What is a Self Directed 401K / Solo 401(k) Plan
A Self Directed 401k is a qualified retirement plan approved by the IRS. It follows the same rules and requirements as any other 401k plan – these rules being established in 1981. In 2001 the EGTRRA law was passed. This is commonly referred to as one of the two “Bush Tax Cuts”. This act made significant changes to the IRS code lowering taxes for qualified plans such as a personal 401k plan.
The participants of the plan have complete flexibility to invest in anything they wish – as long as they are legal. They simply write a check and make their investments – they are not confined or stifled as most people are with their traditional brokerage retirement accounts.
Self-directed 401(k)’s are perfect for self-employed consultants, contractors, sole proprietors etc. They allow for spouses to be plan members and eliminate the need for a custodian (as required with an IRA).
- Types of 401(k) Plans
- What Rules Affect a Self Directed 401k?
- 401(k) Eligibility Requirements
- Investments in Self Directed 401(k)
- Setting Up a Self Directed 401(k)
- Pros and Cons of a Self Directed 401k
- Self Directed Facts and “Secrets”
- Funding Self Directed 401(k)’s
- Contributions to The Plan
- Self Directed 401(k) Loans
- Checkbook Control Facilities
- What is Roth Solo 401(K) Plan?
Here is the list of different types of Self directed 401K Plans.
Traditional 401(k)s – These plans allow employers to match 401(k) contributions on behalf of eligible employees, besides the employee’s own elective deferral contributions.
Self Directed 401(k)s – Similar to traditional 401(k)s, these plans allow for pre-tax savings and automated pay check deductions, but employees can choose where to invest funds.
Safe Harbor 401(k)s – Unlike traditional 401(k)s, employer contributions are fully vested and non-forfeitable, and can even be made for employees without personal elective deferral contributions.
Tiered Profit Sharing 401(k)s – Ideal for profitable business with 50 or fewer employees, these plans allow owners to contribute on a profit sharing basis to employee groups.
Simple 401(k)s – Ideal for business with 100 or fewer employees that receive at least $5000 each, these plans allow for fully vested employer and employee contributions.
These are the two main rules and in many situations they go hand in hand:
Prohibited Transactions – A Self directed 401k cannot invest in collectibles such as rugs, works of art, auto mobiles etc.
Disqualified Persons – These are persons the plan is forbidden to “do business with”. A more detailed list can be found on site.
We encourage our clients to contact us if they have any suspicions their actions might violate these rules.
In order to be eligible for opening and making contributions to self directed solo/individual 401(k) plans, you need to meet the following 401k eligibility requirements:
- If you’re a business owner, you need to be the sole proprietor and have no employees other than your spouse. If your business is a partnership, it should have no employees other than self-employed partners and their spouses.
- You have received taxable compensation in the form of a salary or wages as an individual, during the current financial year. Whether your business is incorporated or incorporated, a sole proprietorship, partnership or corporation, the deadline for establishing a self directed 401(k) is the last day of the tax year.
In addition to the 401k eligibility requirements listed above, you should also note that the individual 401(k) should be the only arrangement maintained by your business if it’s not part of a controlled group under federal tax law.
A Solo 401(k) can invest in almost anything. Examples are: Real Estate – residential or commercial – rentals, foreclosures raw land, Tax Liens, Precious Metals, Private Placements, Foreign Currency, Hard Money Lending etc.
Prohibited Transactions Rules
In a twist, the IRS does NOT describe what a Solo 401k plan can invest in, only what it CANNOT invest in.
A disqualified person by virtue of IRS 4975(e)(2) is generally described as follows:
– A person providing services to the Plan (a trustee etc.)
– A person providing fiduciary services (someone who has authority to make investment decisions for the plan
Family members – parents, grandparents, children, grandchildren, spouses children or grandchildren. Parents-in-law, brothers, sisters, cousins, aunts or uncles, step-bothers or stepsisters and friends are not treated as disqualified persons.
There are other disqualified considerations, we ask you to call if you are unsure.
