Business Owners — Why the Self-Directed Solo 401k May Be The Choice For You

The answer depends on your situation, your goals, and how you plan to use the assets in your account. In most cases, we find the investor is better off with a Self-Directed Solo 401k than a SEP IRA. This is due to the potential for contributions on the employer side (so –called “profit sharing contributions”) and the tax-free loan feature that you can give yourself (and any employees) when you set up your own 401(k) plan.

The Self-Directed Solo 401k plan may allow you to reach your annual maximum allowable contribution faster than a SEP IRA: As of 2016, plan participants under age 50 are allowed to make a maximum contribution of $18,000. With a Self-Directed Solo 401k, you also have more flexibility in choosing how your assets are taxed: You can set up a ‘Roth option’ within your 401(k) and enjoy tax free growth on any assets you leave in your Roth account for at least five years. (You will still be liable for any 10 percent taxes on early withdrawals that may apply, though).

The combination of employee-side contributions and profit sharing contributions can make a big difference compared to the SEP, which only allows for profit-sharing contributions. No employee-side contributions are allowed.


Imagine Dave, a 55-year-old owner of an S-Corporation has no employees. But working on his own in his professional consulting business, he earns $100,000 in ordinary income, in total self-employment wages. Suppose he knows next year he’s going to earn exactly $100,000 in W-2 income. He wants to choose a retirement plan that will allow him to contribute the maximum allowable amount.

What plan should he select, a 401(k) plan or a SEP?

If he chooses a SEP, he can have his corporation defer a maximum of $25,000 of his income. Unlike with Self-Directed Solo 401k plans, SEPs do not allow for catch-up contributions for those over age 50. So his maximum deferral is limited to 25 percent of his income.

If he chose a solo 401(k), David knows he can contribute $49,000 as a salary deferral, as the employee of his own company. But he can also have his company contribute another 25 percent of his compensation, which would work out to a total contribution, including employee contributions and employer contributions, of $59,000.

Note: If David owned a sole proprietorship or a single-member LLC, he would only be able to have the company defer 20 percent of his compensation instead of 25 percent, because of the effects of self-employment tax.

Furthermore, the Self-Directed Solo 401k also offers him the option of treating some or all of his contributions under Roth tax treatment. The SEP IRA provides no such flexibility.

Furthermore, the SEP does not allow for tax-free loans. The 401(k), should David choose, can loan him up to $50,000 tax free, at any time. He has up to 5 years, typically, to pay his 401(k) back.

So if your W-2 compensation or self-employment income is well below the 200,000 per year mark, the advantage goes to 401(k)s, as far as the owner or highly-compensated employees are concerned, where the objective is to maximize contributions.

The 401(k)’s advantage narrows, however, as income goes up over $200,000 and up.

A Key Advantage For a Self-Directed Solo 401k

Additionally, the Solo 401(k) may be a better match for those who use self-directed strategies and who want to own leveraged real estate (or leveraged anything else, for that matter) in their self-directed 401(k)s. This is because the 401(k) allows David to escape the unrelated debt-financed taxable income that normally applies to other retirement accounts that purchase assets using non-recourse loans. Whereas if he tried to purchase an investment property for a self-directed SEP IRA and borrowed 50 percent of the purchase price using a non-recourse loan, he would have to pay unrelated debt-financed income tax on 50 percent of any income generated by that property, and on 50 percent of any capital gains when the property is sold.

Advantages for SEP IRAs

The SEP IRA allows you to make contributions as late as April 15th of the following year, just like an IRA. So if David has a big bonus coming at the end of the year, he may want the extra time.

SEP IRAs may help you avoid the necessity of making matching contributions for employees who have not yet worked for you in at least three out of the last five years. If you sponsored a 401(k) and brought on employees, you would have to cover them, and provide the same profit sharing benefits to rank and file employees that you do for yourself. Generally, you would need to grant them to any worker who has worked at least 1000 hours and who has been with you for at least 1 year.

Outside of these two advantages, however, the case for the solo 401(k) plan is strong.

American IRA, LLC specializes in providing third-party administration services to people who want to take a more personalized approach to their retirement investing via a self-directed 401(k), SEP, SIMPLE IRA, IRA or Roth IRA. We also support self-directed Coverdell Education Savings Accounts and Health Savings Accounts. Our offices are in Charlotte and Asheville, North Carolina, but we work with successful investors nationwide.

Want to learn more? Call us today at 866-7500-IRA(472), or visit us at

We look forward to serving you.