Solo 401k Vs Self-Directed IRA: Which is Better for You?

The choice between a solo 401k and a self-directed IRA LLC really depends on you—there is no one-size-fits-all solution. However, as we will see, a solo 401k is usually the best option for self-employed people.

What is a Self-Directed IRA?

A self-directed individual retirement account (SDIRA) is a type of individual retirement account (IRA) that can hold alternative investments normally prohibited from regular IRAs. The account is administered by a custodian or trustee, but managed by the account holder. This is why it's called "self-directed."

The benefits of the self-directed IRA include having the ability to use your retirement funds to make almost any type of investment (including real estate).

What is a Solo 401k?

A solo 401k is an IRS-approved retirement plan, which is suited for business owners who do not have any employees other than themselves and perhaps their spouse. The solo 401k is not a new type of plan. It is a traditional 401k plan covering only one employee. It lets you contribute up to $60,000 each year.

9 Reasons Why A Solo 401k Is Better for Self-Employed People

There are a number of options that are specific to solo 401k plans that make the Solo 401k plan a far more attractive retirement option for a self employed individual than a Traditional IRA.
Here are nine of the best reasons we've found.

  1. Reach your Max Contribution Amount Quicker.

A solo 401k includes both an employee and profit sharing contribution option. Compare this to a traditional IRA, which has a low annual contribution limit.

Under the 2017 solo 401k contribution rules, if you're under the age of 50, you can make a maximum employee deferral contribution in the amount of $18,000. On the profit sharing side, your 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 your employee deferral, of $54,000.

If you're over the age of 50, you can make a maximum employee deferral contribution in the amount of $24,000. Up to a combined maximum of $60,000.

  1. Roth Feature Options.

A solo 401k plan contribution can be made in pre-tax or Roth (after-tax) format.  Whereas, in the case of a  Self Directed IRA, contributions can only be made in pre-tax format.

  1. Tax-Free Loan Options.

With a Solo 401K Plan you can borrow up to $50,000 or 50% of your account value in the form of a loan for any purpose. With a Traditional Self-Directed IRA, you can't even borrow $1 dollar from the IRA without triggering a prohibited transaction.

  1. You Can Use Non-recourse Leverage & Pay No Tax.

With a solo 401k, you can make a real estate investment using non-recourse funds without triggering the Unrelated Debt Financed Income Rules and the Unrelated Business Taxable Income (UBTI or UBIT) tax.
However, the non-recourse leverage exception is only applicable to 401k qualified retirement plans and does not apply to IRAs. In other words, using a Self-Directed IRA to make a real estate investment involving non-recourse financing would trigger the UBTI tax.

  1. Open the Account at Any Local Bank.

With a Solo 401k Plan, the 401k bank account can be opened at any local bank or trust company. However, in the case of a Traditional Self Directed IRA, a special IRA custodian is required to hold the IRA funds.

  1. No Need for the Cost of an LLC.

With a solo 401k plan, the plan itself can make real estate and other investments without the need for an LLC, which depending on the state of formation can be expensive.
Since a 401k plan is a trust, you can be the trustee on behalf of the trust and can take title to a real estate asset without the need for an LLC.

  1. Better Creditor Protection.

A Solo 401k Plan offers you greater creditor protection than a Traditional IRA. The 2005 Bankruptcy Act protects all 401k Plan assets from creditor attack in a bankruptcy proceeding.
Note: Most states also offer greater creditor protection to a Solo 401k than a Self-Directed IRA outside of bankruptcy.

  1. Easy Administration.

With a Solo 401k Plan there is no paperwork required if your plan has less than $250,000 in plan assets.
Note: In the case of a Solo 401k Plan with greater than $250,000, a simple 2 page IRS Form 5500-EZ is required to be filed. Royal Legal Solutions can help you with that.

  1. Flexible Structure.

Royal Legal Solutions' Solo 401k Plan is a flexible, self-directed plan that will allow you to make traditional as well as non-traditional investments, such as real estate, by simply writing a check.

Bottom Line: Most Self-Employed People Benefit from the Solo 401k

The solo 401k plan was designed with owner-operated businesses in mind. If you're self employed, there aren't too many other plans out there that offer more benefits than the solo 401k. Of course, this is a generalized statement and your unique circumstances may be different.

We recognize that not all self-employed people are the same. That's why we recommend talking over your retirement plans with a professional. You may also be interested to read Solo 401k Vs. SIMPLE IRA: Which is Better for You?

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.

Learn How To Achieve Total Asset Protection In This FREE 5-Part Series

Ready to know more than your attorney? You'll get over two hours of instruction combined with five ebooks to teach you how to best structure your real estate investments.

ACCESS THE ROYAL ACADEMY VAULT

SIGN UP FOR OUR EMAILS

Join thousands of real estate investors in all 50 states as they enjoy exclusive content, special promotions, and behind-the-scenes access to me and my guests. No spam, ever. Just great stuff!

SUBSCRIBE

FREE GROUP MENTORING

COMMUNITY NETWORKING

POSTS BY CATEGORY

Do you have asset protection questions? We can help!

GET A PRICE


© 2022 - Royal Legal Solutions