Self-Directed IRA Versus Solo 401(k)

Many self-directed investors have the option of choosing between a self-directed IRA or a self-directed solo 401k. Both accounts can be self-directed so that you can invest into any investment allowed by law such as real estate, LLCs, precious metals, or private company stock. However, depending on your situation, you may choose one account type over the other. What are the differences? When should you choose one over the other?

We’ve been advising clients for over a decade on self-directed IRAs and solo 401(k)s and what we’ve learned is that there is no universal answer to the question. Instead, you need to learn what is best based on your personal situation and investment objectives. Do you even qualify for a solo(k)? What investments do you plan to make and does one account type make a difference for your investments? The good news is that either way you go, we can help with a self-directed IRA at Directed IRA, where we are a licensed trust company and can serve as custodian of your IRA. Or, we can set-up a solo(k) at KKOS Lawyers using our pre-approved plan documents.

 IRA Solo 401K
Qualification Must be an individual with earned income or funds in a retirement account to rollover. Must be self-employed with no other employees besides the business owner and family/partners.
Contribution Max $6,000 max annual contribution. Additional $1,000 if over 50. $56,000 max annual contribution (it takes $140K of wage/se income to max out). Contributions are employee and employer.
Traditional & Roth You can have a Roth IRA and/or a Traditional IRA. The amount you contribute to each is added together in determining total contributions. A solo 401(k) can have a traditional account and a roth account within the same plan. You can convert traditional sums over to Roth as well.
Cost and Set-Up You will work with a self-directed IRA custodian who will receive the IRA contributions in a SDIRA account. Most of the custodians we work with have an annual fee of $300-$350 a year for a self-directed IRA. You must use an IRS pre-approved document when establishing a solo 401k. This adds additional cost over an IRA. Our fee for a self-directed and self-trusteed solo 401(k) is $995 with atty consultation or $495 for the plan only.
Custodian Requirement An IRA must have a third party custodian involved on the account (e.g. bank. Credit union, trust company) who is the trustee of the IRA. Of course we recommend our company, www.directedira.com. A 401(k) can be self trustee’d, meaning the business owner can be the trustee of the 401(k). This provides for greater control but also greater responsibility.
Investment Details A self-directed IRA is invested through the self directed IRA custodian. A self-directed IRA can be subject to a tax called UDFI/UBIT on income from debt leveraged real estate. A Solo 401(k) is invested by the trustee of the 401(k) which could be the business owner. A solo 401(k) is exempt from UDFI/UBIT on income from debt leveraged real estate.

Keep in mind that the solo 401(k) is only available to self-employed persons while the self-directed IRA is available to everyone who has earned income or who has funds in an existing retirement account that can be rolled over to an IRA.

Conclusion

Based on the differences outlined above, a solo 401(k) is generally a better option for someone who is self-employed and is still trying to maximize contributions as the solo 401(k) has much higher contribution amounts. On the other hand, a self-directed IRA is a better option for someone who has already saved for retirement and who has enough funds in their retirement accounts that can be rolled over and invested via a self-directed IRA as the self-directed IRA is easier to and cheaper to establish.

Another major consideration in deciding between a solo 401(k) and self-directed IRA is whether there will be debt on real estate investments. If there is debt and if the account owner is self-employed, they are much better off choosing a solo 401(k) over an IRA as solo 401(k)s are exempt from UDFI tax on leveraged real estate.

Choosing between a self-directed IRA and a solo 401(k) is a critical decision when you start self-directing your retirement. Make sure you consider all of the differences before you establish your new account.

Stuck With a 401K Loan and Leaving Your Job

Have you taken a loan from your employer 401(k) plan and plan on leaving? Unfortunately, most company plans will require you to repay the loan within 60 days, or they will distribute the amount outstanding on the loan from your 401(k) account. Its one of the ways they try to keep their employees from leaving. “Don’t leave or we’ll distribute your 401(k) loan that you took from your money in your 401(k) account.”

How to Buy Yourself More Time & Avoid the Distribution

The good news is that following the Tax Cuts and Jobs Act (TCJA) you now have the option to re-pay the loan to an IRA to avoid the distribution and you have until your personal tax return deadline of the following year (including extensions) to contribute that re-payment amount to an IRA. By re-paying the amount outstanding on the loan to an IRA, you will avoid taxes and penalties that would otherwise arise from distribution of a participant 401(k) loan.

How It Works In Practice

Let’s say you left employment from your employer in February 2019 and that you had a 401(k) loan that was distributed by your employer’s plan following your termination of employment. You will have until October 15th of 2020 (if you extend your personal return, 6 month extension from April 15th) to make re-payment of the amount that was outstanding on the loan to an IRA. These funds are then treated as a rollover to your IRA from the 401(k) plan and your distribution and 1099-R will be reported on your federal tax return as a rollover and will not be subject to tax and penalty. While it’s not perfect it’s far great time than was previously allowed. Traditionally, you had 30 or 60 days at most to try to make re-payment.

Limitations

The ability to rollover an outstanding 401(k) loan amount to an IRA is only available when you have left an employer (for any reason). It does not apply in instances where you are still employed and have simply failed to re-pay the loan or to make timely payments.