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Pocket 401k for Notes/Loans

pocket 401k for notes/loans

IRA Financial’s Pocket 401k for notes/loans will allow you to use your retirement funds to invest in all types of debt instruments and products directly from your mobile device or PC securely, and cost effectively. You no longer need a third-party custodian involved in every aspect of your investment transaction. Buy, sell, or exchange notes on your own directly from a mobile device or PC with IRA Financial’s Pocket 401(k). Rollover, deposit, or transfer funds between your investment and 401(k) seamlessly and without delay.

Why Notes/Hard Money Loans

In general, a note (or promissory note as it’s often called) is simply a promise to pay. Anytime one lends a third-party money, a document is created that dictates the terms of the loan that says you will pay someone back. A note can either be secured or unsecured. Some examples of common notes are:

  • Mortgage Loans
  • Personal Loans
  • Business Loans
  • Real Estate Loan (Hard Money Loans)
  • Treasury Notes
  • Peer-to-Peer Loans

Secured or Unsecured Notes

When it comes to notes, it’s important to understand the idea of secured vs. unsecured notes.

A secured note essentially means that if someone defaults on the loan, the lender receives something in return as payback. The note is “collateralized.” In the case of a mortgage, the loan is collateralized against the actual home. If you default on your mortgage payments, the bank will foreclose on the property and take ownership.

On the other hand, if you fail to repay a non-secured-backed note, the lender has no legal recourse against the borrower. No collateral is repossessed or foreclosed.

Therefore, when making note investments with a Pocket 401k, it is important to consider whether the loan will be secured or unsecured. Clearly, a secured loan offers the borrower more security and protection in the case of a borrower default.

Hard Money Loans

A hard money loan is simply a loan that is backed or secured by an asset, such as real estate. For example, a real estate developer that wants to develop a property seeks out investors to help finance the project. Since 2008, for many small real estate developers or general partners, acquiring bank financing in these circumstances still remains quite difficult.

Hence, the real estate developer or general partner may then look to secure a loan from a hard money lender, such as a solo 401(k) investor who is willing to give them the money that is secured by the underlying real estate asset(s) connected with the real estate project. If the borrower defaults on their loan, the lender would have the legal rights to the real estate secured by the loan.

Peer-To-Peer Loans

The Peer-to-peer lending industry has increased in popularity significantly over the last 10 years. Peer-to-peer lending platforms such as Lending Club and Prosper allow investors to invest in notes offered by the site.

Under a traditional peer-to-peer lending platform, borrowers are matched directly with investors through a lending platform. Investors can see and select exactly which loans they want to fund. Peer-to-peer loans are most commonly personal loans or small business loans. The majority of peer-to-peer loans are not secured, or asset backed.

Small Business Loans

When small business or start-up businesses need working capital or seed capital, it is common to look for investors to either invest in the company in the form of equity (stock) or debt (loan). In most cases, if a small business cannot acquire financing through a bank they may have to seek out private investors, such as solo 401(k) investors. Small business loans can either be secured or unsecured.

Tax Advantages

The advantage of using retirement funds to invest in notes or hard money loans investments is that all the income and gains generated by the debt investment would not be subject to any tax or penalty. Instead of paying tax on the returns, such as interest, associated with the debt investment, tax is paid at a later date, leaving the investment to grow unhindered. Using a pocket 401k for notes/loans is tax advantageous. The tax on the interest payments can be deferred in the case of a pre-tax 401(k) or exempted permanently in the case of a Roth 401(k).

In addition, solo 401(k) investments are made when a person is earning higher income and is taxed at a higher tax rate. Withdrawals are made from an investment account when a person is earning little or no income and is taxed at a lower rate.

Why You Need a Solo 401(k) to Invest in Notes/Loans

Unfortunately, none of the major financial institutions will allow you to use 401(k) plan funds to invest in Notes/Loans or essentially anything outside of Wall Street. The reason for this is simple. Banks do not make money when you invest in non-traditional equities, such as private loans. They make money when you buy stock, mutual funds, and other financial products they market. As a result, a large number of individuals are turning to a Pocket 401k to invest in notes or other debt instruments.

Unrelated Business Taxable Income

In general, almost all retirement account investments generating passive income will not be subject to Unrelated Business Taxable Income (UBTI or UBIT) or Unrelated Debt Finance Income (UDFI) Tax.

