Still Working into Retirement? Here’s how your Self-Directed Solo 401(K) Works

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Case Study: George and Loretta, a married couple in their late 60s, have a small company they run together in Raleigh. They have plenty of income from pensions and do not expect to need the income from their Self-Directed Solo 401(K) for a long time, if ever. They preferred to let the assets compound until they pass them on to their children and grandchildren. To avoid RMDs, they began rolling over chunks of their Solo 401(K) to an IRA and then converting to a Self-Directed Roth IRA several years ago. They may sell their company to a competitor in their town, or to an interested family member and remain as employees, in order to continue to defer distributions and avoid RMDs.

Most of our Self-Directed IRA clients understand that they need to begin taking required minimum distributions (RMDs) from their Self-Directed IRAs and other tax-advantaged non-Roth retirement accounts by April 1 of the year after the year in which they turn age 70½ and take their next RMDs by December 31st of every year thereafter.

But more Americans are working well into their retirement years, and often because they want to. Advances in medical technology, lifestyle and nutrition have us living much longer than prior generations, and fewer of us are working in physically punishing professions that our ancestors worked, like coal mining, farming and construction.

For those of you working or planning to work well into your retirement years – and beyond age 70½, here’s how your RMDs from Self-Directed IRAs work:

If you have a qualified plan such as a 401(K) from your current employer, you may be able to continue to defer RMDs from that company’s plan. As long as that’s true, you have no required minimum distributions due until you actually separate from the service of that company or roll the assets into an IRA or Self-Directed IRA.

This provision only applies to employer plans like 401(K)s and 403(b)s, but not to IRAs. The IRS also does not allow you to apply this provision to Self-Directed SEP IRAs or Self-Directed SIMPLE IRAs.

So, what, precisely, does “still working” mean? Neither Congress nor the IRS has been entirely clear on this point. In theory, one could claim one is still working at a firm even if he or she is only working a single day out of the year.

But there is a trap here: It is easy for the unwary to say, “A-ha! I can form my own corporation, establish a Self-Directed Solo 401(K), load it up with assets, show up to “work” just an hour every year on New Year’s Day, and avoid taking RMDs indefinitely! I can let my retirement assets compound until the cows come home!”

But the cows would tell you that’s a bad mooooove.

Why? The IRS prohibits plan members still in the work force from deferring RMDs from their company’s plan if they own 5 percent or more of the business.

If you want to avoid RMDs entirely on your Self-Directed Solo 401(K), you have a couple of options:

You can establish a Roth 401(K) and contribute to that instead of a traditional tax-deferred Self-Directed Solo 401(K). But only your contributions are taxed under Roth rules – you still have the same issue with employer contributions, which would still be subject to RMDs.

The other option is to sell your company and continue to work there. As long as you do not retain more than a 5 percent ownership interest in the company, and as long as the plan’s documents allow for a still-working exemption, you can continue to defer taxes on it and you will not be required to take RMDs.

The other option to avoid being forced to take RMDs is to roll your 401(K) assets over to an IRA, and then convert it to a Self-Directed Roth IRA or Roth conventional IRA.

This move does involve a distribution – a large one, normally – which can push you into a higher marginal income tax bracket if you are not careful. You will have to pay income taxes on your Roth conversion. But once that’s done, you can continue to defer taxes on income and capital gains alike until you pull that money out of your Roth IRA or Self-Directed Roth IRA – tax-free.

Of course, to qualify for tax-free treatment, that money has to remain in the Roth for at least five years and have reached age 59 ½.  So be sure to plan ahead and execute the Roth conversion well before you expect to begin to need the money.

Interested in learning more about Self-Directed IRAs?  Contact American IRA, LLC at 866-7500-IRA (472) for a free consultation.  Download our free guides or visit us online at www.AmericanIRA.com.

Self-Directed 401(K) Loans

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Generally, a participant is not permitted to make a withdrawal from an account under an employer-sponsored retirement plan, until that employee experiences a triggering event[1]. A loan is an exception to this requirement, allowing employees to take loans from their account balances under an employer sponsored retirement plan regardless of whether they experience any triggering events.

