I've been reading a lot about both the Solo 401(k) and the Self-Directed IRA LLC. From my layman's perspective, it would appear at first glance that Solo 401(k) is the way to go. No custodian to deal with and higher contribution limits to name a couple of things seem to weigh in its favor. Can anyone tell me the downsides of a Solo 401(k) vs
the SDIRA LLC, if any?
I have two other considerations that I need to keep in mind as well:
1) The account will be initially funded by rolling over some money from an existing IRA. Subsequently, funds will come primarily from tax lien certificate investments and related activities. I'd like to be able to pay myself a salary out of the funds in the account. So, for example, let's say I roll 50K into the account initially, and during the year I make $7500 after expenses. I would like to be able to pay myself the $7500 (or any higher or lower amount, for that matter) as a salary for the work I do pertaining to tax lien investing - property research, attending auctions, administrative duties, etc. I'm thinking that this could be a way to get at some of the funds in my tax-deferred account without having to make early withdrawals and getting hit with penalties, etc. Has anyone done this? Which of the two structures would lend itself better to this type of thing?
2) I currently have a full-time job (unrelated to real estate), at which I already contribute to the company's 401(k) plan. Will this prohibit me from participating in my own Solo 401(k) or SDIRA LLC?
Thanks for reading,
Unless you are over age 59 1/2, you cannot draw any capital from a self directed IRA or 401(k), and then only by taking taxable distributions. These plans are for retirement investing only and there can be no direct or indirect benefit to you personally.
The decision between IRA and 401k hinges on a lot of factors specific to your situation, employment status, funding type, investment goals, etc. Speaking with a qualified advisor is the best means to make this determination.
You have to be self employed personally in order to establish a Solo 401k. The investment activities you plan to engage in with the Solo 401k do not classify as that self employment. For many people, a 401k is not an option, or if it is thanks to secondary self employment that is limited in nature - does allow for them to take advantage of the higher contribution limits - which must come from self employment income.
The key down-side of a Solo 401k is the need to maintain the qualifying status of being self employed with no full time employees. If this will not be a long term situation, then you might need to terminate the plan when you grow your business and add employees or shut down your business. Otherwise, yes, there are some advantages as compared to an IRA based program. What we find, however, is that a lot of folks do not really qualify, but have been swayed by their reading on the internet that the Solo 401k is the best things since sliced bread and really want to go that way. The best plan in the world is no good if it does not fit your situation.
If you are legitimately self employed and have a full time job with a 401k, your combined employee contributions will be capped at $18,000 if you are under age 50 or $24,000 if you are 50 or older. Employer profit sharing contributions and the plan maximum are not impacted by participation in two plans.
Both an IRA and 401k that are self directed are a fantastic way to diversify your investments into real estate and related non-traditional assets.
Brian provided you with number of good points above. Just would like to add my two cents.
1) It would be illegal to pay yourself compensation, regardless if you are using IRA or 401k.
2) You having a full time job will not impact your ability to participate in any of the plans. However you need to keep few things in mind:
- If you already contributing to your employer sponsored 401k plan, this will impart the ability to contribute to your Solo 401k. The salary deferral limit is based on participant, not the plan. In other words, if you contributing to your employer 401k $10,000 for this year, you can only contribute additional $8,000 into the Solo 401k until you reach the limit of $18,000. Those who are 50 year or older have additional $6,000 in catch up contributions. The contributions to Solo 401k plan must come from the earned self-employed income. If you wish to learn the specifics, please PM me and I'll send you a link to educational video on YouTube that spells out all of the contributions details.
- 401k plans are meant to be permanent in nature, therefore you need legitimate self-employment activity (which can be side business or part time self-employment in addition to your full time job) that is continuous. Otherwise your plan may be deemed disqualified and the results of that are not pleasant.
That being said, if you truly qualify for Solo 401k I believe that it would be superior option over IRA LLC for several major reasons, but again, to piggy-back on Brian's comment above it is important that you speak with the expert about particulars of your own situation.