The UBTI tax is only triggered if:

  • Retirement account uses margin to buy stock
  • Retirement account invests in an active business through a passthrough entity, such as an LLC

The UDFI tax is triggered if:

  • A 401(k) uses a non-recourse loan (real estate acquisition financing to purchase real estate)
  • Exemption for 401(k) plans
    • IRC 514(c)(9)

The UBTI & UDFI Trigger the Same Tax Rate

The UBTI and UDFI trigger the same tax rate, which is a maximum of 37% for 2019. Therefore, if you plan to invest into loan/debt related investments using a Pocket 401k and the underlying investment will not involve an investment into a business operated via a passthrough entity, such as an LLC, has debt or margin, then the UBTI tax rules will likely not be triggered.

Your IRA Financial assigned specialist will help you understand the potential application of the UBTI/UDFI tax rules and potentially reduce or eliminate it.

Act Quickly on Investments

With a Pocket 401(k), you will have the power to act quickly on a potential investment opportunity. When you find an investment that you want to make with your 401(k) funds, as manager of the Checkbook LLC, simply write a check or wire the funds straight from your Solo 401(k) LLC bank account. The Pocket Real Estate 401(k) allows you to eliminate the delays associated with an custodian, enabling you to act quickly when the right investment opportunity presents itself.

In addition, with the Pocket 401(k) structure, all income and gains from 401(k) investments will generally flow back to your LLC tax-free. Because an LLC is treated as a pass-through entity for federal income tax purposes and the 401(k), as the member of the LLC, is a tax-exempt party pursuant to Internal Revenue Code Section 408, all income and gains of the LLC will flow-through to the 401(k)tax-free!

What is the Pocket 401k?

IRA Financial’s Pocket 401(k) is essentially a solo 401(k) with checkbook control. It is an IRS approved structure that allows one to use his or her retirement funds to make debt and other investments tax-free and without custodian consent. The Pocket 401(k) involves the establishment of a limited liability company (“LLC”) that is owned by the 401(k) (care of the custodian) and managed by you or any third-party. As manager of the LLC, you will have control over the 401(k) assets to make the investments you want and understand – not just investments forced upon you by Wall Street.

How it Works:

  1. Establish solo 401(k) with IRA Financial Trust & Capital One online though our mobile app
  2. Your 401(k) cash/assets can be rolled over to IRA Financial Trust tax-free directly from our mobile app
  3. The 401(k) assets will then be transferred to the LLC tax-free in exchange for 100% interest in the LLC
  4. As manager of the LLC, you will open a bank account for the LLC at any local bank. IRA Financial will draft an LLC Operating Agreement identifying you as manager of the LLC and the 401(k) as the sole member
  5. You, as manager of the LLC, will then have checkbook control over all the assets/funds in the LLC to make the debt/note investment

Because the LLC is owned 100% by a 401(k), it will be treated as a disregarded entity for tax purposes. There is no need to file a Federal income tax return and all income and gains will flow back to the 401(k) without tax.

With a Pocket 401(k), you will have the power to act quickly on a potential investment opportunity. When you find an investment that you want to make with your 401(k) funds, as manager of the Checkbook LLC, simply write a check or wire the funds straight from your Solo 401(k) LLC bank account. The Pocket 401(k) allows you to eliminate the delays associated with an custodian, enabling you to act quickly when the right investment opportunity presents itself. In addition, with the Pocket 401(k) structure, all income and gains from investments will generally flow back to your LLC tax-free. Because an LLC is treated as a pass-through entity for federal income tax purposes and the 401(k), as the member of the LLC, is a tax-exempt party pursuant to Internal Revenue Code Section 408, all income and gains of the LLC will flow-through to the 401(k) tax-free!

2019 Most Popular Debt Investments

The following debt investments have been popular with our solo 401(k) clients in 2019:

  • Hard money loans to real estate investors – secured
  • Hard money loans to real estate investors – unsecured
  • Private business loans
  • Peer-to-peer loan platforms
  • Mortgage notes

Getting Started

We’re here to help. Contact IRA Financial to establish the Pocket 401(k) directly at 800-472-0646 or fill out one of our contact forms to speak with a tax specialist.

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