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Contributing Capital Gains Income to a Solo 401(k) and more | Client Q&A

AdMail Podcast

IRA Financial’s Adam Bergman answers questions about capital gains and the Solo 401(k), using a Roth IRA to start a business and buying company options with a Roth.




Question 1 from Terry O in Stockton, CA: Can I contribute capital gains income to a Solo 401(k) plan?

The answer to this one is no, you cannot contribute capital gains to a Solo 401(k). The simple fact is that it is not considered earned income. The only contributions that may be considered for any retirement plan is earned income, which is compensation for performing a service. Basically, it’s the salary you make from your job, or taxable self-employed income.

Capital gains income is considered passive income, in that you do not work for those funds. Other types of income that are not eligible for Solo 401(k) contributions include welfare, unemployment, stock dividends and rental income. Therefore, if all of your income is Schedule E (for example your income is solely from rental income), you would need to move some to Schedule C. You can treat those funds as management fees or other services. You can then use that income (and that income only) to fund your Solo 401(k) plan.

Question 2 from Judy W in Passaic, NJ: Can I use a Roth IRA to start a business and eliminate any potential tax from the business?

With tax rates expected to go up if Joe Biden wins the election, many people are looking to make moves now to avoid that extra tax. A Roth IRA allows you to fund a retirement plan with after-tax money and see tax-free income during retirement. Whether you directly contribute to the Roth or convert pretax funds, you pay taxes now, on a known, and possible lower, rate than it may be in the future.

But can you avoid the taxes from income a business earns by using a Roth. There are two things to consider. First, if you will be personally involved with the business, you cannot use your Roth. It’s a prohibited transaction because you, and not just the Roth IRA, will benefit from the investment. Secondly, if you own more than 50% of the business, you also cannot use the Roth.

However, you can invest in a business with your Roth IRA. Obviously, you cannot be actively involved with the business itself. It’s purely an investment. If the business does well, your investment will grow tax free. Further, the Roth should not own a large percentage of the business. For example, if you own 5%, that’s safe from an IRS perspective. However, if the IRS deems the Roth is there to help fund the business, it will be contested. You should ask yourself, will the business be fine without my IRA funds invested. If the answer is yes, you should probably be okay.

Question 3 from Adam T in Palo Alto, CA: I work at a growing start-up and have been granted options in the company – can I have my Roth IRA buy?

Many start-ups offer employees options to entice them to work there, and to keep working there. The option gives you the opportunity to buy stocks in the company at a very low price. Obviously, if the company grows and starts making lots of money, having stock in the company is a good idea. However, can your Roth IRA buy these options?

This is a tricky situation since the options were granted to you and not the Roth IRA. While you do earn the IRA, you must look it as a different entity. Technically speaking, the assets in the plan are not yours until you withdraw them. If you have a $1 million in an IRA, you don’t have a million dollars, your IRA does, until you distribute the funds.

You want to shift the right to buy the options to your Roth, which is a very risky proposal. You can be sure the IRS will scrutinize this, since they want to ensure you are not taking advantage of the system. One thing you may be able to do is, when presented with the options, tell your employer you would like the options for your Roth IRA. It’s still a risky proposition, but may have some merit.

AdMail – Keep it Coming

We hope you enjoyed the latest episode of AdMail. Mr. Bergman will continue to respond to questions each week so long there is a demand for them! If you have any questions for him, email him at [email protected].

As with his other podcasts, you can check out AdMail on SoundCloud. Be sure to subscribe to know when the next one pops up! Thanks for listening and have a great day, Self-Directed Nation!

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