POST-TAX invest. acct like Roth IRA?
    The fees for my POST-TAX(income tax) Roth IRA is only a month for 6 free investments and I have wide range of ETFs and stocks to choose from. I can take money out but with some penalities and or none at all based on the rules. I anticipate making a huge withdrawal to pay for a house.

    The fee for my PRE-TAX(income tax) is .50 for every K but I have a small range of funds that I can invest in. I can’t take the money out of this account until i retire. There are certain rules that allow me to take the money out for things such as purchasing a house, but I would have to pay that money back. So it’s like taking a loan out on my own money.

    What would be more beneficial for me?

    • ANSWER:
      You may want to rethink the idea of taking anything out of a 401(k) because if you leave the job, the money needs to be back there ASAP–there are penalties, etc. associated with that.

      As for a Roth IRA, I prefer maxing out IRAs whenever possible because you have more choices and freedom with an IRA than a 401(k). IF your employer offers something in matching for a 401(k) it’s probably worth contributing to max out what he’ll put in as it’s effectively free money.

      I think you need to read this, though, as if I’m following you, I think you may believe you can pull money from either kind of account for a house without worries–there are conditions in both cases:

      http://www.kiplinger.com/columns/starting/archive/2006/st0309.htm

      Good luck!

  8. QUESTION:
    Can you withdraw IRA funds early to pay student loan debt off?
    If I wanted to take money out of an IRA that was a rollover from a previous 401k to pay off student debt of my wife of 11 years in the amount of K, can I consider this an exception to the 10% additional tax rule? Thanks

    • ANSWER:

  9. QUESTION:
    After the financial collapse and the huge lose of jobs….?
    A sensible person would look at these events with an open mind right?

    The financial system failed because groups like acorn forced banks to advance loans to people who couldn’t afford to repay them?

    The majority of these loans was made by state controlled mortage companies, who then sold them to investment banks (governed by the SEC, not the FDIC or OTC). The investment banks then bundled these loans and sold them in pieces, named derivatives. Insurance companies like AIG insured these derivatives.

    Unemployment whose to blame?

    Rules and regulations? sure why worry about paying a fair wage, and giving decent working conditions when you can send the work to some third world country and boost profits.

    Unions demanding more than the company can afford, then threatening to strike? Unions ony want workers to recieve fair compenstion for their work. Almost all union contracts have a no strike clause today.

    Corporate taxes – Through abatements and other tax breaks most pay no taxes.

    I guess when people are working 20 hours a day for minimum wage they will be happy. At least your 401k will be doing good. Problem is most won’t have any money left to put into the 401k.

    At the rate we are going in 10 years a college graduate will be lucky to make enough to cover their student loans, and a college degree will be required to work at McDonalds. Obtaining a better job will require a masters, Mba, or doctorate.

    • ANSWER:
      According to the only two people (out of millions) who correctly predicted the crash, Ron Paul and Peter Schiff have both stated Fannie Mae and Freddie Mac caused the increase in home prices, caused intereference in the free market, and allowed people to remortgage their homes to consume other goods.

      To keep it short: We’re a consumer based economy. The Housing bubble by Fannie and Freddie allowed us to consume way more then we would have. We had the crash. And the solution is to become a production based economy through the free market.

      Unemployment has risen and has not recovered because their is no recovery.

      Gold will continue rising due to excessive government spending.

      And we wont have a recovery until we quit spending more then we earn through production.

      AKA. Its only going to get worse. Your correct, but less government spending and interference through the free market is the only way out. Not more.

      And therefore, your wrong.