Thanks guys. I think what threw me at first was that I wouldn't be able to make contributions to a Solo 401(k) out of money I made from real estate investing, because paying myself out of that account would be prohibited, but I was thinking about it all wrong. My main source of income is software development. I spend most of my time as a software developer for my employer in my regular W2 job. But on increasingly rare occasion, I'll take on some consulting work on the side. I can use that income to contribute to the Solo 401(k), and use that money, along with whatever money I decide to roll over from my existing Traditional IRA into the Solo 401(k).
So now my question becomes, well what if I don't do any consulting work at all in a given year? Do I have to make a contribution in every year? And for that matter, do I have to make a contribution in any year ever? Can I just open the Solo 401(k) plan, roll a ton of money into it, never make a single contribution, and just start using that money to invest in real estate? If that's the case, then the decision between SDIRA LLC and the Solo 401(k) is really a no-brainer. Opinions welcome...
The self employment activity that you utilize to sponsor the 401k needs to be a legitimate, ongoing for profit activity. Periodic software consulting would be fine. You will want to have demonstrated income from the business that you file on a schedule C if you are a sole proprietor. You can have years were there is no income, but definitely need to truly be "in business".
As for contributions there is no requirement to make them.
Our general opinion is that unless you live in a very high LLC fee state like California, or will definitely plan to use non-recourse mortgages in your investing, there is no great advantage to using the Solo 401k over an IRA if you are borderline on the self employment & contribution side of the equation. IRA's by their very nature have a certain permanence to them. A 401k is dependent on the continued existence of the qualifying owner-only business.
I see a lot of discussion on the Solo 401k that could be considered "shiny object syndrome". Focus on what you need to achieve your goals.
To reiterate... you will not in all likelihood be able to make a well informed decision based on internet research and forums. That can point you in the general direction and perhaps focus you on some key questions, but there is no substitute for a one-on-one consultation with an expert in the field (or more than one).
Contributions to Solo 401k plan are not required to be made every year. However, the plan will not be considered "Qualified" if it appears that it was established as a temporary program. It will also be considered temporary, if it is abandoned within a few years after it is established for reasons other than business necessity. A plan will be considered temporary if substantial and recurring contributions are not made.
A plan will be considered permanent even though contributions are not made every year as long as substantial contributions are being made occasionally.
If your intention is to continue doing side consulting work (which will qualify you for a Solo 401k), and you are trying to decide between IRA LLC and Solo 401k, the 2nd choice would be superior in my opinion for several major reasons:
- 401k has loan feature allowing you to access up to $50K in your retirement funds at any time tax-free and penalty-free. If there is a potentially very profitable transaction that would otherwise be prohibited, you can pull the loan out and do it in your own name.
- Solo 401k has Roth account as an option, you can have both pre-tax and post-tax contributions under the same plan. If you had IRA you will need separate Roth IRA account.
- No custodian and custodian fees, no LLC and LLC fees.
- 401k can be great tax-shelter allowing contributions up to $59,000 per year.
- If your spouse is involved in your business you can potentially double the contributions and your spouse can have separate account under the plan at no additional cost.
- Exempt from UDFI tax on leveraged real estate.
Here are some similarities:
The Self-Directed IRA and Solo 401k Similarities
- Both were created by congress for individuals to save for retirement;
- Both may be invested in alternative investments such as real estate, precious metals tax liens, promissory notes, private company shares, and stocks and mutual funds, to name a few;
- Both allow for Roth contributions;
- Both are subject to prohibited transaction rules;
- Both are subject to federal taxes at time of distribution;
- Both allow for checkbook control for placing alternative investments;
- Both may be invested in annuities;
- Both are protected from creditors;
- Both allow for nondeductible contributions;
- Both are prohibited from investing in assets listed under I.R.C. 408(m); and
- Neither may invest directly in your own business startup.
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