Self directed 401k for my mom who is retiring in Illinois soon...

4 Replies

Hopefully get some good response for my question. My mom is retiring soon and has a little money put away in a 401k. I have been trying to figure out the best way to re invest the money as well as the easiest way to liquidate if needed with least amount of tax implications. I am thinking self directed 401k and then investing that money or at least a portion of it into some real estate. She needs to be able to get to it for emergencies. Anyone have any good suggestion of what you might do in this situation? Thank you in advance!

John, 401k is NOT an emergency fund. She should have some funds liquid in an emergency fund equal to about 6 months of her living expenses, this would have to be in a personal account (not retirement). If she takes out a distribution from her retirement account prior to normal retirement age the consequences would be ordinary income taxes plus penalties. Relying on retirement account for emergencies is not financially prudent. So with that in mind I would suggest that your mom focus on earning/saving enough cash for emergencies then then start looking at investments. 

Also, in order for her to do a self-directed individual 401k she needs to own a small business or be self-employed, is that the case for her? If not then her option would be self-directed IRA.

Hope this helps.

@John McConnell

If your mother will be self-employed, the Solo 401k might be a good option.  It would give her full control over investing with the plan, so long as all investments are done at arm's length.

If she is not self employed, then an IRA based self directed plan would be the right path.

Either way, she is looking at taxable distributions from the plan if she chooses to personally take a distribution of plan funds.

@John McConnell

Both the IRA and the solo 401k are tax shelters so federal taxes will need to be paid once distributions commence assuming we are talking about pretax funds.

Here are a few similarities between the solo 401k and the IRA

  • 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 are protected from bankruptcy creditors; and
  • Both are prohibited from investing in assets listed under I.R.C. 408(m).

Here are a few differences between the IRA and the solo 401k

  • In order to open a solo 401k, self-employment, whether on a part-time or full-time basis, is required;
  • To open a self-directed IRA, self-employment income is not required;
  • In order to gain IRA checkbook control over the self-directed IRA funds, a limited liability company (self-directed IRA LLC) must be utilized;
  • The solo 401k allows for checkbook control outside the LLC;
  • The solo 401k allows for personal loan known as a solo 401k loan;
  • If you borrow from your own IRA, it will be deemed a taxable distribution;
  • Unlike an IRA, a Solo 401k can invest in life insurance;
  • The solo 401k business owner can serve as trustee of his or her solo 401k;
  • The self-directed IRA participant/owner may not serve as trustee or custodian of his or her IRA; instead, a trust company or bank institution is required;
  • Unlike an IRA, generally when distributions commence from the solo 401k a mandatory 20% of federal taxes must be withheld from each distribution and submitted electronically to the IRS by the 15th of the month following the date of each distribution;
  • Roth solo 401k funds are subject to RMDs;
  • A Roth 401k may be transferred to a Roth IRA--from a planning perspective, it may be advantageous to transfer Roth Solo 401k funds to a Roth IRA before turning age 70 ½ in order to escape the Roth 401k RMD requirement;
  • Roth IRA funds are not subject to requirement minimum distributions (RMDs);
  • The fair market value (FMV) of assets held in a self-directed IRA is reported on form 5498;
  • The fair market value of assets held in a solo 401k are reported on Form 5500-EZ;
  • At termination, the solo 401k is required to file a final Form 5500-EZ and 1099-R; and
  • At termination, the self-directed IRA is only required to file a form 1099-R.

Wow. So I need to do some more reading and studying on this subject it seems. It looks like the self directed 401 is the better solution but as you all mentioned she has to be self employed or business owner. But as I am reading it it also looks like an LLC, even if not making profit, is sufficient to cover this requirement. Will be back soon with more questions. Thanks for all the responses so far.