Solo 401k - Advantages of This Powerful Self-Directed Plan
Many real estate investors (including BiggerPockets members) have heard about the ability to use self-directed IRA for real estate investing, private lending and other non-traditional investments. However, very few are aware of the existence of a self-directed Solo 401k. And even those who heard about Solo 401k do not have full understanding of the very powerful benefits it offers that are not available with self-directed IRA!
So as an alternative to a self-directed IRA, you should consider truly self-directed, trustee-managed Solo 401k plan. Just like self-directed IRA it allows you to invest in alternative assets, but offers some unique features that are not available with SD IRA, which make this plan superior to SD IRA and Checkbook IRA (IRA owned LLC). Take a look at few:
- Solo 401k offers Participant Loan Feature which allows you to access your retirement funds any time for any reason (example would be investing in a transactions that would be otherwise prohibited). It's like creating your own bank that will never turn you down. Some may never use this feature, but it is sure great to have this option. With an IRA you can't touch your money until you are over 59 1/2 and if you do - you are taxed and penalized heavily!
- Roth Solo 401(k) - you can maintain additional, separate 'bucket' under your Solo 401(k) plan where you could make after tax contributions, thus, investing tax free for the rest of your life. The limit on Roth contribution in Solo 401k is up to $23,000 (compared to $6,500 in Roth IRA) and there is no income restriction on contributions unlike with Roth IRA. Also, pre-tax portion could be converted into after-tax (Roth). (Tax professional should be consulted prior doing so).
- With Solo 401(k) custodian is not required. The plan can be self-administered which could mean significant savings $$ on custodian, transactions and asset based fees that would be there in a case of SD IRA. You also have a checkbook control and don't have to obtain custodian consent when making investments. This could be huge on time-sensitive investments and give great level of convenience.
- Large contribution limit of up to $57,500 for 2014 (significantly higher than an IRA, which is only $6,500). In additional to all other benefits mentioned above, Solo 401k is a great tax-sheltering vehicle, allowing you to shelter huge amount of money from taxes.
- When you use financing to acquire real estate in a SD IRA, the portion of the income from the property will be subject to UDFI tax (type of the UBIT of about 35%)! When you finance real estate inside of Solo 401k - it would be exempt from UDFI, which makes it even more attractive to use for real estate investment with leverage.
You should also be aware that while anyone with earned income or existent retirement account can establish self-directed IRA, not everyone will qualify for a Solo 401k (although most people can). Solo 401k can be established by anyone who has legitimate self-employment activity (part time or full time) and who does not have full time employees working for them (by IRS definition "Full Time" is someone who works for you 1,000 or more hours per year). Independent contractor are not considered employees. The business can be in any structure or capacity - LLC, Corporation, Partnership, Sole-proprietorship, etc. It can be a side business in addition to the full time job you have working for your employer. Here are some examples of legitimate business activity:
- Property Manager (even if you manage your own property)
- Network Marketing Business
- IT consultant
- Registered Nurse receiving 1099 income
- Day Trader
- Independent consultant
- Reselling items on ebay
- etc, etc, etc...
Solo 401k subject has been discussed here on BP in great details many times and you can find a lot more info and learn about the experience of those who used it.
The bottom line is you should educate yourself, use resources that are available to you and make informed decisions.
Please feel free to ask any questions you may have below in comments section.