Loans are available to an employee, only if the employer’s plan includes a feature allowing loans.

Loans may not be made from Self-Directed IRAs. Loans may be made from accounts under employer sponsored retirement plans[2].

A loan is nontaxable, providing it meets statutory requirements, which include limitations on the amount and repayment periods.

This document provides an overview of the rules that apply to these loans.

Self-Directed 401(K) Loan General Loan Requirements

The following are the general requirements that a loan and loan program must meet:

  • Must be made available to all participants and beneficiaries under the plan on a reasonably equivalent basis;
  • Must not be made available to highly compensated employees, officers or shareholders in an amount greater than the amount made available to other employees;
  • Must be made in accordance with specific provisions regarding loans as provided under the plan;
  • Must bear a reasonable rate of interest; and
  • Must be adequately secured.

Self-Directed 401(K) Maximum Loan Amount

The maximum amount that a participant may borrow is the lesser of:

  • 50% of his/her vested account balance, or
  • $50,000

A plan may allow a participant to borrow up to 50%, even if it is more than 50% of that participant’s vested account balance. However, the dollar amount can never exceed $50,000[3].

A plan may allow participants to have multiple loans (per participant) from the plan at the same time. In these cases, the plan administrator must perform a more complex calculation to ensure that the outstanding loan balance does not exceed statutory limit.

Self-Directed 401(K) Repayment Period

Loans must be repaid in substantially equal amounts that include principal and interest, and repayments must be made at least quarterly.

The payment period should not exceed 5-years, unless the loan was taken for the purpose of purchasing the employee’s principal residence.

For loans taken by employees performing military service, repayments may be suspended.

Self-Directed 401(K) Deemed Distributions and Offsets

While loans are generally not treated as distributions, exceptions apply. Under these exceptions, a loan can be treated as a deemed distribution or an offset.  And, whether the amount is eligible to be rolled over depends on whether it’s a deemed distribution or an offset.

Deemed Distribution

A loan that fails to meet the statutory requirements would be ‘in default’. Examples include loans that exceed the statutory limit and the permitted repayment terms.

A loan that is in default is generally treated as ordinary income to the participant, with any pre-tax amount being taxable.

A deemed distribution is not a true distribution, and therefore cannot be rolled over.

The Plan Document should be consulted to determine when a loan becomes a deemed distribution, and how deemed distributions should be handled.

Offset

An offset typically occurs when a participant’s employment is terminated with the employer, and the participant has an outstanding loan balance. If the loan is not repaid, the participant’s account balance can be offset (reduced) for the outstanding loan amount.

An offset is a true distribution, because it occurs as a result of the participant experiencing a triggering event. As such, it can be rolled over (as long as the amount is rollover eligible).

If a plan loan is offset against a participant’s balance, the amount can be rolled over within 60-days. However, if the offset occurs as a result of the participant’s termination of employment or the termination of the plan, the usual 60-day period for completing rollovers is extended to the participant’s tax filing due date, including extensions, for the year in which the offset occurs[4].

Self-Directed Solo 401(K) Plan Administrator Services Required

The administration of loans is a complicated process, and the services of a plan administrator should be engaged to ensure compliance with regulatory requirements as well as to ensure that loans are handled in accordance with the terms of the governing plan document.

Interested in learning more about Self-Directed IRAs?  Contact American IRA, LLC at 866-7500-IRA (472) for a free consultation.  Download our free guides or visit us online at www.AmericanIRA.com.

 

[1] Meeting a requirement to make a withdrawal, such as reaching retirement age or no longer working for the employer

[2] Qualified plan, such as a 401(k) or pension plan, 403(b) and governmental 457(b)

[3] Exceptions can apply. For example, the dollar limit was increased to $100,000 and the percentage limit increased to 100% for plan participants affected by Hurricanes Harvey, Irma, or Maria- from August 23, 2017 (affected by Harvey), September 4, 2017 (affected by Irma), or September 16, 2017 (affected by Maria), through December 31, 2018.

