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?

Last Updated: 
October 24, 2017

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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