Disqualified Person in a Self-Directed IRA or 401k
Plan owners of the Solo 401k and self-directed IRA need to be aware of Prohibited Transactions. These transactions usually involve a disqualified person and are not allowed by the IRS. Engaging in a prohibited transaction can lead to expensive tax charges and fines. In severe cases, the self-directed retirement plan may even be disqualified. Account owners are encouraged to understand the concept of a Solo 401k / IRA disqualified person and follow the IRS regulations closely.
Definition of a Disqualified Person
A disqualified person is usually someone who owns the retirement plan, who provides services to the plan, or who may become the beneficiary of the plan. The IRS defines different categories of disqualified person in the Internal Revenue Code, Section 4975. These categories are:
- The plan owner of a Solo 401k or IRA
- The spouse of the plan owner
- The ancestors and descendants of the plan owner, such as their parents and children. The children’s spouses are also disqualified.
- The fiduciaries of the plan, such as the plan trustee or custodian
- The fund managers or financial advisors
- Entities in which any of the above holds at least 50% interest, including businesses (corporations, LLC, or partnership), trusts, or estate.
What a disqualified person cannot do
Generally, a Solo 401k / IRA disqualified person is not allowed to enter a transaction with the retirement plan. They cannot extend credit or guarantee a loan for the plan. Also, they cannot personally benefit from the plan’s investments, such as getting a commission for a real estate purchase within the IRA or Solo 401k.
Who is not a disqualified person
In the Internal Revenue Code Section 4975, the definition of a disqualified person does not include step-parents, step-children (not adopted), siblings, aunts, uncles, cousins and friends.