[4] Tax Cuts and Jobs Act (Pub. L. No. 115-97)

Baby Boomer, Gen X Retirement Saving Inadequate, Study Says

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When it comes to retirement saving, the Baby Boomer generation is in trouble.

Despite many of them now entering retirement, the majority of those born between 1946 and 1964 report having less than $250,000 in retirement assets. Only about 1 in 3 Boomers has that much saved up – leading to a retirement income shortfall of between $3,864 and $12,072, according to research from the Insured Retirement Institute.

And things are not looking too great for Gen Xers, either. According to the Insured Retirement Institute’s (IRI) fourth biennial report on Generation X, about 4 in 10 members of this generational cohort do not have money saved for their retirement. Despite an overall improvement in the economy, this represents a deterioration of about 5 percentage points from two years ago.

Of those with retirement savings, about 6 in 10 have saved less than $250,000. On the other hand, the percentage of those who have saved at least $250,000 or more has nearly doubled over the same time frame, rising from 12 percent in early 2016 to 23 percent in 2018.

According to the IRI, about 60 percent of Generation X respondents report being generally confident they will have enough money saved for retirement. Their top three economic concerns are changes in Social Security (66 percent), higher than expected health care expenses (64 percent) in retirement and running out of money (59 percent).

Ultimately, people across the generations need to get serious about putting money away.

Use “Catch-Up Contribution Limits”

The Baby Boomers and the oldest of the Generation Xers can both take advantage of “catch-up contribution” limits, available to those ages 50 and older. Congress anticipated the need for older Americans to sock more money away as they enter their peak earning years and their children have reached adulthood.

For Self-Directed IRAs, individuals age 50 and older can put an additional $1,000 away each year in combined Roth IRA and Traditional IRA contributions – over and above the normal $6,500 annual limit. Some limitations apply for those at higher income levels.

Older Self-Directed 401(k) beneficiaries can also increase salary deferral contributions. As of 2018, those ages 50 and older can contribute an additional $6,000 per year to employer-sponsored Self-Directed 401(k) plans, on top of the generally applicable $18,500 contributions, for a total potential employee contribution of $24,500 per year.

Similar provisions also apply to 403(b) plans, the federal Thrift Savings Plan and many Section 457 deferred compensation plans for public employees. They also apply to Self-Directed 401(k)s and small business Self-Directed 401(k)s.

Those turning 50 and older this year should consider taking full advantage of these more generous tax-advantaged compensation limits.

Working longer

Many Americans will have little choice but to stay in the work force longer and put off retirement. This means more years of earning an income, and more years of potential retirement contributions and compounding within retirement accounts. It also means higher monthly Social Security benefits, if you can put off collecting Social Security until you reach full retirement age.

Staying in the work force also means you do not have to stretch your retirement income over as many years. With today’s advances in health care and nutrition, it has grown commonplace for Americans to live into their late 80s and 90s. Taking income out of your portfolio for 10 years rather than 20 years can make a big difference in the sustainability of your retirement income.

For more information on getting started with Self-Directed IRA investing, call American IRA today at 866-7500-IRA (472).

Is Congress Really Talking About Slashing Contribution Limits to 401ks including the Self-Directed Solo 401k ?

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No. If they were, it would be big news to many of our clients, who went through the trouble of setting up a Self-Directed Solo 401k for their small businesses or consulting ventures. And there’s some talk in the media about Congressional Republicans pushing to slash allowable contribution limits to around $2,400.

The New York Times writes it up here:

House Republicans are considering a plan to sharply reduce the amount of income American workers can save in tax-deferred retirement accounts as part of a broad effort to rewrite the tax code, according to lobbyists, tax consultants and congressional Democrats.

Notably absent from the story: Any language that’s actually in a bill on the House floor. More than that, there’s also the notable absence of a single Republican lawmaker that has ever, ever publicly advocated to reduce allowable 401k contributions to that level.

Moreover, there’s not even a single named source on record saying that this is what the GOP is floating.

