401k Prohibited Transactions

All retirement plans have prohibited transactions, the most two common 401k prohibited transactions are letting your employer use money from your 401k fund and not depositing ones contributions in the frame period allowed. 401k prohibited transactions and not only them, are direct or indirect financial dealings that involve plan resources and a “party-in-interest” or “disqualified person.” These persons or parties include but are not limited to fiduciaries, sponsoring employers, or certain owners of the sponsoring employer. 401k prohibited transactions consist of the trade, switch, or lease of property, extension of credit, reassign or use of plan resources, along with definite investments in owner securities or property.

These transactions are called prohibited transactions because no one should be allowed to use other people resources without having their consent. Furthermore the goal of these retirement plans like 401k is to save money while you work so you can have a decent life when you are retired. If these types of transactions would be allowed you might have no more assets in your fund or in the best case you might still have a part of them, but not all of them. Even though the 401k is an employer sponsored plan, no funds should be taken from a person’s fund and used by another person be it a trustee or the sponsor himself.

Not all the transactions are prohibited. There are several exceptions to 401k prohibited transactions. These types of exceptions can be permitted by the Department of Labor where there is security in the plan and in the way of performing the business. For example if you have a 401k fund you can offer to lend money through your plan. This however has to be done in such a way that the retirement plan and all the other contributors are protected. Thus if such a loan is approved it will be seen as a plan investment.

The IRS and ERISA (Employee Retirement Income and Security Act)incorporate in their guidelines and rule what is prohibited and by whom with regard to the investing options one has with the funds from retirement plans. ERISA helps defend 401k plan participants' privileges and retirement reserves. In order to protect your 401k fund from prohibited transactions you have the option of buying ERISA bonds or a fiduciary liability insurance. These two types of protection can be bought by the employer and are quite reasonably priced. However if your employer does not have either of them and your fund was caught in one or more 401k prohibited transactions there are still a few things you can do.

If you find yourself in the position of being a disqualified person you have to correct the deal and pay an excise tax based on the sum caught up in the business. The first tax on a prohibited transaction is 15% of the sum involved. You can void paying the compulsory tax which is 100% of the sum involved if you correct the transaction as soon as possible and the transaction is corrected before the next taxable period.