Under IRS rules, a Solo 401k is prohibited from certain types of investments or transactions. Some examples are:
Engaging in a Transaction with a Disqualified Person
– Plan participant buys a condo and lets daughter live there
– Plan participant buys part of business owned by his Father
Direct or Indirect Lending of Money
– Plan participant loans money to his wife or son
– Father signs a loan guarantee for the Solo 401k Plan
Receiving Direct or Indirect Benefits of the Plan
– Plan participant buys property and charges a management fee
– Plan participant “fixes” a property himself rather than paying a 3rd non-disqualified party.
– Plan participant receives a commission for selling a property to the Plan.
A Solo 401(k) can invest in shares of a C Corp but the rules of an S Corp prohibit a Solo 401(k) from the purchase of shares.
Yes – it is one of the most popular investment choices. Real Estate is an asset class just like stocks and bonds. However most financial institutions do not allow for real estate investments. They have their “advisors” who must restrict their advice to “their products.”
Buying Real Estate with a Self Directed 401K
It really isn’t complicated. When we establish a new Self Directed 401(k) plan, we assist the client to transfer or rollover qualified funds into the new plan. The new plan will have a checking account. When an R E opportunity arises, the client simply writes a check and the title company titles the property in the name of the 401(k). The client will also write a check for any ancillary fees or “fix up” expenses. If the purchase is a long-term hold, the tenant will pay the rent directly to the 401(k) plan. When the property is sold, the title company will send the profit to the 401(k) plan. The client, acting as trustee of the plan, makes all the decisions for the plan. With a Self Directed 401(k) plan vs. a Self Directed IRA, there isn’t the need for a custodian. Therefore the client (trustee) doesn’t have to submit paperwork or ask permission. He simply makes the decision and writes the check.
Of course we are always a call or email away to answer any questions our clients have during the purchasing processes.
At Self Directed Retirement Plans LLC we have a system, which is efficient, cost effective and a pleasant experience for our clients. Our client’s experience hands on assistance and guidance. We know this is a big step for most, even scary because most financial advisors or CPA’s are not familiar with Self Directed 401(k)’s. Consequently the advice they give is not correct. We have been creating these plans for almost ten years and our clients are thankful for that experience.
This is a valid question and one we are asked quite often. The pros of course are the ability to have total checkbook control of your plan and take immediate action when an investment becomes available. The con would simply be – the client is now the decision maker. We are pro-active with our clients – encouraging them to contact us about all facets of their new plan.
Self Directed 401K Benefits
- Any contributions made to these plans, as well as investment returns and earnings, are tax-deferred until withdrawal, and employers receive tax benefits too.
- You can opt for voluntary elective contributions from your salary, and your employer can also make contributions on your behalf.
- In tax year 2018, you are allowed to defer up to $18,500 (up from $18,000 in 2017) or all of your earnings annually (whichever is less), with catch-up contribution limits of $6,000 once you’re over the age of 50.
- You retain greater control over investments, and can choose where your funds will be invested from any of the options offered by the plan.
- These plans are highly portable and you can roll them over if you change jobs, rather than establishing a new plan for every employer.
Self Directed 401K Drawbacks
- Any withdrawals made from the plan before the age of 59 1/2 may incur a 10% penalty, except for employees who retire within the calendar year when they turn 55.
- The company can set eligibility requirements to some extent, and can restrict employees who’ve worked with them less than a year or work part-time, union members, etc.
- If you don’t have a range of index funds available as part of your plan’s options, the long-term management of the investment portfolio can be problematic.
- These plans can be expensive to establish and monitor, especially when it comes to administrative costs associated with loans taken against them, early withdrawals, etc.
- You may not be able to access a very wide range of investment options for your 401(k) funds, and the ones available might be below average in terms of quality.
Facts – Ten thousand Americans are turning 60 EVERY day . They are better educated, have gone through at lease two severe downturns in the “market” and are looking for help to have more “control”.
