Which is better? Solo 401k or self directed IRA

Question

Dmitriy Fomichenko · Answer

@Hunter Estess

If you qualify for it the Solo 401k is almost always a better option (for the reasons Brian described above).

If you don't qualify for the Solo 401k there is another options: self-directed IRA on steroids (aka Checkbook IRA or IRA owned LLC). This option allows you to bypass the custodian and have checkbook control (similar to a Solo 401k) over your retirement funds.

Brian Eastman · Answer

@Hunter Estess

The Solo 401k is a more powerful platform, but whether it will be "better" will depend on your situation.

Firstly, such a plan is only available to those who are self-employed and have no full time employees.

Both plans can be fully self directed and invest in anything the IRS rules allow for, including real estate in many forms, notes, etc.

The key advantages of the 401k over the IRA are:

Higher contribution limits, so if you are self-employed, you can set aside more capital into the plan and defer the taxes on those contributions.

401k plans are not subject to UDFI taxation on leveraged real estate investing.  So, if you are intending to use mortgages to acquire plan-owned real estate, there is an advantage there.

The Solo 401k allows for participant loans, though one needs to use those judiciously.

I'd recommend you speak with a firm that offers both self-directed IRA and 401k plans and let them help you determine which will best suit your situation and goals.

Dmitriy Fomichenko · Answer

RMD stands for Required Minimum Distribution. More info here:

https://www.irs.gov/retirement-plans/plan-particip...

Michael Lee · Answer

Hello and welcome to BP!  That was a great comparison.  I have been checking that out lately and I was trying to decide which one to use.  You do not have a custodian in the 401K, at least I thought I understood.  I also heard that to be qualified to be in the 401K you must currently have your own company, it could not be used as a former company. I had a brain aneurism and a stroke over 5 years ago and was not qualified because of that.  I also found out I was not qualified for any social security because I did not pay myself and I had no recent W-2.  They only go by current employment.  I also lost my broker license because of my injury.  They wanted me to take everything over.  What does RMD stand for?  Your information was good. Thank you and good luck!

Justin Windham · Answer

@Hunter Estess

It looks like you are eligible for a Solo 401k so you would likely be better off with that structure. You can compare a few companies that offer this plan and see if it seems like a good fit to you.

Mark Nolan · Answer

@Hunter Estess

Following are the similarities and differences between the solo 401k and the self-directed IRA.

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

The Self-Directed IRA and Solo 401k Differences

• 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 (IRA LLC) must be utilized;
• The solo 401k allows for checkbook control from the onset;
• The solo 401k allows for personal loan known as a solo 401k loan;
• It is prohibited to borrow from your IRA;
• The Solo 401k may be invested in life insurance;
• The self-directed IRA may not be invested in life insurance;
• The solo 401k allow for high contribution amounts (for 2015; the  solo 401k contribution limit is $53,000, whereas the self-directed IRA  contribution limit is $5,500);
• The solo 401k business owner can serve as trustee of the solo 401k;
• The self-directed IRA participant/owner may not serve as trustee or  custodian of her IRA; instead, a trust company or bank institution is  required;
• 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;
• Rollovers and/or transfers from IRAs or qualified plans (e.g.,  former employer 401k) to a solo 401k are not reported on Form 5498, but  rather on Form 5500-EZ, but only if the air market value of the solo  401k exceeds $250K as of the end of the plan year (generally 12/31);
• When funds are rolled over or transferred from an IRA or 401k to a  self-directed IRA, the amount deposited into the self-directed IRA is  reported on Form 5498 by the receiving self-directed IRA custodian by  May of the year following the rollover/transfer.
• Rollovers (provided the 60 day rollover window is satisfied) from an  IRA to a Solo 401k or self-directed IRA are reported on lines 15a and  15b of Form 1040;
• Pre-tax IRA contributions on reported on line 32 of Form 1040;
• Pre-tax solo 401k contributions are reported on line 28 of Form 1040;
• Roth solo 401k funds are subject to RMDs;
• A Roth 401k may be transferred to a Roth IRA (Note that 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  RMD requirement applicable to Roth 401k contributions including Roth  Solo 401k contributions and earnings.);
• 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.

Dmitriy Fomichenko · Answer

@Hunter Estess

Did you mean to say "Can I contribute to a Solo 401k before filing your taxes with the IRS?"

If that is what you meant - then yes, contributions to a Solo 401k (just like with any other retirement plan) has to be made before tax filing. The contributions will be tax-deductible - meaning that your taxable income will be lowered by the amount you contribute.

Also please note that with Solo 401k you are allowed to make post tax Roth contributions. They are not tax-deductible but will allow you to grow your wealth tax free.

Brian Eastman · Answer

@Hunter Estess

Yes, as an employer retirement plan, a Solo 401k allows you to take some of the income from your business (the plan sponsor) and set that aside into the plan. For someone under age 50, the plan maximum is $53K per year, but that is dependent on income in your business.  You can elect to make up to $18K of that $53K as the employee, and choose whether to designate the contributions as tax-deferred or Roth status.

The investments of the plan are not taxed, just like any other retirement plan.

If you have remained in a tax-deferred status, you will pay tax on distributions from the plan in retirement, but the lack of taxes along the way will allow you to create a much larger pool of funds to draw from in retirement.  If you focus on a Roth strategy, you will pay taxes on funds as they go into the plan, but those funds will then grow tax free and be tax-free when distributed in retirement.

Yes, well managed, a Solo 401k can be a fantastic wealth building tool.  With a self-directed plan and the ability to diversify the plan investments into something you know and understand such as real estate, the potential gets even better.

Dmitriy Fomichenko · Answer

@Hunter Estess

you can only contribute from the earned income into a Solo 401k plan. Income from capital gains could not be sheltered into a Solo 401k.

The max you can contribute per year is $53K per participant.

Not sure I understand your question:

Could I pay the "solo 401k fund" prior to the IRS taxing it?

Can you please elaborate?

Which is better? Solo 401k or self directed IRA

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