It would also put a major dent in the GOP brand, which at least ostensibly seeks to reduce the tax burden on working Americans and businesses.

It seems to us that a bunch of wonks at a planning session were looking at potential ways to offset revenue losses from a planned corporate income tax rate cut, and when they keyed in what they’d have to cap the allowable 401k contribution rate at to recoup the revenue loss, the computer spat out a figure close to $2,400. Nobody wanted to do it, but someone in the room ran to the media “on background,” unwilling to put his own name to the story, and the knuckleheads ran with it.

Our take: It is exceedingly unlikely that the GOP tax reform bill will contain any large reduction in allowable 401k contributions – at least not without a corresponding increase in contribution limits to alternative investment vehicles like IRAs and self-directed IRAs. Messing with 401ks – the primary retirement savings vehicle of the middle class – would be likely to cause an electoral revolt. The Obama administration had to quickly abandon a push to tax Section 529 plans a few years ago, as the Times notes in their article.

There is some legislative risk to those sitting on so-called “jumbo” IRAs, including jumbo self-directed IRAs, with assets above about $5 million. If any tax-advantaged investment account counts as ‘low-hanging fruit’ to revenue-hungry Congressional representatives, it’s those.

Naturally, self-directed IRA owners are over-represented among jumbo IRA account owners, because people that are able to amass $5 million or more in IRAs tend to be successful real estate and venture capital or private equity investors.

At this point, we don’t see any major legislative risks to the Self-Directed Solo 401k structure, though we’ll be keeping an eye on developments as the Republicans in Congress cobble together their expected proposal for tax reform.

Why Independent Contractors Should Consider a Self-Directed Solo 401k

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Independent contractors should take note of the Self-Directed Solo 401k. The 401k is America’s most widely-adopted retirement plan – largely replacing the ever more elusive traditional pension plan as one of the three legs of the American retirement ‘barstool,’ the other two being private savings (including conventional and self-directed IRAs and Roth IRAs) and Social Security. Employers are attracted to the 401k’s high contribution limits and flexibility, as well as its very manageable costs compared to traditional defined benefit pensions, while employees favor the pretax contributions and any employer contributions they may receive.

But the Self-Directed Solo 401k version is rapidly gaining traction as well. This variant of the 401k plan is specifically designed to give independent contractors, freelancers, artists, consultants and very small business owners an incentive and a path toward increased retirement savings and future financial security. If you are a sole proprietor, or an owner-operator of a business with no full-time employees other than yourself and a spouse, the Self-Directed Solo 401k has some tremendous advantages:

Self-Directed Solo 401ks support self-directed investing. With traditional employer-sponsored 401ks, you are limited to those mutual funds, annuities or guaranteed investment contracts (GICs) that your employer chooses for you. But your employer may be focused more on protecting themselves from liability than on choosing the very best funds available for you – and what gives them the expertise to do so? If you are your own plan sponsor, in contrast, you can invest independently of the Wall Street investment firms that market their investment products to employers. You can pick out your own investments, from individual rental real estate properties to oil & gas opportunities to limited partnerships, LLCs, private equity, venture capital, gold and precious metals and just about anything else you can imagine! The only exceptions are life insurance, collectibles, certain forms of precious metals of questionable or inconsistent purity, jewelry and gemstones and alcoholic beverages.

High contribution limits. Participants under age 50 can contribute up to $18,000 in salary deferral to the Self-Directed Solo 401k. But the business can make additional contributions of 20 percent of compensation (for single-member LLCs and sole proprietorships) or 25 percent (for all other businesses) up to a combined maximum of $54,000. That’s nearly ten times higher than the $5,500 limit imposed on IRAs for individuals under age 50. And unlike IRAs, 401ks don’t have an income test for eligibility to make pre-tax contributions.

If you’re over age 50, you can make additional contributions to your solo 401k of an additional $6,000 per year.

Asset Protection. Assets held 401k plans enjoy near-complete protection from creditors in every state. Even the IRS has trouble cracking open a 401k account, since 401k assets aren’t held in the owner’s name directly, but instead are held in trust for the owner’s benefit.

