Self directed IRA prohibited transaction rule gotchyas

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Was reading a case today where the Department of Labor was saying an individual violated his fiduciary responsibilities by amongst other things, loaning money to his employees.  Appears the guy even went to jail for all the stuff he was doing with the retirement plan.

I like to think I know the prohibited transaction rules pretty well and couldn’t figure out how a loan between a retirement plan and an employee of the company sponsoring the plan was a prohibited transaction.  So I pulled up the actual court documents and looked up the laws cited by the Dept. of Labor.  Ahhh, there was my mistake, the Department of Labor was using the definition of a “party in interest” from the labor code, not the disqualified persons rules in the tax code.  In particular, 29 USC 1002(14)(H) includes the following as parties in interest:

(H) an employee, officer, director (or an individual having powers or responsibilities similar to those of officers or directors), or a 10 percent or more shareholder directly or indirectly, of a person described in subparagraph (B), (C), (D), (E), or (G), or of the employee benefit plan; or

So an employee is a party in interest to the plan for the labor code, but not for purposes of the tax code.  Now how do these rules apply to self directed IRAs and self directed 401ks? If the IRA you are using is really a self directed SEP, and there are employees in the business, you are probably subject to both the labor and tax code rules.  Same thing with the 401k.  If there are employees involved you have to follow both rules.

Why is this important?  There are going to be a lot of cases determining if someone’s self directed retirement plan is qualified or not.  While a number of internet experts are out there telling you what you can and can’t do, most of that info is incorrect and certainly doesn’t take into account the labor code definitions as well as the income tax definitions.  As I said at the top of this post, the individual who violated these rules actually ended up in jail.  Make sure you are fully aware of what rules apply to you and what rules don’t apply to you before you go doing something off the beaten path.