Less than one percent of CPA’s are familiar and comfortable enough to discuss self directed 401(k)’s and their intricacies .
Most financial advisors are bound by rules their employers place on them . In most cases this means they can only “advise” their clients to purchase products their employers sell. Self Directed 401(k)’s generally are not on that list.
Secrets – Mr. and Mrs. Smith work 9-5 and contribute to their respective company 401(k) plans. Mr. Smith has part time self-employment income. Mr. and Mrs. Smith are eligible for their own personal self directed 401(k) plan. BOTH can now transfer former qualified funds into the personal plan. This immediately creates a much larger investment pool vs. two separate ira’s AND these funds can be co-invested.
Transfers, personal deferrals (contributions) and profit sharing are the main funding sources.
Transfers – an individual can transfer previous 401(k) funds, SEP IRA funds, SIMPLE IRA funds, and Traditional IRA funds – in fact any previous “qualified” funds. Roth IRA funds cannot be transferred.
Contributions – personal deferrals are determined by age. If a client is under 50, they can have a personal deferral of 100% of their self-employed income up to $18,500. Over 50 this limit increases to $24,500.
Profit Sharing – the self directed 401k plans we establish are also psp’s or profit sharing plans. The IRS publication 560 establishes the amount of profit sharing allowed and includes a step-by-step worksheet. In general terms the profit sharing can be up to 25% of the sponsoring entitie’s profit.
What are the maximum 401(k) contribution limits for 2018?
The maximum contribution limit for 401(k) accounts in 2018 is rising to $18,500 for elective contributions, up from $18,000 in 2017. Elective contributions are money you choose to have withheld from your paycheck and invested for retirement.
For older workers 50 and up, additional catch-up contributions are permitted. Catch up contributions are additional elective contributions older workers can make on top of the $18,500 every eligible worker can invest. In 2018, older workers were allowed to make catch-up contributions of $6,000. People 50 and over will be allowed to contribute a maximum of $24,500 in elective contributions in 2018, compared with $24,000 in 2017.
|Contribution Type||2018 Limit||2017 Limit||Change|
|Elective contributions for all eligible workers||$18,500||$18,000||+$500|
|Catch-up contributions for workers 50 and over||$6,000||$6,000||No change|
|Total elective contributions for workers 50 and over||$24,500||$24,000||+$500|
|Defined contribution maximum from all sources for workers under 50||$55,000||$54,000||+$1,000|
|Defined contribution maximum from all sources for workers 50 and over||$61,000||$60,000||+$1,000|
Limits – Annual contributions are completely discretionary and consist of two factors or parts – Personal Deferral and Profit Sharing.
Personal Deferral – Under the age of 50 is $18,500 and it is $24,500 if you turn 50 in any part of the year. This can be pre-tax (Traditional) or an after-tax (Roth) contribution.
Profit Sharing – The business can make a profit sharing contribution between 20% and 25% depending upon the type of business.
Total Limits – For participants under the age of 50 a combined contribution of $55,000 and over the age of 50 $61,000. IMP – if both spouses participate in the sponsoring business and earn compensation the total contribution can be up to $110,000 or $122,000. Very compelling reasons to have a self directed 401(k).
Roth Contributions – Built into the Solo 401(k) is a Roth sub account. This allows high earning plan participants to elect a Roth contribution. High income earners are prohibited from contributing to a Roth IRA or converting a Traditional IRA to a Roth IRA. Coupled with the higher contribution levels, Solo 401(k)’s allow high income earners to enter the Roth arena.
Personal Loans – The Solo 401(k) allows plan participants to borrow personally from the plan.The participant can borrow up to 50% of their account value or $50,000 – whichever is less. This low interest loan can be used for any purpose.
With a Solo 401(k), all assets of the plan are under the control of the plan participant(s). You act as trustee of the plan, eliminating the need for a bank or trust company to serve as a trustee. As trustee you can establish a Solo 401(k) trust account at any local bank or credit union. This gives the plan checkbook control enabling you to act decisively and quickly when an investment opportunity presents itself.