Self-Directed Solo 401k Eligibility

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The Self-Directed Solo 401k is a top-notch retirement vehicle for certain small business owners and self-employed individuals and couples. With maximum combined contributions of up to $54,000 in 2017, the flexibility to establish a Roth account within your 401k plan, the ability to engage in self-directed investment strategies such as direct ownership of real estate, and the ability to borrow against your 401k balance if you choose to structure your plan to allow it, the Solo 401k plan is both versatile and powerful. It also has unmatched power as an asset protection vehicle, nearly impervious to creditors.

But the Self-Directed Solo 401k plan is not for everybody. There are certain criteria that have to be met even to establish a Solo 401k or make contributions. And it’s not always the best answer for growing companies.

Here are the important eligibility criteria for Solo 401k plans, to include Self-Directed Solo 401k plans:

  • You must have self-employment or owner-employee income. That is, you must be able to show income from self-employment, or via your own C corporation, S corporation, partnership, or LLC.
  • You must not have any full-time employees in your company, other than yourself and a spouse.

Unlike IRAs, there are no maximum income thresholds or phase-outs that affect your ability to establish a Solo 401k or Self-Directed Solo 401k. The same goes for Roth solo 401ks and self-directed solo Roth 401ks. You can establish and contribute to a Solo 401k no matter how much money you are earning or project to earn. There are limits to how much you can contribute, of course, but simply earning too much will not make you ineligible for the Solo 401k altogether.

One advantage to Solo 401ks: You will not find your contributions limited because you can’t convince rank and file employees to contribute enough, thereby triggering “top hat” restrictions on highly-compensated employees. As long as you and your spouse are the only full-time employees in the company, you don’t need to worry about these non-discrimination provisions.

Part-timers

You yourself do not have to work full-time in order to enjoy the benefits of participating in a solo 401k. As such, the solo 401k is potentially a great solution for semi-retired persons, as well as those with part-time occupations and practices.

Coordination with other retirement plans.

You can participate fully in your Self-Directed Solo 401k even if you already have an IRA, or you participate in another retirement plan at another workplace. However, eligibility for IRA contributions could be affected if you do have access to a solo 401k plan. Call us at American IRA, LLC if you have questions: 866-7500-IRA(472).

Employees.

Generally, to maintain eligibility for a solo 401k plan, you can’t have any full-time employees in your business other than yourself and your spouse. However, you can have other employees. Current law exempts employees under age 21, employees who work fewer than 1,000 hours, and non-resident aliens. You can also exempt union employees, who are generally provided for under their collective bargaining agreement.

Solo 401k plan sponsors can also have all the part-time employees and independent contractors they want without affecting solo 401k eligibility.

Self-Directed 401k – Using Loans To Make Investments

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One of the most powerful features of the Self-Directed Solo 401k plan is the ability of plan sponsors to structure their plans to allow for loans against the 401(k) balance. This feature is a popular one, as small business owners are keenly aware of the problem of temporary cash crunches disrupting business activity.

However, owners of Self-Directed Solo 401k or conventional Self-Directed 401k plans should use caution before committing loan funds to investments in certain circumstances. This is because it’s very easy for Self-Directed Solo 401k owners to run afoul of prohibited transaction rules when they use 401(k) loan proceeds to make investments.

Here’s why:

Under Internal Revenue Code Section 4975, disqualified persons (that’s you, the owner, along with your spouse, children, grandchildren, parents and grandparents and those of your spouse) cannot personally guarantee loans made from within your solo 401(k) plan. Any loan that you or any prohibited person must personally sign to guarantee, or for which you or any other prohibited person must put up collateral other than the purchased investment for inside the 401(k) is likely going to break the rule. Any participant in the 401(k) plan is likely considered a disqualified person under IRC 4975.

You can borrow money against your 401(k) for any purpose, but you cannot then pour those proceeds back into a 401(k) investment if you are personally guaranteeing the debt. All mortgages on property held within a solo 401(k) account (or any other tax-advantaged retirement plan, for that matter) must be taken on a non-recourse basis. The lender must have no option to go after you or anyone else in the event of a debt default, other than to foreclose on the property within the 401(k).

