I need some help regarding how to proceed on determining a SDIRA vs. Solo 401K. I've got about $100K in a 403B plan (equivalent of 401K for non-profit organizations) from a former employer. I am currently an employee of another healthcare organization and have a separate 403B through them. My wife and I have an LLC for real-estate investing purposes, and we are both managers and members. So here are my questions:
1. Am I even eligible for a Solo 401K if I am still employed in a W-2 position?
2. Which is a better vehicle for real-estate investing? Pros/Cons of each? For instance, I've read you can borrow against your Solo 401K, but not with a SDIRA.
3. To what extent do you diversify within a given account? Meaning, would it be prudent for me to keep some part of the $100K in stocks, or commit the entire sum to real-estate investing? I realize my audience may be slightly biased here :-)
I also know it's not a super large amount of money in the grand scheme of things, but I want to be strategic about how I allocate it. Thanks in advance for your input!
Your eligibility for a Solo 401(k) would hinge upon how your real estate LLC generates income. Passive rental income does not qualify as self-employment income for purposes of sponsoring a retirement plan. If you are engaging in active forms of real estate with the LLC such as flipping, wholesaling or new construction, then a Solo 401(k) would be an option.
If you have legitimate self-employment that can qualify to sponsor a Solo 401(k), you can have both your individual 401k and also be employed elsewhere and participate in a separate retirement plan. Employee contributions have one cap across all plans, but employer contributions are independent.
Generally speaking, if you solidly qualify for a Solo 401(k) and will for the long term, it is a more robust retirement plan, with higher contribution limits, the availability personal loans, and exception from taxation on debt-financed real estate investments - to name just a few key benefits.
A self-directed IRA, while not quite as powerful, is also a great way to diversify your retirement savings and invest in real estate.
As with so many thing in investing and real estate, there is no one right answer that applies to everyone. Which would be the better plan in your situation will depend on a lot of factors.
Diversification is always a good strategy. With $100K, you will not have that much ability to invest in real estate AND other conventional assets, but if your retirement plan that is tied to your W-2 job is in the financial markets, then that is a form of diversification.
As Brian explained Solo 401k plan is not for everyone. Just having an LLC does not mean you qualify for it. You must have earned (not passive) income. However, if you are eligible Solo 401k has several significant benefits making superior to SDIRA:
- Large contributions level up to $60K/yr
- Greater creditor protection
- Ability to correct a prohibited transaction
- Participant loan allowing you access up to $50K of your balance tax and penalties free
- No tax on leveraged real estate
- and more
Both, SDIRA and Solo 401k offer virtually limitless investment options so you can diversify to the extend you wish.
Brian and Demetri are right on with their answers.
I would do as many tax deferred tax free plans as I could --a 401k, an IRA, ESA, HSA etc
However, Our solo 401k clients biggest mistake is they hire employees which soon nullifies a solo 401k plan and adds new 401k plan costs. If you are going to have employees -go with the IRA to begin with -and research the 401k option with your accountant and a TPA. If no employees for a few years the solo 401k is a good choice especially if you can afford larger contributions.
As far as diversification evaluate risk, return, and control and govern yourself accordingly. As warren buffet says don't invest in what you don't know.
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; and
- Both are prohibited from investing in assets listed under I.R.C. 408(m).
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 2017, the solo 401k contribution limit is $54,000, 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.
You can still be eligible for a Solo 401k even if you are employed at a W2 job. You must have self-employment activity and no full time employees to be eligible. The Solo 401k is generally a much better structure if you are eligible. If you are not eligible, a self-directed IRA is the way to go.
Compared to an IRA, Solo 401k contributions limits are roughly ten times higher and there is no custodial requirement for the 401k. You can take participant loans from the plan, you don't need the additional expense and administration of an LLC to have checkbook control, and there is a built in-Roth component. A spouse can also participate in the same plan, there are additional tax benefits compared to an IRA, and there is generally greater privacy. Finally, the plans are often quicker to setup and cost less money over time especially compared to most IRA LLCs.
A lot of good information. Many are talking about one plan vs another. You can have multiple plans. More importantly --How much cash do you have for contributions, do you have employees, are you married, children, etc? Goals? Asset protection?
Solo401k and SEP IRA have contributions that are similar. SIMPLE IRA has benefits over solo and SEP if you have employees
Personal Roth and traditional IRA can be in addition to the above mentioned plans. Spousal IRA, ESAs, HSAs are also available plans. All can be self directed or with traditional investments.
You have some homework to do--Talk yo your accountant and get his advice. Make sure you have an accountant that understands the different plans. If you want to do a conference call PM me or call.
I might have missed this in all the content, but more specifically, would I be able to rollover my old 403B (as myself, NOT as my LLC) into either a Solo 401K or SDIRA at this point?
