Advantages of a Self-Directed Solo 401k
A self-directed Solo 401k plan is perfect for sole proprietors, small businesses owners and independent contractors. A Solo 401k Plan (also known as Owner-Only 401k or Individual 401k) can be adopted by any business with no employees other than the owner and his or her spouse. The business can be established as a sole proprietorship, LLC, corporation, or partnership. A Solo 401k plan offers the similar advantages as a Self-Directed IRA LLC (also known as Checkbook IRA), but without having to hire a custodian or create an LLC.
The Solo 401k plan is unique because it is designed specifically for small, owner-only business. It’s a tax efficient and cost effective plan that offers all the benefits of a Self Directed IRA, but also comes with a bunch of additional benefits. There are many features of the Solo 401k plan that make it so appealing and popular among small business owners.
Checkbook Control without Custodian Fees
In a Solo 401k Plan, after the plan is set up, there is a trust that is created to hold assets of the plan. Usually, plan participant is designated as trustee of the plan, which gives him or her “checkbook control” over the plan’s assets. Making an investment with a Solo 401k Plan is as easy as writing a check.
Another significant benefit of the Solo 401k is that unlike with SD IRA it does not require the participant to hire a trust company to serve as trustee or custodian. This means that all assets of the 401k trust are under the sole authority of the Solo 401k participant. A Solo 401k plan allows you to eliminate the expense and delays associated with an IRA custodian, enabling you to act quickly when the right investment opportunity presents itself. And because trust account for Solo 401k plan may be opened at any local bank, you won’t be required to pay custodian fees for the account as you would in the case of an IRA.
High Contribution Limits
While an IRA only allows a $6,000 contribution limit (for the year 2019) plus additional $1,000 “catch up” contribution for those over age 50, the Solo 401k annual contribution limits are significantly higher: $56,000 plus $6,000 in "catch up" contributions with combined maximum of $62,000 per participant for the year 2019. Also, if your spouse receives compensation from the business, he or she can also participate in the plan which would effectively double the contributions limit.
Under the 2019 new 401k contribution rules, a plan participant under the age of 50 can make a maximum employee deferral contribution in the amount of $19,000. That amount can be made in pre-tax or after-tax (Roth) dollars. On the profit sharing side, the business can make a 25% (20% in the case of a sole proprietorship or single member LLC) profit sharing contribution up to a combined maximum, including the employee deferral, of $56,000.
Plan participants who are over the age of 50 can make a maximum employee deferral contribution in the amount of $25,000. That amount can be made in pre-tax or after-tax (Roth) dollars. On the profit sharing side, the business can make a 25% (20% in the case of a sole proprietorship or single member LLC) profit sharing contribution up to a combined maximum, including the employee deferral, of $62,000.
While you have the option to shelter large portion of your income, contributions to a solo 401k plan are completely discretionary. You have the option to contribute as much as legally possible, but at the same time you always have the option of reducing or even suspending plan contributions if necessary. In other words, you have the ability to make contributions to your Solo 401k Plan, but are not required to do so.
Unlimited Investment Options
With a truly self-directed Solo 401k Plan, you will be able to invest in almost any type of investment opportunity you discover, including: real estate (residential rentals, commercial, tax deeds, tax liens, foreclosures, raw land, multi-family, etc.), private businesses, precious metals and hard money lending as well as stock and mutual funds. Your only limit is your imagination. The income and gains from these investments will flow back into your Solo 401k plan tax-deferred (or tax-free in the case of Roth). Making an investment with your Solo 401k plan is as simple as writing a check. As trustee of the Solo 401K plan, you will have total control over your retirement assets to make real estate and other investments without custodian approval.
The only investments that are not allowed are collectables and subchapter S-corporations. Plan is also restricted from conducting any transactions with a "disqualified person" which is defined as account owner and his/her spouse, lineal ascendants/descendants and their spouses and any fiduciary to the plan.
With an IRA, those who earn high incomes are disallowed from contributing to a Roth IRA. The Solo 401k plan contains a built-in Roth sub-account which can be contributed to without any income restrictions. With a Roth Solo 401k sub-account, you can make Roth type contributions while having the ability to make significantly greater contributions than with an IRA.
The awesome benefits of a Roth is that not only investments grow tax-deferred, but the distributions come out tax-free after retirement. Also, keep in mind that since contributions to a Roth have been taxed already - they can come out tax-free and penalty-free before retirement.
Participant Loan Feature
If you have an IRA and ever need to access those funds for personal use before retirement - you will be taxed and penalized on both the state and federal levels. Solo 401k plan on the other hand has participant loan feature, which allows plan participants borrow up to $50,000 or 50% of their account value (whichever is less) for any purpose at a low interest rate of Prime plus 1%. This offers plan participants the ability to access up to $50,000 for use for any purpose, including paying personal debt or funding a business.
Exempt from UDFI
When an IRA buys real estate that is leveraged with mortgage financing, it creates Unrelated Debt Financed Income (“UDFI”) – a type of Unrelated Business Taxable Income (also known as “UBTI”) on which taxes must be paid. The UBTI tax is approximately 37%. Whereas, with a Solo 401k plan, you can use leverage without being subject to the UDFI rules and UBTI tax. This exemption provides significant tax advantages for using a Solo 401k versus an IRA to purchase leveraged real estate.
Pull Multiple Accounts Together
A Solo 401k plan can accept rollovers of funds from another retirement savings vehicles, such as Traditional IRA, SEP IRA, or a previous employer’s 401k, 457 or 403B. Thus, you can directly rollover your IRA or qualified plan funds to your new Solo 401k Plan.
Please note: Roth IRA funds cannot be rolled into a Solo 401k Plan.
Cost Effective and Easy to Administer
Solo 401k plans are easy to operate. There is no annual filing requirement unless 401k plan exceeds $250,000 in assets, in which case you will need to file a short information return with the IRS (Form 5500-EZ). And because there is no Custodian or Third Party Administrator you will also benefit from reduced cost to operate the plan.
Who is Eligible for a Solo 401k?
You should also be aware that not everyone will qualify for a Solo 401k (although most people can). Solo 401k can be established by anyone who has legitimate self-employment activity (part time is OK) and who does not have full time employees working for them. Independent contractor are not considered employees. It can be any type of legal business structure: LLC, corporation, partnership, sole-proprietorship, etc. (yes, you don't need to be incorporated to do it, just sole-proprietorship who files schedule C on his tax return is sufficient). It can be a side business in addition to the full time job you have working for your employer. Here are some examples of legitimate business activity:
- Property Manager
- Network Marketing Business
- IT consultant
- Registered Nurse receiving 1099 income
- Day Trader
- Independent consultant
- Reselling items on ebay
- etc, etc, etc...
Many real estate investors are utilizing self-directed Solo 401k plan to grow their wealth in a tax-deferred environment. It can be a powerful wealth-building tool for you too!