  10. QUESTION:
    severance check advice — experienced replies please?
    my question is what to do with a 50k severance check i recently received. working in same industry as before making same salary (just under six figures).

    i own a rent house on which i owe 25k. total payment for it is 430/month but i rent it for 650/month. my loan is through a local bank… 8% interest… 15 year loan… been paying 0 extra every month since loan began. could deposit 25k into CD and borrow at 2% above what they’re currently paying (~2%).

    my own house payment is ~1800/mnth (600/month of this is taxes). our loan is 5 years old/we haven’t missed a payment/don’t intend to. loan is for ~200,000 at 5.25% for 30 years. would consider refinancing to another 30-year at 4-4.5% but dont’ know if A) could find rates like this or B) if it’d be cost-effective to do so (closing costs, etc.).

    contribute about 4% to 401k.

    have ~80k in roth iras, traditional iras and individual stocks.

    have two kids. have not begun college savings plan for them.

    own car on which we owe 9k (about 320/month).

    where to start? pay off car first, put that extra 320 toward rent house? pay extra on house or is it worth it? gotta set up college 529 or other plans for college – what do? contribute to roths? beef up 401k?

    main goal: be out of debt. can follow dave ramsey’s rules.

    any/all SMART advice appreciated.

    • ANSWER:
      A couple of things Dave would tell you.

      You don’t OWN your car if you OWE K on it.

      If you have paid on your home for 5 years, you should never even think about refinancing for 30 years. 15 maybe, but you don;t want to drag this out forever.

      You talk about investing in a CD and borrowing. Dave would never consider that.

      If I were you, I would pay off the cars and rent house, invest a little for college, and use the rest as my emergency fund.

  11. QUESTION:
    Do You Think We Are About To Elect The Worst Possible Candidate?
    Our economy is crumbling, ACORN got those sub-prime mortgage loans and created the mess, Obama trained them, funded them and supported them etc. We have had the worst majority Democratic Congress in history that appears to have another couple of years to do more damage. Our House Speaker is against all ENERGY and when she -Pelosi – don’t get her way, she just blocks the voting etc. This is just so hard to believe that people are allowing the most richest people in the world to BUY A PRESIDENT. Brainwashed people! To believe A Obama administration would support any ENERGY at all! They are the ones who have blocked our energy for Decades, now that we need it the most- they won’t give it to us! cause they will RULE the gov’t, take our money, take our 401k’s -which they are working on RIGHT NOW! Thats right they want to RAISE TAX on peoples investments to RETIRE! PELOSI is the head of that insane bill!
    Worst time in HISTORY caused by Democrats, and Democrats are going to win????? WHAT THE?
    Now there is PROOF Obama wants to ULIMATE and BANKRUPT COAL! THAT IS TOTALLY NUTS! What do you Obama supporters think you will use for ENERGY? You think Obama’s 500.00 check is going to cover the bills- when the bills will most likely double or triple! Gas will definetly at least get to 15.00 a gallon with democrats in charge- they don’t want to drill, don’t want coal, won’t ever build nuclear plants either! They are so darn PICKY! It will take decades to get alternatives. NO NEW ENERGY -NO ONE BUYS CARS! MILLIONS LOSE JOBS that Make cars. Its happening now cause PELOSI BLOCKED NATURAL GAS AND DRILLING VOTING IN CONGRESS! She knew it would PASS! PELOSI WOULD BE OBAMA’s TRAINER! OH MY GOSH!

    • ANSWER:
      Tell your friends, and show them the proof.

      Adolf Hitler was well-known to have used hypnosis on crowds to gain power in Germany. (Just Google it if you doubt it.) So why cant this happen in America? It is happening.

      Now, this document, An Examination of Obama’s Use of Hidden Hypnosis Techniques in His Speeches is really spreading. Many people, including young people, are starting to wake up.

      Young people have come up with a saying, “Don’t drink the kool-aid Obama is pushing on you.”

      Obama has no accomplishments, we don’t know him, he wrote a memoir, he has racist connections, he is using hypnosis, and he thinks he’s the Messiah and that he should be in control of the world. We’ve seen this story before in Germany in the 1930′s, haven’t we? We know what happened there.

      Obama’s use of hypnosis in speeches is why:
      -nothing sticks to him
      -the huge crowds
      -the huge money contributions
      -the mesmerized effect, especially in young people, who, because of their imaginations are more susceptible to hypnosis (read the document)
      -the exorbitant election fraud, rule-breaking and bias in the media
      -he gets away with changing every position
      -people are calling him the “greatest leader of a generation” with no accomplishments

      You have to read this document to understand how his hypnosis works. Logically and rationally, why not get to know this guy a little more before handing the world over to him? Why not wait?

