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Solo 401k vs Self-Directed IRA

Why the Solo 401k always wins

It can be difficult to know which type of retirement account is best for your financial needs. There is a long list of options, including IRAs, Self-Directed IRAs, SEP IRAs, Simple IRAs, and Solo 401ks.

However, if you want to invest retirement funds into alternative assets – such as real estate, private businesses, or essentially anything not listed on a stock exchange – there are only two options: the self-directed IRA and the self-directed Solo 401k.


Simply put: the self-directed Solo 401k is always a better option if you qualify. The Solo 401k is less expensive, has higher contribution limits, allows for loans, and has significant tax advantages.


But before we get into why the Solo 401k is a superior account, let’s talk a bit about how a Solo 401k and self-directed IRA are similar.

Solo 401k and Self-directed IRA: Similarities


To gain a clearer picture of the differences between the Solo 401k and self-directed IRA, it’s important to first understand how they’re similar.


Here’s a quick-list of similarities between the Solo 401k and self-directed IRA. These are important to take note of because they can help you better understand how the two accounts work in general:

Solo 401k and self-directed IRA similarities:

  • Contributions and taxes: You can make pre-tax and Roth (after tax) contributions to both accounts. In both cases, contributions are tax deductible, gains grow tax-free, and distributions are subject to federal taxes.
  • Roth contributions: Both allow for Roth (or after tax) contributions. Roth contributions to both accounts aren’t tax deductible but the gains still grow tax-free and there are no taxes due when you withdraw money at retirement age.
  • Alternative investments: Both offer various alternative investments such as real estate, precious metals, ETFs, and more.
  • Protection: Both accounts offer invaluable protection from creditors.
  • Checkbook control: Both allow for checkbook control (access to checkbook control differs, though, which we’ll talk about later).

When taking into account the above similarities, a traditional self-directed IRA and Solo 401k can seem quite similar. However, upon closer inspection, the details tell a much different story.


Let’s dig into 6 key features to see just why the Solo 401k is a superior retirement plan:

Feature 1: Checkbook control


What is checkbook control and why is it important?
Checkbook control is a feature that allows the beneficiary of the retirement account (you) to complete investments without requiring the involvement of a 3rd party custodian to process the paperwork. I.e., with checkbook control you can literally write and sign checks or other investment instructions yourself.

Self-Directed IRAs and (the lack) of Checkbook Control


Unfortunately, self-directed IRAs do not offer checkbook control so a 3rd party custodian must execute all activities related to your investment. In other words, with a self-directed IRA you will have to call, fax, or email the IRA custodian to perform transactions related to your investment for every single transaction.


There two main downsides to the lack of checkbook control with a self-directed IRA:

  • Self-directed IRA custodians charge expensive fees for their involvement
  • Self-directed IRA custodians are slow at executing your instructions

First, self-directed IRA custodians charge significant fees for executing transactions on your behalf. Depending on the custodian, these fees will either be a flat percentage of the asset’s value, or in many cases, an opaque mix of per-activity fees. In either case, these fees are charged year after year for as long as you own the asset.


In addition, if use a self-directed IRA custodian to purchase an asset, you are legally required to use them for all future transactions related to the investment.


For example, if you make a real estate investment through your self-directed IRA, every time you need to pay an expense on the property, even something as simple as mowing the grass, you will have to pay a custodian to issue the payment. This same process would have to then be repeated for every bit of maintenance, every expense, and every bill related to the asset.


Obviously, whenever possible one should avoid unnecessary fees when investing so as to maximize returns.


Second, regarding execution speed, the number one consumer complaint with self-directed IRA companies is the slow speed with which they execute investment instructions. These delays are frustrating at best, and at worst, they will altogether prevent you from making investments that require swift execution of transactions, such as real estate and tax liens.


In addition, when an investment requires ongoing maintenance, such as real estate, you will be dependent on the IRA custodian to relay your instructions before work can begin.


A Solo 401(k) with Checkbook Control


In contrast, with a true self-directed Solo 401(k) plan, such as the one offered by Maverick, you are the custodian of your account. As a result, you do have checkbook control.


This checkbook control gives you the following benefits:

  • No transaction fees
  • No annual Assets Under Management (AUM) fees
  • No unnecessary delays in your investment workflow

As a result, a self-directed Solo 401(k) is always the better option if one qualifies.


Please note: as a rule, Solo 401(k) plans offered by large financial institutions, such as Fidelity or Capital One, do not include checkbook control. But the Maverick Solo 401(k) is a truly self-directed Solo 401(k) in that it includes checkbook control at no extra cost and we do not limit your investment choices in any way.

Feature 2: Loans


One of the most useful and significant differences between the Solo 401k and self-directed IRA is that with a Solo 401k you can take out a personal loan. There’s no competition here because loans are prohibited from IRA, self-directed and otherwise.  


This is especially useful considering the fact that the Solo 401k was designed for small business owners and the self-employed. This makes a Solo 401k a highly useful and flexible retirement vehicle, allowing for the ability to take out a loan when the business is in need of extra capital or simply during a personal emergency.


Important note: Keep in mind that not all Solo 401k plans are made equal. Specifically, Solo 401k plans offered by large financial institutions such as Fidelity typically do not allow loans. The reason is that that they make their money by charging a percentage on the amount of money in your account  so they make it difficult or impossible to take a loan. However, a Maverick Solo 401k lets you take loans.