So when does it make sense to take out a loan from a 401(k)? It can be a good strategy if you simply need access to cash to bridge a short-term liquidity need – one you expect to be able to pay off in a year or so. One good example: Purchasing a car or truck for business use for a corporation, LLC or partnership – especially one that sponsors your Solo 401(k) plan. Many real estate investors we know who own solo 401(k)s occasionally use loans against their Solo 401(k)s to pay for contractors to get an apartment or house ready to rent – and then aggressively pay back the 401(k) loan with the rent proceeds. If it weren’t for the 401(k) loan option, in some cases they wouldn’t have the cash they needed to turn the rental around immediately, and the home would go unoccupied and idle for that much longer. A 401(k) loan may enable them to get a tenant in the property much sooner – and that would be worth any interest on the 401(k) loan many times over.

Note: Anyone who uses 401(k) loans should be aware that while the original contributions were pre-tax, they must repay the loan with after-tax dollars.

Rolling Over A Former Employer’s 401k? Consider A Self-directed Solo 401k

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Have a 401k from a former employer you need to either cash out or move to another plan soon? Consider your options carefully. The knee-jerk recommendation from many advisors is to roll over a 401k into an IRA or Roth IRA because of the access to a much wider array of mutual funds, stocks, bonds or other securities. But in some circumstances, this isn’t the best advice – especially for investors interested in Self-Directed Solo 401k strategies.

For example here are some questions to consider when thinking about a Self-Directed Solo 401k,

Will you want to begin withdrawing the money early? If you’ve left the work force, the 401k allows you to begin withdrawing your money earlier than the IRA – without the need to pay a 10 percent excise tax for early withdrawals. IRAs impose the 10 percent penalty on withdrawals before you turn age 59½. A 401k allows you, in certain circumstances, to begin taking money out penalty free beginning at age 55.

Asset Protection Issues

IRAs enjoy substantial creditor protection, especially if the IRA is not an inherited asset but was funded using the owner’s own earnings, or the earnings of a spouse, via a spousal IRA. But the IRS can still levy an IRA account, including, potentially, self-directed IRAs, in order to satisfy a tax debt.

But 401k plans are different. Assets in a 401k are not held in your name personally, but in a trust on your behalf. This means that they cannot be seized in the event of a bankruptcy or judgment against you. Even the IRA cannot directly levy a 401k account because of a personal debt. The best the IRS – or any other creditor – can do with assets in a 401k is obtain a charging order – authorizing them to intercept income from the 401k when you take money out of the account, similar to a wage garnishment. But you can control when you take a distribution.

Few creditors want to wait years or decades for their money, and fewer still plaintiff lawyers want to wait that long to get paid. This is enough to dissuade many creditors or plaintiff’s attorneys, or to convince them to settle a case early on a basis favorable to you.

Tax Benefits of Real Estate 401k’s

If you are self-employed, or the owner-employee of your own company, and you are interested in owning real estate, it may make sense to roll your old 401k assets into a new Self-Directed Solo 401k you establish for your business. The Self-Directed Solo-401k may be an excellent match for businesses with just one full-time employer, or businesses owned and operated by married couples: In addition to the asset protection benefits, 401k’s are not generally subject to unrelated business income tax. This means your Self-Directed Solo 401k plan can borrow money to invest in real estate (on a non-recourse basis) without generating a tax liability on capital gains or income received from the 401k.

Real estate held in a Self-Directed Solo 401k is considered ‘passive income’ by the IRS, and therefore exempt from UBIT.

Otherwise, if you simply rolled your old 401k into an IRA and tried to pursue leveraged real estate strategies, you could be forced to pay income tax and capital gains tax on any amounts attributable to the leverage, rather than on your own money.

If you are interested in real estate ownership within your 401k, IRA or any other retirement vehicle, or you simply want to go over your options for rolling over a 401k from a prior employer, call American IRA, LLC today at 866-7500-IRA(472).

