Self-Directed IRA Versus Solo 401k

SD-Retirement-TipMany 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?

 IRASolo 401K
QualificationMust 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$5,500 max annual contribution. Additional $1,000 if over 50.$53,000 max annual contribution (it takes $140K of wage/se income to max out). Contributions are employee and employer.
Traditional & RothYou 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-UpYou 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 preapproved 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 $1,200.
Custodian RequirementAn 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.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 DetailsA 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.

Based on the differences outlined above, a solo 401(k) is generally a better option for someone who is self-employed and 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.