      An Examination of Obama’s use of Hidden Hypnosis Techniques in His Speeches can be found at

      or here

      http://www.pennypresslv.com/Obama’s_Use_of_Hidden_Hypnosis_techniques_in_His_Speeches.pdf

      The media must feel compelled to cover this information and decide to let informed people decide.

      PS – “Dont drink Obama’s Kool-Aid”

  12. QUESTION:
    Jehovah’s Witnesses: What do you make of the admonition in 1st Timothy 5:8?
    It says:

    “Certainly if anyone does not provide for those who are his own, and especially for those who are members of his household, he has disowned the faith and is worse than a person without faith.”

    According to the Pew Report, Jehovah’s Witnesses have next to the lowest average income of any organized religion. There are two reasons for this:

    First, the Watchtower society prohibited and now discourages Witnesses from attending university.

    Second, in order to get eternal life, you are expected to spend twenty or more hours distributing Watchtower literature.

    Ideally, a man in his middle-age would have no debt except for a modest home mortgage. Second, he would have a substantial retirement savings in a 401k or something similar.

    If you are a middle-aged Jehovah’s Witnesses with substantial consumer debt (e.g., credit cards or car loan), do you believe you are in violation of Biblical rules?

    • ANSWER:
      Greetings,

      I am a Witness who is past middle age (ouch). I have been self-employed working part time my whole life except for about 6 years working for a large electronic company. While we live a life that is very simple even in comparison to most Witnesses, I have ALWAYS been able to take care of my family and work as a full time minister. Witnesses who obey the admonition in 1Tim. 5:8 and 6:6-8 avoid getting overburdened with debt. They are able to balance both their preaching and their family responsibilities.

      In direct answer to your question, when a Witness does lose focus and falls into great debt because of poor choices he is violation the Biblical principles. As with other “sins of weakness” one must also work hard to correct it once they realize their failure.

      Yours,

      BAR-ANERGES

  13. QUESTION:
    I work for public works in my town and my pension is controled by the state of NJ?
    My pension contributions are not matched by my employer or state. If i want to (borrow) MY MONEY i can only do so twice a year. Even in emergence! I have a bill that i have to pay and because i took two small loans they wont let me borrow any more of MY MONEY !!! I’m not asking for a free hand out . i also pay 5.25 in intrest that does not get added to my account!! i hate New Jersey i fell like i live in Russia! If i dont pay this bill it will ruin my credit and i want to buy home in NC in the spring. Is this rule fair?!! i cant even take the money and put in a 401K plan.People think that working state or local Gov isa dream job they have no idea of the politics and corruption that goes on!! What would you do!? Any ideas or help Thank You

    • ANSWER:

  14. QUESTION:
    Should I be worried about being seen as a zero tax return?
    I have been unemployed for several years. No unemployment benefits anymore. I don’t own a house or property that has to be taxed. I have no W2′s. I am on SNAP card. I did my return for 2010 to file it even though it is zero because I read if you might want to get a student loan in the future you should file and I want to go back to school. But now I just read something about the “zero return” and “frivalous” tax fee for people who lie on their returns and try to have it be zero. Mine is zero because I honestly haven’t worked or owe tax on anything. Last year, I owed taxes because I did an early withdrawal from my 401K (which is gone now). Will the IRS flag me as doing a “zero return” even though I am not lying? I definatley don’t need to get hit with a fee! Sounds like a punishment for not oweing anything! Anyone know what the rules are on this? I searched and it was pretty confusing.

    • ANSWER:
      No, it won’t cause any problems or raise any red flags.

      If you happen to be audited, you have nothing to worry about because your return is accurate. The IRS is after the people who earn tons of money but write [FAQ-ANSWER] down for taxable income because they’ve made up some non-existent legal loophole on why they think their income isn’t taxable.

      FYI, the advice you got about filling just to get a student loan is bogus. If you go to school and need to fill out the FAFSA form for financial aid, you can get a letter from the IRS showing that you did not file a tax return for a particular year because your income was below the filling requirement.