Alternatively, you can visit our website at www.americanira.com, and download hundreds of timely, informative articles, guides, blog posts and e-books about the advantages of self-directed investing.

We look forward to hearing from you.

 

 

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

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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.

Example

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 www.americanira.com.

We look forward to serving you.

Save More For Retirement With a Self-Directed Solo 401k

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Most people would love to set aside more money for retirement. But tax-deductible IRA contributions are limited to $5,500 per month for most of us, at best. Fortunately, those who own their own small businesses, are independent contractors or otherwise have self-employment income have another option that allows for much higher contributions:  the Self-Directed Solo 401k, sometimes called one-participant 401(k) or individual 401(k) plans.

If you qualify, setting up your own self-directed solo-401(k) allows you to effectively double-down on your allowable retirement contributions, sheltering much more money from taxes than you can relying on IRAs alone. Here’s how it works:

Self-Directed Solo 401k Contribution Limits

The Self-Directed Solo 401k allows you to contribute money on two levels: You can make elective salary deferrals as your own employee. For 2016, that limit is $18,000, or over three times what you could contribute using an IRA by itself for any given tax year. If you are age 50 or over, you can contribute an additional $6,000 in catch-up contributions. But there’s much more:

Employer contributions in Self-Directed Solo 401k plans

When you establish a Self-Directed Solo 401k plan, you are your own employer as well as plan employee – the plan sponsor as well as the plan participant. This allows you to ‘match’ your own employee contributions to the plan as you see fit, up to certain limits:

You can make employer contributions of up to 25 percent of total compensation as defined by the plan – up to a compensation cap of $265,000. If you are self-employed, however, as opposed to the owner/employee of your own corporation, you must make a special calculation to account for your contributions to the plan plus one-half of your self-employment tax. You may then generally contribute up to 25 percent of what is left over in an employer contribution.

The Self-Directed Solo 401k Plan Secret Sauce

Because of the way contribution limits are calculated, solo 401(k) plans offer a nice perk for certain higher-earning plan sponsor/participants: Anything you contribute to the plan as an elective deferral not counted as compensation. Which increases the amount of money eligible for the 25 percent employer’s non-elective contribution.

The Self-Direction Advantage

Self-direction also increases your purchasing power, because your solo 401(k) can actually borrow money to make leveraged investments. Yes, this increases risk, but it also magnifies potential returns. It is quite common for self-direct solo 401(k) sponsor/participants to have their 401(k)s borrow money with which to make investments – especially in real estate.

401(k) plans have the additional advantage of substantial creditor protection – going even beyond the generous limits for IRAs established by federal law. Even the IRS can’t levy assets in a 401(k) to satisfy personal debts, since 401(k) assets are typically held in trust for the beneficiary, rather than considered personal assets.

Solo 401(k)s can also be structured to allow for personal loans to yourself from your 401(k) for any reason. Ask us about this particular feature of our Self-Directed Solo 401ks.

Diversification

Using a self-directed 401(k), rather than a standard Wall Street prepackaged product allows much more diversification than is usually possible for most plan sponsors. You are not limited to a window of stocks, bonds and mutual funds.  you can bring your retirement assets to bear on any number of investment strategies and asset classes:

  • Direct ownership of rental properties
  • Oil gas and pipeline investments
  • Tax liens and certificates
  • Raw land
  • Foreign real estate
  • Closely-held C corporations, partnerships and LLCs
  • Farms and ranches
  • Precious metals
  • Venture capital
  • Private equity
  • Private lending and hard money lending
  • Mortgage lending

And much more!

Caveat: The solo 401k is not a great match for you if you have any employees besides yourself and a spouse, or if you want to hire employees very soon. However, you can get many of the same benefits using a SEP IRA.

American IRA, LLC works with many successful Self-Directed Solo 401k sponsors who are even now pursuing many different successful investment strategies. For more information, give us a call at 866-7500-IRA(472). Or visit us online for a wealth of informative informational articles, brochures and other literature at www.americanira.com.