5 Pros and 5 Cons of a Self-Directed 401(k)

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Today, many Americans rely on the 401(k) plans set up by their employer as a means of saving for their eventual retirement. A 401(k) plan allows you to use your pre-tax dollars to invest in mutual funds, as well stocks, bonds, and Target Date funds. Most likely, a firm contracted by your employer manages your 401(k) plan. Often, the funds in these 401(k) accounts are automatically invested per your employer or managing firm’s direction. However, did you know there was a way to have more control and be more involved with your 401(k) investments? A self-directed 401(k) offers you more control, flexibility, and investment diversity. Before opening one of these specialized types of 401(k) plans, take a look at the pros and cons below.

The Pros

  • As with your employer’s 401(k) plan, contributions, investment returns and any earning are all tax-deferred. Your employer continues to receive the same benefits as they would through their selected 401(k) plan as well.
  • You are still in control of your voluntary contribution. This means that you are still able to use your pre-tax dollars to invest in your self-directed 401(k) plan and benefit from the income tax benefits associated with your reduced post-tax wages. If your employer matches or contributes a percentage to your standard 401(k) plan, they can continue to do so with your self-directed 401(k) as well.
  • For your 2018 taxes, you will be able to defer taxes on up to $18,500 on your annual earnings. (This is a $500 increase from your 2017 taxes!) After the age of 50, you can make catch-up contributions up to $6,000.
  • One of the biggest benefits of a self-directed 401(k) plan is the personal control you have over your investments and the types of things you can invest in. Like a self-directed IRA, you can invest in almost anything. This includes real estate, precious metals, and private placements. (Your employer’s 401(k) does not permit these types of investments and thus limits your portfolio’s diversity.)
  • When you change employers, your previous 401(k) will need to be closed and new accounts, as selected by your new company, will be opened. With a self-directed 401(k), however, this is not so. You can roll these accounts to your new employer instead of having to establish a new one.

The Cons

  • As with your employer’s 401(k) plan, any withdrawals from your self-directed 401(k) before the age of 59 ½ will suffer a 10% tax penalty.
  • Just like the 401(k) plan established by your employer, contributions made by your employer to a self-directed 401(k) may be subject to eligibility requirements. For example, some employers only partially match your contributions for the first year of your employment. Others may only match contributions for full-time employees. These eligibility requirements are dictated primarily by your employer and not your 401(k) plan itself.
  • You need to have an optional range of index funds in order to have the best long-term investment portfolio.
  • Self-directed 401(k) plans can be more expensive to open and manage.
  • Investment options for your self-directed 401(k) may be limited in both scope and quality. Be vigilant with your investments and do your research.

Royal Legal Solutions Can Help You

Royal Legal Solutions has many years of experience with Solo 401(k) plans. As a firm that specializes in accounts that give the owner more options, flexibility, and control–we understand how important your investment choices are for your future finances.


Last Updated: 
April 7, 2018

Scott Royal Smith is an asset protection attorney and long-time real estate investor. He's on a mission to help fellow investors free their time, protect their assets, and create lasting wealth.

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