Last Updated on November 13, 2020
IRA Financial’s Adam Bergman Esq. explains your options if you are deciding on self-directing your retirement plan, including the Solo 401(k) for self-employed individuals and the Self-Directed IRA.
There are essentially three self-directed retirement options: Self-Directed IRA, Solo 401(k) and Rollover Business Startup (ROBS). The first thing you need to determine what you want to do with your retirement funds. Next, you need to determine where your income comes from. If you are self-employed or have an owner-only business, generally, your best option is the Solo 401(k). If not, the Self-Directed IRA is the next choice. Finally, if you wish to start your own business, and be involved with it, that’s when you look to ROBS.
The Solo 401(k) Plan
If you are self-employed, the Solo 401(k) is the clear choice for you. There are eligibility requirements to open one. As we just touched on, you must have some sort of self-employed income. This can come from consulting work, gig jobs or from a business. However, you cannot have full-time employees, other than a spouse or business partner, in order to take advantage of the many benefits of the Solo 401(k).
First and foremost, you can contribute much more to a Solo 401(k) than you can an IRA. For 2020, you may contribute up to $57,000 plus an additional $6,500 if you are at least age 50. That’s nearly ten times the amount you can contribute to an IRA annually.
Next, you can borrow money at any time to use however you see fit. A 401(k) loan allows you to withdraw up to $50,000 or 50% of the account balance, whichever is less. You pay the loan back, with interest, directly to the plan. Further, you can make contributions with pretax funds or after-tax or Roth. It all depends when you want to pay your taxes.
One last important benefit of the Solo 401(k) is for real estate investors. 401(k) plans are exempt from the UBTI tax. When investing in real estate, you may need to borrow money (take out a mortgage) to purchase the property. When doing it with a Solo 401(k), you will not be taxed on the amount borrowed. We’ll talk about this more in the Self-Directed IRA section below.
The Self-Directed IRA
Of course, if you do not have self-employment income, you cannot use the Solo 401(k). That’s where the Self-Directed IRA plan comes in. Also, if you have Roth IRA funds you want to use, you cannot roll them into the Solo 401(k). You must use a Self-Directed Roth IRA.
The Self-Directed IRA is all about investing. You make an investment and let it grow in value. It doesn’t matter if it’s real estate, precious metals, Bitcoin or a business. So long as you are not personally benefiting from the IRA investment, it’s all good.
There are a few things you cannot invest in with an IRA – life insurance, most collectibles and something that involves a disqualified person. Hence, this is why you cannot invest in a business that you want to be involved in. Of course, you can be a silent investor with IRA funds and reap the rewards of a good business. If you want to start your own business, you will have to look at the ROBS solution.
If you want to use a Self-Directed IRA, you then have the choice between custodian controlled and checkbook control. Custodian control is more hands-off, comes with more fees, but is a good option for those who don’t need/want complete control. For those who wanted the limited liability protection and the freedom to make an investment whenever they choose, the Checkbook IRA is the way to go. Also good for investments that have ongoing expenses, such as a real estate property.
Lastly, if you invest in real estate, you must be aware of the UBTI rules. When you borrow money to purchase an investment property, the amount borrowed will be subject to tax, which can go as high as 37%. Therefore, any income generated (such as rent) or from the sale of the property, will be subject to the tax based on the amount you borrowed.
Rollover for Business Startups
The best option for starting your own business you want to personally be involved in is ROBS. Although the structure has been scrutinized, it is perfectly legal within the IRS rules. Your business must be a C Corporation (not an LLC). The C Corp adopts a newly formed 401(k) plan, which is funded with your retirement money. The 401(k) buys the stock in the C Corporation. You now have the capital to start or expand your business.
There are other ways to start a business such as a 401(k) loan or from a taxable distribution. However, they are not tax-efficient options. Plus, you can only borrow up to $50,000 from your 401(k), which may not be enough to start your business.
It’s up to You!
You need to determine for yourself what you want to accomplish with your retirement funds.You have choices, so there’s not one right answer for everyone. Your investment goals, income and age are all important factors for deciding on a self-directed retirement plan.
To recap, if you are self-employed, the Solo 401(k) should be at the top of your list, unless you want to start a business for yourself. If you want to make passive investments, such as real estate, but don’t work for yourself, look at the Self-Directed IRA. Lastly, if you want to start your own business, look at ROBS.
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Join us next episode as Mr. Bergman discusses the 401(k) plan rollover rules, when you can perform one and what are your options.