Investing inside solo 401k plan vs. self directed IRA

4 Replies

Hello,

I have a question for anyone out there who has any experience or knowledge about solo 401k plans.

I'm thinking about rolling my 401k money at work into a solo 401k. I've read that the solo 401k has many advantages over the self directed IRA for investing in real estate. I understand that the rules are a little different, and that it must be tied to a business (e.g. a real estate business) and involve earned income. My question is can the rental income be taken as a distribution from the plan, with minimal taxation, once reaching age 59 1/2?

Thanks!

@Sal Souza

Yes, you may distribute to yourself from a self-directed IRA or Solo 401(k) after age 59 1/2. As retirement plans, the self-directed versions are no different than those offered by mainstream financial firms. Things like contributions, distributions, timelines, etc. are identical. Self-directed plans are just configured differently to provide access to a broader range of investment options.

@Sal Souza

The plus about waiting to take distributions from your IRA or solo 401(k) until you reach age 59 1/2 is that the early 10% distribution penalty will not apply. However federal and state taxes will apply.

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 2018, the solo 401k contribution limit is $55,000, 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.

Sal,

Your understanding is correct. If you qualify for it - Solo 401k would be superior option to an IRA. However you must have and maintain legitimate self-employment activity to keep the plan active and be IRS-compliant. 

Yes, if your 401k owns a rental property, essentially you can take the rental income out as a distribution. Another option to consider is to distribute the entire property "in-kind" so that you will be the owner of the property and can take advantage of depreciation deduction. 

Here is another discussion on the topic that you might find helpful: 

https://www.biggerpockets.com/forums/51/topics/527...

Dmitriy Fomichenko, Broker
(949) 228-9393

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