  15. QUESTION:
    Personal Finance………..?
    1. Match the following words to its correct definition.
    A. General and progressive increase in prices
    B. Investment in which you are loaning money for a certain time period to the issuer
    C. Individual retirement account in which a person can set aside after-tax income up to a specified amount each year, earnings are tax-free, and tax free withdrawals may be made after age 59 1/2
    D. Distributions of profit a company pays you because you own stock in that corporation
    E. Supplemental retirement system in the United States
    F. Individual Retirement Account
    G. The amount of money you make on an investment in relation to the amount of time your money is invested stated as an annual percentage
    H. Quick and easy way to estimate how long it will take for you to double your money
    I. Type of tax-qualified deferred compensation plan in which an employee can elect to have the employer contribute a portion of his or her cash wages to the plan on a pretax basis
    J. Retirement plan for certain employees of public schools, employees of certain tax-exempt organizations and certain ministers
    K. An exchange where security trading is conducted by professional stockbrokers
    L. The age at which someone stops working permanently
    M. Asset purchased for profit
    N. An arrangement to provide income to people when they are no longer earning income
    O. Collection of financial securities (stocks, bonds, cash) that is managed by a company or a person on behalf of many investors

    Rule of 72
    Dividend
    Mutual Fund
    Bond
    Stock Market
    Rate of Return
    Inflation
    Pension
    Retirement
    Social Security
    IRA
    Roth IRA
    401K
    403b
    Investment2.

    How do mutual funds reduce risk?
    A) They invest in stocks
    B) They provide investment diversification
    C) They use an investment manager
    D) None of the above

    3. Your grandpa is 62 and asks you if he is eligible to collect Social Security. What do you tell him?
    A) He could collect his full payment now.
    B) He could have started collecting at age 59 1/2.
    C) He can receive reduced payments now.
    D) None of the above.

    4. Which type of account is usually used when employees can have a matching contribution from their employer?
    A) Roth IRA
    B) Traditional IRA
    C) 401k
    D) 403b

    5. In the future, you and your friends plan to receive Social Security after you retire. At what age can you currently plan to receive full benefits?
    A) 59 1/2
    B) 62
    C) 65
    D) 67

    6. Which type of individual retirement account should you choose if you want your contributions to be tax deductible?
    A) Roth IRA
    B) Traditional IRA
    C) 401k
    D) 403b

    7. When you reinvest dividends,
    A) you will receive them by check
    B) you will receive them by direct deposit
    C) the dividends are deposited into a Certificate of Deposit
    D) the dividends are used to buy more shares of stock

    8. Bonds are known as
    A) fixed income investments
    B) equities
    C) dividends
    D) no load mutual funds

    9. When you purchase stock in a corporation
    A) you are loaning money to the corporation
    B) you are technically becoming a part owner of that corporation
    C) you do NOT earn the right to vote on the direction of the company
    D) you have to own the stock for at least one year before you are allowed to sell it.

    10. Which of the following is the oldest measure of the U.S. stock market and the most widely used indicator of stock market activity?
    A) The NASDAQ
    B) The S&P 500
    C) The Dow Jones Industrial Average
    D) The Russell 2000

    11. The total value of the securities a mutual fund owns divided by the number of shares outstanding is known as the mutual fund’s
    A) Face Value
    B) Net Asset Value
    C) Market Value
    D) Yield

    12. Mutual Funds called “load” funds charge a high flat fee whyou purchase the fund or sell the fund.
    A) True
    B) False

    13. TD Ameritrade is an example of a full-service brokerage company.
    A) True
    B) False

    14. Treasury bonds are considered to be more risky than owning stocks.
    A) True
    B) False

    15. A Roth IRA is beneficial because your withdrawls are tax-free.
    A) True
    B) False

    16. IRA stands for Important Retirement Assets
    A) True
    B) False

    • ANSWER:
      That’s a lot of questions. If you care to email me any particular ones you are having trouble with, I’d be glad to help you. Or, if you email me your answers, I’d be glad to check them over for you. Good luck.