Can You Use Self-Direction in a 401(k)

Self-Directed 401K, Solo 401KThe use of Self-Directed IRAs, is gaining increasing popularity and acceptance with financial advisors, the media and the financial community. However, some individuals may be frustrated with the relatively low contribution limits available with IRAs. Is it possible to take advantage of the powerful concept of a Self-Directed 401(k) plan?

It turns out that yes, you can employ a Self-Directed 401(k) plan. Indeed, there are a number of advantages in doing so. But you do need to control your 401(k) plan. Self-direction is not something you are going to be able to do with an off-the-shelf 401(k) solution from a broker-dealer or mutual fund company. And it’s not an option your employer is likely to make available for you, if you happen to work for someone else.

Solo 401(k)s

Because the owner of the business sponsoring the Traditional 401(k) plan has to approve the concept of self direction, many 401(k) plans we see that allow for self-direction are actually “solo 401(k) plans.” That is, they were designed to work for a self-employed individual, LLCs, corporations, and partnerships.

These plans work well for self-employed individuals, LLCs, corporations, and partnerships because of the low startup costs and relatively high contribution limits. You can contribute up to $17,500 per year as an employee. On top of that, the business can also contribute up to 25 percent of compensation as an employer match. (Self-employed individuals must subtract half of their self-employment tax from total compensation before calculating allowable contributions.

Those participants over 50 may contribute an additional $5,500 in “catch-up” contributions.

Advantages of Self-Directed 401(k)s

  • Relatively high contribution limits compared to IRAs
  • Tax deferral of contributions.
  • Substantial protection from creditors
  • No unrelated debt-financed income tax liability
  • Opportunity for greater diversification into different asset classes
  • Qualifies for tax credit for startup costs for small business retirement plans
  • More control over fees. Mutual funds add a substantial expense ratio to your mutual fund holdings. With self-directed investments, you control the fees.
  • Ability to borrow from 401(k)s

Self-Direction vs. Brokerage Windows

Note that Self-direction and the use of brokerage windows are not quite the same thing. A brokerage window within a 401(k) plan allows you to maintain an account with a securities broker-dealer. That allows you to buy and sell individual securities through your 401(k). So if you want to restrict yourself to trading publicly-traded stocks, bonds, ETFs and closed-end funds, and you want the freedom to make intra-day trades, a brokerage window can service this purpose.

However, there are many, many types of investments that you can make using a self-direction option within a 401(k) that you cannot make with a brokerage window. Your broker/dealer cannot help you buy an individual piece of rental property, for example.

For more information, give us a call at American IRA, at 866-7500-IRA (472). We are an experienced third-party administrator specializing in self-directed retirement accounts. We look forward to working with you!




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