Prohibited Transactions — What are They?

Understanding what constitutes a prohibited transaction is very important when it comes to making investments within your Self-Directed 401(k). The IRS defines a prohibited transaction as follows:

“Generally a prohibited transaction is any improper use of your 401(k) account or annuity by you, your beneficiary or any disqualified person. Disqualified persons include your fiduciary and members or your family (spouse, ancestor, linear descendant, and any spouse of linear descendant).”  IRS Publication 590

IRC 4975 is the section that lays out the rules on prohibited transactions. Prohibited transactions generally involve one of the following: (1) doing business with a disqualified person; (2) benefiting someone other than the 401(k); (3) loaning money to a disqualified person; or (4) investing in a prohibited investment.

Bluntly stated, prohibited transactions are those transactions that violate the basic intent of IRS code as it relates to the operation of the 401(k).  Always consider this basic statement:  Your activities with the plan must always benefit the plan and not you personally.  If one always keeps this premise in mind, it will greatly assist them in the “common sense” approach to operating and administering their plan.