Important Solo 401k loan details:

  • Amount: Participants taking out a Solo 401k loan can borrow up to $50,000 or 50 percent of the account value, whichever is less.
  • Loan use: The loan can be used for any purpose including bills, emergencies, mortgage payments, even purchasing a primary new home (as long as it’s your primary residence), and virtually anything else.
  • Repayment: A Solo 401k loan can be paid back over a five-year window with interest as low as at the prime rate. Additionally, payments are only required once every quarter, so the length and space between payments offer flexibility.

Additionally, if you take out a Solo 401k loan for the purpose of purchasing a primary residence, the loan can be extended provided you obtain a sworn statement certifying you’re using the loan to purchase a primary residence.

Feature 3: Contribution limit (and options)


The difference in contribution limits and options between the Solo 401k and self-directed IRA is big (and even that may be an understatement). Let’s start with contribution limits:

  • Solo 401k: As of 2017, the Solo 401k allows contributions up to $54,000 and up to $60,000 if the participant is over 50 (depending on self-employment income, which we’ll talk about in a bit).
  • Self-directed IRA: Allows contribution limit of $5,500.


For small business owners and solo entrepreneurs looking for a powerful retirement vehicle that can take them to financial freedom, the Solo 401k offers a high contribution limit and additional features that make it very attractive.


While a self-directed IRA only allows a low annual contribution, a Solo 401k plan allows you to participate in both employee and profit-sharing contribution options, giving you more flexibility in how you contribute to your retirement plan:


Employee deferral contributions: As of 2017, contribution rules state that participants under 50 can make employee deferral contributions in the amount of $18,000. And, as mentioned earlier, those contributions can be made pre-tax or after tax contributions further adding to the flexibility of the plan.


Profit-sharing contributions: In addition, you as a self-employed person can make a 25% (profit sharing) contribution (the percentage being based on your income). This amount is combined with any employee deferral contributions made and can go up to the maximum of $54,000 (or $60,000 is over 50) in total.


Example: As an example, let’s take John and Jane, who are both 35 years old. John has a self-directed IRA through a financial institution while Jane has a Maverick Solo 401k. In 2017, Jane earned $100,000 in self-employment income (W2), so she was able to contribute $18,000 as an employee deferral contribution as well as $25,000 through profit sharing (25% of her $100,000 income) for a total of $43,000 for 2017. In contrast, John could only contribute $5,500 into his self-directed IRA for 2017.

Feature 4: Fewer taxes when investing in real estate


While it is possible to invest in real estate with either a self-directed Solo 401k or a self-directed IRA, if one needs to borrow money to complete the transaction, the Solo 401k is always the better choice.


The reason is that IRA transactions that use leverage (debt) trigger a special tax called the Unrelated Business Income Tax (UBIT). And the UBIT tax is a heavy tax.


To give a real world example, let’s say you wanted to invest in a $400,000 property using non-recourse financing with a self-directed IRA. If you were using $200,000 from your IRA and a mortgage for the second $200,000, the $200,000 which was loaned to your IRA would be subject to the UBIT tax. At a 40% tax rate as of 2017 (the UBIT tax rate) that would be a significant $80,000 that your self-directed IRA would need to pay in taxes.  


In contrast, debt-financed transactions from a Solo 401k are not subject to UBIT and as a result you can potentially save thousands of dollars in taxes.


For example, if we duplicated the example $400,000 property investment using a Solo 401k instead of a self-directed IRA, that’s $80,000 in tax savings. The impressiveness of this tax savings is magnified when you consider how much more money you can add to your nest-egg if you prudently re-invest that $80,000.


Once again, the Solo 401k is obviously the better choice.

(Note: you may also see this tax referred to as UDFI or Unrelated Debt-Financed Income. The occurrence of UDFI is what triggers UBIT. See this article for more details on UBTI.)

Feature 5: Protection of your assets


Credit protection involves the protection of all 401k retirement account assets from creditor attacks in the case of bankruptcy.


The 2005 Bankruptcy Act states that creditors may not seek to obtain repayment for debts owed by debtors from 401k assets, a valuable benefit which therefore extends to owners of all Solo 401k plans.


In addition, many states offer additional protection for Solo 401k assets beyond just bankruptcy. In general, the Solo 401k offers more creditor protection than a self-directed IRA.


This is an obviously situational benefit, but one which can serve as invaluable, so it’s nice to have this added layer of protection in place just in case.


In addition, when you invest in real estate using a Solo 401k, if you need to borrow money you can do so via a non-recourse loan.


This offers additional asset protect as with a non-recourse loan the lender can not go after the plan owner or other retirement assets to repay the loan. If the loan defaults, or foreclosure occurs on the property, the lender is only allowed to go after the property itself to repay the debt.

Feature 6: The Option to Invest in Life Insurance

In addition to all of the above advantages, the Solo 401k has one more advantage when it comes to investment options. Solo 401ks are allowed to invest in life insurance but it is illegal for IRAs to invest in life insurance.


When would one want to invest in life insurance via a 401k?

Here are a few common situations:

  • You do not otherwise have the funds to purchase life insurance
  • You want to add further protection for your beneficiaries
  • Or you may not otherwise qualify for life insurance due to health reasons


Perhaps none of these situations apply to you now. But as always, it’s better to have a feature and not need it than to need a feature and not have it.

Get the Best Vehicle for Retirement Investing


From easier account setup and maintenance to better account security, loans, higher contributions, and more the Solo 401k is a superior retirement vehicle in every way when compared to a traditional self-directed IRA.


If you’re a small business owner, solo entrepreneur, or have another form of self-employment income and are interested in seeing if you qualify for a Maverick Solo 401k, contact us here or call us at (844) 486-4015.

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