WHAT IS SELF DIRECTED 401 K / SOLO 401 K PLAN

A Self Directed 401k is a qualified retirement plan approved by the IRS.  It follows the same rules and requirements as any other 401k  plan – these rules being established in 1981.  In 2001 the EGTRRA law was passed.  This is commonly referred to as one of the two “Bush Tax Cuts”.  This act made significant changes to the IRS code lowering taxes for qualified plans such as a personal 401k plan.

The participants of the plan have complete flexibility to invest in anything they wish – as long as they are legal.They simply write a check and make their investments – they are not confined or stifled as most people are with their traditional brokerage retirement accounts.

401(k) Eligibility Requirements

In order to be eligible for opening and making contributions to self directed solo/individual 401(k) plans, you need to meet the following 401k eligibility requirements:

• If you’re a business owner, you need to be the sole proprietor and have no employees other than your spouse. If your business is a partnership, it should have no employees other than self-employed partners and their spouses.
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• You have received taxable compensation in the form of a salary or wages as an individual, during the current financial year. Whether your business is incorporated or incorporated, a sole proprietorship, partnership or corporation, the deadline for establishing a self directed 401(k) is the last day of the tax year.

In addition to the 401k eligibility requirements listed above, you should also note that the individual 401(k) should be the only arrangement maintained by your business if it’s not part of a controlled group under federal tax law.

Investments in Self Directed 401(k)

A Solo 401(k) can invest in almost anything. Examples are: Real Estate – residential or commercial – rentals, foreclosures raw land, Tax Liens, Precious Metals, Private Placements, Foreign Currency, Hard Money Lending etc

Prohibited Transactions

Under IRS rules, a Solo 401k is prohibited from certain types of investments or transactions. Some examples are:

Engaging in a Transaction with a Disqualified Person

– Plan participant buys a condo and lets daughter live there
– Plan participant buys part of business owned by his Father

Direct or Indirect Lending of Money

– Plan participant loans money to his wife or son
– Father signs a loan guarantee for the Solo 401k Plan

Receiving Direct or Indirect Benefits of the Plan

– Plan participant buys property and charges a management fee
– Plan participant “fixes” a property himself rather than paying a 3rd non-disqualified party.
– Plan participant receives a commission for selling a property to the Plan.

Corporate Stock

A Solo 401(k) can invest in shares of a C Corp but the rules of an S Corp prohibit a Solo 401(k) from the purchase of shares.

Pros and Cons of a Self Directed 401k

This is a valid question and one we are asked quite often.  The pros of course are the ability to have total checkbook control of your plan and take immediate action when an investment becomes available.  The con would simply be – the client is now the decision maker.  We are pro-active with our clients – encouraging them to contact us about all facets of their new plan.

Self Directed 401K Benefits

1. Any contributions made to these plans, as well as investment returns and earnings, are tax-deferred until withdrawal, and employers receive tax benefits too.
2. You can opt for voluntary elective contributions from your salary, and your employer can also make contributions on your behalf.
3. You are allowed to defer up to $18,000 or all of your earnings annually (whichever is less), with catch-up contribution limits of $6000 once you’re over the age of 50.
4. You retain greater control over investments, and can choose where your funds will be invested from any of the options offered by the plan.
5. These plans are highly portable and you can roll them over if you change jobs, rather than establishing a new plan for every employer.

Self Directed 401K Drawbacks

1. Any withdrawals made from the plan before the age of 59.5 may incur a 10% penalty, except for employees who retire within the calendar year when they turn 55.
2. The company can set eligibility requirements to some extent, and can restrict employees who’ve worked with them less than a year or work part-time, union members, etc.
3. If you don’t have a range of index funds available as part of your plan’s options, the long-term management of the investment portfolio can be problematic.
4. These plans can be expensive to establish and monitor, especially when it comes to administrative costs associated with loans taken against them, early withdrawals, etc.
5. You may not be able to access a very wide range of investment options for your 401(k) funds, and the ones available might be below average in terms of quality.