Yes Adam, IRS rules allow rollover old 403B into IRA or Solo 401K
Yes. I think I addressed that in my original post.
A new IRA or Solo 401k would be able to accept a rollover from a prior employer plan such as a 403b, 401k, etc.
For a list of accounts that can be transferred to an IRA or a 401k, please see the following.
You can roll your 403b into a Solo 401k (if eligible) or an IRA. Either way, you will be transferring the assets as the individual participant in the 403b plan to the new structure as the participant in the Solo 401k or the accountholder in the IRA. The funds won't pass through your LLC.
Do the payments received have to stay in the 401(k) plan? What are the logistics of the process, receive payment into checking account at normal band, then transfer to the Solo 401(k) plan?
For rental property purchased in a Solo 401k, the 401k is the owner of the property and retains all profits. Those profits receive the tax benefits of the 401k plan. As the 401k participant, you could distribute funds to yourself, though this is typically done in "retirement" when you start drawing taxable (or tax free, if Roth) income from the 401k.
A bank account is typically opened in the name of the Solo 401k. This account can be used to make investments, pay investment-related expenses, and receive deposits for 401k contributions and investment earnings.
Whoa, Nelly! That’s a big question. I’m sure this all seems uncertain right now, but we’re going to get you on a clear path to profit in no time. Let’s start with what you’re trying to accomplish. I’ll assume that you’re looking into real estate because you want to earn lump sum profits and/or residual income and to take advantage of the best tax shelter on the planet. With that in mind, understand that a solo 401k is just a company retirement plan; so you’re just as eligible to set one up as you are eligible to open your own business. The fact that you’re also an employee is a separate thing.
Now to tackle the question of which is better: A Self-Directed "Solo" 401k or a Self Directed Roth IRA? The pros and cons of the Solo vs Roth are easily found online, but we can make this question far easier by looking at what you want these accounts to do for you: 1) You want to be able to lend money, 2) buy tax liens, and 3) flip property out of them. Both entities can accomplish these stated goals. The Roth IRA, however, allows your contribution and any profits it makes to grow tax-free; and that makes it a far better IRA option than the "traditional" IRA or the Solo for the same reason. Some people will argue that the Solo gives you checkbook control, but you can set that up with a Roth/LLC structure too. Frankly, though, checkbook control is overrated. You just don't need it that much unless you're holding real estate for a longer term, which you don't want to do anyway in a retirement account because you're not allowed to take depreciation or losses, which are huge write-offs for property owners. Keep your keeper properties in an LLC, and sell tax-deferred with the 1031 exchange.
But what about penalties for taking your money out? Also overrated. Don’t take money out the conventional way. Instead, I like using the private bank concept. It works like this: Let’s say I want to take out $25,000 to sink into my custom ‘82 Jeep Scrambler diesel conversion (ahem, let’s just say). And, my buddy wants to withdraw $25,000 out of her account to go fishing. If we did that, we’d both pay penalties. However, if I made a loan to my buddy and my buddy made a loan to me, both for $25,000, and we paid each other back, voila! It’s a legal, tax-free, smart-as-a-tack way to effectively withdraw funds penalty free. Which leaves one last question – your corporate structure.
You mentioned that you have an LLC for investing and that your wife and you are both managers and members. All you've done is create liability for both of you. And, if the corporate veil is pierced because let's say, you take rent money from your LLC and accidentally put it in your personal account, then you've just put your home at risk too. Assuming that both of you are on title to your home, and assuming you don't personally have millions in the bank, put the first rental in your name. Your home is insulated from it because she's on your home's title too. Put the second rental in her name. Your home is insulated from risk there too because you're on your home's title too. And both rentals are insulated from each other because neither of you are on title to the property owned by the other. So, your first two rentals are "free". Simple! No need for business entities. Your third rental goes into your LLC.
How many properties are too many to place in an LLC? Well, at one point over the 25 years I've been buying and developing real estate, I had single LLCs for each and every property. Why not? They were cheap to form and they protected me and each other. Then, my state, "The People's Republic of Maryland", began charging a yearly $300 LLC filing fee. So, I started placing five to ten properties in each LLC. My commercial properties, especially my bars, nightclub, and restaurants, and my development projects (which are the higher risk) each got their own LLC. Just remember though before you allow anyone to get you all wound up about asset protection and bulletproofing assets and LLC/trust structures, and lawsuits and buying seminars on the whole mess, business entities are the last line of defense. They're no substitute for quality properties, quality tenants, solid management skills, and a proper insurance policy. And at the end of the line, your LLC is, as our late friend and national speaker Albert Aiello, CPA, used to say, "The Beethoven of Business Entities."
Finally, regarding your question about diversification, let’s break that down because it’s a word that is constantly thrown around by wall street types to justify risky decisions. Whether you’re investing in a company (stock) or in real estate, you should judge your investment in terms of the six things that make an investment “good”:
§ Tax Advantages
§ Protection Against Inflation
§ Preservation of Capital
Notwithstanding my brief answer, the scope of your question was such that this post is already fairly long, so I should close for now.
You've made some dangerous suggestions in your post (prohibited transactions) and I have to disagree with some of your comparisons.
One thing I must point out is when you say:
"However, if I made a loan to my buddy and my buddy made a loan to me, both for $25,000, and we paid each other back, voila! It’s a legal, tax-free, smart-as-a-tack way to effectively withdraw funds penalty free. Which leaves one last question – your corporate structure."
This is neither legal nor smart.
Originally posted by @Ian Parrish :
But what about penalties for taking your money out? Also overrated. Don’t take money out the conventional way. Instead, I like using the private bank concept. It works like this: Let’s say I want to take out $25,000 to sink into my custom ‘82 Jeep Scrambler diesel conversion (ahem, let’s just say). And, my buddy wants to withdraw $25,000 out of her account to go fishing. If we did that, we’d both pay penalties. However, if I made a loan to my buddy and my buddy made a loan to me, both for $25,000, and we paid each other back, voila! It’s a legal, tax-free, smart-as-a-tack way to effectively withdraw funds penalty free.
What you describes is NOT legal and is "prohibited transaction" according to the IRS. The rules do not allow you to receive any personal benefits from your IRA and that is exactly what you described. You must refrain from making such recommendations!
Originally posted by @Ian Parrish :
Now to tackle the question of which is better: A Self-Directed “Solo” 401k or a Self Directed Roth IRA? The pros and cons of the Solo vs Roth are easily found online, but we can make this question far easier by looking at what you want these accounts to do for you: 1) You want to be able to lend money, 2) buy tax liens, and 3) flip property out of them. Both entities can accomplish these stated goals. The Roth IRA, however, allows your contribution and any profits it makes to grow tax-free; and that makes it a far better IRA option than the “traditional” IRA or the Solo for the same reason. Some people will argue that the Solo gives you checkbook control, but you can set that up with a Roth/LLC structure too.
Truly self-directed Solo 401k plan has built-in Roth, allowing to have both: pre-tax as well as post-tax (Roth) accounts within the same plan. A simple side-by-side comparison reveals that Solo 401k plan is way superior to an IRA:
@Ian Parrish I appreciate your thorough response, and I would love a copy of your report. You shared a lot of great information, but as other posters have noted, I am cautious about transactions that blur the lines of legality. I'd like to fly under the radar with the IRS as much as possible...
Thank you again to all of you for your comments and wisdom.
@Dmitriy Fomichenko @Justin Windham
I appreciate the feedback about the Private Bank Concept, and I apologize if I oversimplified the matter. The posters who urged caution are exactly right - what I described was a concept that should only be implemented with a competent advisor.
Regarding legality, it is legal for a person to lend money from his or her SDRIA to a nondisqualified person (for example, an unrelated person.) If anyone disagrees with this, then I would urge a citation. So, neither of the loans I described is illegal. However, the question I believe some posters are getting at is this: Could the Private Bank Concept appear in the eyes of the IRS to be a business structure to circumvent withdraw penalties? Yes, if it’s done improperly and if you were both audited at the same time, it certainly could and that’s a very bad thing! To protect yourself, you would want to make the loans as far apart in time as possible, and, if possible, make the loans not directly to each other so it does not appear as a quid pro quo. Remember, what we’re speaking about here is the intent. You must be able to show that the intent is not to defraud the IRS. A competent advisor can guide you through it.
Thanks again for the excellent feedback!
You're right about the intent being meaningful and the IRS would agree. What you describe is a way for people to knowingly attempt to circumvent the prohibited transaction rules with the intention to indirectly benefit from the investment of their retirement funds. Making a prohibited transaction "not appear as a quid pro quo" doesn't make it any more legal.
You’re welcome, Adam. I close with this: If the line between right and wrong, legal or illegal, profitable or otherwise is ever blurry to you, then you should always exchange hesitation and doubt with knowledge. Because if you’re ever not sure what do to, it’s not because you aren’t an exceptional person; it’s more likely that you simply don’t have enough information.
"Go rob a bank, but make sure you are well prepared. Hire an expert to train you how to rob a bank. If you plan it well you are likely not going to get caught. But if you do, have a back up plan to show that it was not your intent".
This is ridiculous!!! Regardless if you get caught of not you commuted a crime! That same with your suggestion, regardless if you get audited or not prohibited transaction took place. Period!